The Hindu Business Line : `Govt must rescind order treating pref shares as debt'

Markets - Foreign Institutional Investors
Corporate - Preferential Allotments
Government - Policy
`Govt must rescind order treating pref shares as debt'

D. Murali
C. Ramesh

Chennai May 11 The Finance Ministry recently issued a press note specifying that redeemable preference shares issued to foreign investors on or after May 1, 2007 would be regarded as external commercial borrowing (ECB), with the exception of those that are compulsorily convertible.

This move renders preference shares a meaningless instrument, according to Mr Vivek Mehra, Executive Director of PricewaterhouseCoopers.

Speaking to Business Line on the implications, he said that the decision has taken investors completely by surprise and thrown into disarray the plans of several foreign investors.

"We have had several enquiries from investors and are at a loss to explain the rationale behind this policy change."

He added: "Going through various statutes and looking at the issue rationally, one can only conclude that the Ministry has not thought out the issue before issuing the note."

Mr Mehra said that preference shares are a low-risk capital, but capital nonetheless.

"Preference shares have a risk profile nearly identical to that of equity. It is, therefore, difficult to understand how the Ministry arrived at this decision."

According to him, there is no reason anymore for any investor to subscribe to redeemable preference shares because they would need to comply with all the restrictions of an ECB, while at the same time, due to the Companies Act provisions coming into play, redemption of capital and payment of coupon would be subject to profit availability.

Under the Indian company law, all preference shares, whether redeemable or convertible, are treated as equity. "The `preference' part is derived from the fact that the holder is entitled to payment of fixed dividends." Also, the holder is accorded priority on the payment of dividends and on liquidation of the company capital over that of ordinary shares. However, dividends can only be paid from profits for all classes of equity, including preference shares.

Mr Mehra pointed out that interest payments are a contractual obligation and not linked to profit.

"Redeemable preference shares can be redeemed only when the company is financially capable of doing so. Whereas, in the case of bankruptcy, issuers of debt or ECBs are ahead of holders of preference shares."

He also said that there have been several decisions where Indian and UK courts have "very clearly held that a preference shareholder is not akin to a debt holder and cannot have rights of a debt holder."

Mr Mehra said that it is unfortunate that the legal system and judicial precedents would deprive the preference shareholder of any rights of debt issuer, while for the purposes of the policy it would be subject to all the restrictions of debt.

On the country's need for huge investment requirements, he said that they cannot be met by domestic capital alone. "At a time when the Government should be encouraging foreign investment, the Ministry, in one stroke, has effectively blocked this investment channel and created unnecessary insecurity among foreign investors."

Mr Mehra said that the decision has sent out negative signals to the international investing community, "which now thinks India has unstable policies."

It is very difficult for an investor to commit large funds in an unstable and unpredictable policy regime, he added.

"We can only hope that the Ministry reconsiders its decision and withdraws the press note."

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