Kinds of Share Capital and the Nature of a Share

Equity share capital, and shares with differential rights

Explanation (i) defines it residually: all share capital which is not preference share capital. So you identify preference capital first and everything left is equity.

Clause (a)(ii) is MU's separate label, "Equity Shares with Differential Voting Rights". Equity shares may carry differential rights as to dividend, voting or otherwise, in accordance with such rules as may be prescribed.

Three points to make about them. The differential may be as to dividend, as to voting, or otherwise, so the category is wider than the popular name suggests. The conditions are in the rules, not in the section, so a company cannot simply invent a class. And the commercial reason for them is control: a founder can raise equity capital without surrendering proportionate control, by issuing shares with lower voting rights, or can attract income investors with shares carrying a higher dividend and fewer votes.

Preference share capital

Explanation (ii) defines it as that part of the issued share capital which carries or would carry a preferential right with respect to:

• (a) payment of dividend, either as a fixed amount or an amount calculated at a fixed rate, which may be free of or subject to income tax; and
• (b) repayment, in the case of a winding up or repayment of capital, of the amount of the share capital paid-up or deemed to have been paid-up, whether or not there is a preferential right to payment of any fixed premium or premium on any fixed scale specified in the memorandum or articles.

Explanation (iii): participating preference shares are still preference shares. Capital shall be deemed to be preference capital notwithstanding that it is entitled to either or both of:

• (a) in respect of dividends, in addition to its preferential right, a right to participate, whether fully or to a limited extent, with capital not entitled to the preferential right; and
• (b) in respect of capital, in addition to the preferential right to repayment on winding up, a right to participate, whether fully or to a limited extent, in any surplus remaining after the entire capital has been repaid.

That Explanation exists to stop an argument. A shareholder who has both a preference and a share of the surplus looks like an equity holder, and Explanation (iii) says he is not: he remains a preference shareholder.

The nature of a share: sections 44 and 45

Section 44.

The shares or debentures or other interest of any member in a company shall be movable property transferable in the manner provided by the articles of the company.

Movable property, so it passes like goods and not like land. Transferable, which is what gives an investor an exit. In the manner provided by the articles, which is what lets a private company restrict transfer under section 2(68) while remaining a company.

And notice the three words "or other interest". The section is not confined to shares and debentures; it covers whatever interest a member has.

Section 45: numbering.

Every share in a company having a share capital shall be distinguished by its distinctive number.

The proviso disapplies it for a share held by a person whose name is entered as holder of beneficial interest in such share in the records of a depository, that is, a dematerialised share. Since section 29 makes dematerialisation compulsory for public offers, the proviso now covers most shares in the market, and distinctive numbers survive mainly in unlisted companies holding physical certificates.

What a share actually is. Putting sections 43, 44 and 45 together: a share is a unit of the share capital, measured in money, carrying a bundle of rights against the company (to vote, to dividend when declared, to a share in the surplus on winding up), constituting movable property, transferable as the articles provide, and identified by a distinctive number unless held in electronic form.

Voting rights: section 47

MU does not label this separately but it is the practical meaning of the two kinds, so it belongs here.

Section 47(1). Subject to section 43, section 50(2) and section 188(1):

• (a) every member of a company limited by shares holding equity share capital shall have a right to vote on every resolution placed before the company; and
• (b) his voting right on a poll shall be in proportion to his share in the paid-up equity share capital.

The opening words matter. Section 43 lets equity shares carry differential voting rights, so 47(1) yields to a validly created class. Section 50(2) deals with a member who has paid calls in advance and provides that he does not get extra voting rights for it. Section 188(1) stops an interested related party voting on its own contract.

Section 47(2): preference shareholders vote only sometimes. Every member holding preference share capital shall, in respect of that capital, have a right to vote only on resolutions which directly affect the rights attached to his preference shares, and on any resolution for the winding up of the company or for the repayment or reduction of its equity or preference share capital. His voting right on a poll is in proportion to his share in the paid-up preference share capital.

The first proviso fixes the relative weight: the proportion of the voting rights of equity shareholders to those of preference shareholders shall be in the same proportion as the paid-up capital in respect of the equity shares bears to the paid-up capital in respect of the preference shares.

The second proviso is the one to remember. Where the dividend in respect of a class of preference shares has not been paid for a period of two years or more, that class shall have a right to vote on all the resolutions placed before the company.

That is the bargain stated plainly. A preference shareholder gives up his vote in exchange for a preferential dividend. If the dividend stops for two years, the consideration has failed and the vote comes back.

A worked example

Belgaum Bearings Limited has a paid-up capital of three crore rupees: two crore rupees of equity shares of ten rupees each, and one crore rupees of nine per cent preference shares of one hundred rupees each.

Kinds. Under section 43 there are exactly two kinds and both are present. The preference shares carry a preferential right to a dividend at a fixed rate of nine per cent and to repayment of capital on winding up, so they satisfy Explanation (ii). The rest is equity share capital by Explanation (i), because it is not preference capital.

Participating shares. Suppose the preference shares also entitle their holders to share in any surplus after all capital is repaid. By Explanation (iii)(b) they are still preference shares, notwithstanding that additional right.

Differential rights. The founders want to raise sixty lakh rupees without losing control. They issue equity shares with differential rights under section 43(a)(ii), carrying a higher dividend and one vote for every ten shares, in accordance with the prescribed rules.

Voting in an ordinary year. On a resolution to appoint an auditor, the equity shareholders vote, in proportion to their paid-up equity capital on a poll, under section 47(1). The preference shareholders do not, because the resolution does not directly affect the rights attached to their shares.

Voting on a capital reduction. Now the company proposes to reduce its share capital. The preference shareholders do vote, because section 47(2) expressly covers a resolution for the repayment or reduction of equity or preference share capital. Their votes on a poll are in proportion to their paid-up preference capital, and the relative weight of the two classes is fixed by the first proviso: two crore to one crore, so two to one.

Two bad years. The company pays no preference dividend for two years. By the second proviso to section 47(2) the preference shareholders now have a right to vote on all resolutions placed before the company, not merely those affecting their own class.

Transfer. A preference shareholder sells. His shares are movable property transferable in the manner provided by the articles under section 44, and if the shares are in physical form each carries a distinctive number under section 45. Had they been held with a depository, the proviso to section 45 would disapply the numbering requirement.

Distinctions that carry marks

What this does NOT mean

It does not mean there are many kinds of share capital. Section 43 says two. Everything else is a variety within one of the two.

It does not mean participating preference shares are equity. Explanation (iii) expressly deems them preference capital.

It does not mean every equity share carries one vote. Section 43(a)(ii) permits differential rights as to voting, and section 47(1) is expressly subject to section 43.

It does not mean preference shareholders never vote. They vote on resolutions directly affecting their rights, on winding up, on repayment or reduction of capital, and on everything once the dividend has been unpaid for two years.

Quick revision

• Section 43: two kinds only. (a) equity, with voting rights or with differential rights as to dividend, voting or otherwise as prescribed; (b) preference.
• Explanation (i): equity is all capital that is not preference.
• Explanation (ii): preference carries a preferential right to dividend at a fixed amount or fixed rate and to repayment of capital on winding up.
• Explanation (iii): participating shares are still preference shares.
• Section 44: shares, debentures or other interest are movable property transferable in the manner provided by the articles.
• Section 45: every share must have a distinctive number, except a share held in a depository.
• Section 47(1): equity holders vote on every resolution; on a poll, in proportion to paid-up equity capital. Subject to sections 43, 50(2) and 188(1).
• Section 47(2): preference holders vote only on resolutions directly affecting their rights, and on winding up or repayment or reduction of capital. Relative weight in proportion to paid-up capital of each class. If the dividend is unpaid for two years or more, they vote on all resolutions.

Test yourself

1. What are the kinds of share capital? Two: equity share capital, with voting rights or with differential rights as to dividend, voting or otherwise in accordance with the prescribed rules; and preference share capital: section 43.

2. How is preference share capital defined? As that part of the issued share capital carrying a preferential right to payment of dividend, either as a fixed amount or at a fixed rate, and to repayment on a winding up or repayment of capital of the amount paid-up or deemed paid-up: Explanation (ii) to section 43.

3. Are participating preference shares equity shares? No. Explanation (iii) to section 43 provides that capital is deemed preference capital notwithstanding a right to participate in dividends beyond the preference, or in the surplus after all capital is repaid.

4. What is the nature of a share? Movable property, transferable in the manner provided by the articles of the company: section 44. Every share in a company having share capital must carry a distinctive number, unless held in dematerialised form with a depository: section 45.

5. When may preference shareholders vote? On resolutions that directly affect the rights attached to their preference shares, and on any resolution for winding up or for the repayment or reduction of the company's equity or preference share capital: section 47(2). Their voting right on a poll is in proportion to their paid-up preference capital.

6. What happens if a preference dividend is not paid for two years? By the second proviso to section 47(2) that class of preference shareholders acquires a right to vote on all the resolutions placed before the company.