This is fraught with an intellectual absurdity and such statute drafting seems to be the result of a deliberate or nonchalant act of ignoring the conceptual and practical severance between ownership and control. The endeavour here is to show not only that this statutory categorisation of share capital is an undesirable limitation on shareholders and/or a companys right to design its share structure, but also that the definitions given to equity and preferential capital are fallacious vis--vis the way they are globally understood.
An important function of company law is to facilitate bargains among a companys members. Modern company law gives extensive freedom to the promoters/members to design the prospective companys capital structure. Britains Companies Act, unlike its Indian counterpart, doesnt restrict the freedom of the shareholders, qua members, to choose the combination of rights, and leaves it, initially to the contracting members forming a company, and later to the company to design its shares in any possible way.
US company laws are even more permissive as far as the bargaining powers of the members and the company are concerned. The code of the state of Delaware, which is host to the highest number of incorporations in the country, extends endless freedom to the corporators/corporations to design their stock. Other jurisdictions also extend varied degrees of contractual freedom to their companies and its corporators.
In contrast to irrational and rigid Indian statutory provisions, most national laws consider a share as a bundle of negotiable rights. A share is understood to give a combination of certain rights with respect to dividends, return of capital on a winding up (or otherwise), voting, and the like. The word preference only signifies a priority in terms of return of income (dividend) and/or capital at the time of winding up or otherwise vis--vis ordinary shares.
If in addition to being preferential they are also participating, i.e., have a right to share in the profits of the company after the all the shareholders get a specified return, they may be a form of equity shares with preferential rights over ordinary shares. A huge range of rights, relating to dividends, return of capital, voting, conversion into ordinary shares, redemption and other matters may be attached to classes of shares, all of which are conventionally described as preference shares.
Equity shares are those which participate in the dividend and/or return of capital after all other liabilities in those respects have been met. In so far as members can be said to own the company, the equity shareholders are its proprietors. Shares lacking such rights are non-equity shares. Note that these, like equity, may be preferential or ordinary shares. Then there are voting and non-voting shares. Either can be ordinary or preference. Voting denotes control. This exemplifies the otherwise theoretical difference between ownership and control.
Though the draft Companies Bill 2004 has tried to simplify the definition of preference capital, the problems discussed above seem to have failed to attract the attention of the bills architects. Share capital shall only be of two kinds, viz., equity and preference. Equity shares shall only have voting rights to the exclusion of preference shares, as is the case at present. In fact, such rights, now available to preference shares in the event of non-payment of dividend due by the company, seem to have been taken away.
Compartmentalisation of classes of capital is an unwarranted encumbrance upon the contractual rights of companies. Members of a company or the company itself should be left to their wisdom to decide the share structure that would suit their objectives. Such strict categorisation is generally prevalent in and recommended for transition economies, were capital markets are immature and special statutory protection has to be provided for their gullible investors.
The Indian capital market has matured over the years. At a time when we are leaving no stone unturned to woo foreign direct investment, an unwelcome curb on a capital structure choice can take the sheen off a very attractive capital marketIndia, and will render it globally uncompetitive. No doubt, safeguarding the interest of small investors is the raison-dtre for such retrograde provisions in company law. But company law should leave the protection of investors to regulatory authorities, such as the SEC in the US, FSA in the UK and Sebi in India.
Strict disclosure norms at the time of IPOs and further issue of shares and in periodic returns would enable current and prospective investors to take informed investment decisions. For example, an issuing company may be required to state prominently in the offer document the differential attributes of new shares vis--vis existing ones. This may equip the prospective shareholders with adequate knowledge to help them decide judiciously whether the new offer is worth putting their hard earned money into. But, company law, in no way, should stop a company from issuing preference, participating, both regards dividend and capital, irredeemable, convertible equity shares.
The writer is a consultant with Fox Mandal Little