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TMI Blog1973 (11) TMI 98X X X X Extracts X X X X X X X X Extracts X X X X ..... and some of the preference shareholders as to whether the latter are entitled to payment of dividend as per the Articles of Association and Memorandum of the company (i.e.) on a basis of priority over ordinary shareholders. (3) The issued and called up capital, according to the Liquidator, are as follows: 35,000 Preference Shares of ₹ 100.00each 17,50,000.00 50% Called up as per list 'F. 1,45,000 Equity shares of ₹ 100.00each. 100% Called up as per list 'G' 30,400.00 50% Called up as per list 'G' 72,34,800.00 (4) The rights of the preference shareholders have been provided for in clause 7 of the Articles of Association as follows: THEpreference shares shall confer on the holders thereof the right to a fixed cumulative preferential divident @9.5% per annum free of company tax but subject to deduction of taxes at source at the prescribed rates on the capital paid up thereon, and in the event of winding up, the right of repayment of capital and arrears of dividend whether earned, declared or not, up to the commencement of winding up in priority to the equity shareholders. (5) The question for consideration is whe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eference Shares, unless the dividend due on preference shares has remained unpaid for not less than two years, in which case the preference shareholder shall have the same right to vote as an equity shareholder. In the event of the Company intending to create and/or issue further preference shares, ranking pari passu with the preference shares now being issued, the same shall be done only with the consent of the holders of not less than three-fourth of preference shares then outstanding. Preference Shares, if subscribed for by the Haryana Government in terms of their underwriting commitment, shall be redeemable in a lot at the expiry of Twelve years . (7) The difference between the Prospectus and the Articles, shortly stated, is whereas the Prospectus refers to the repayment of capital and any arrears of dividend earned, whether declared or not , Article 7 reads: repayment of capital and arrears of dividend whether earned, declared or not . The bargain has to be ascertained not from what is stated in the Prospectus but in the Articles of Association. There appears to be no doubt that the expressions employed in the Articles are correct; this will become clearer if one un ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... assets or profits of the company.' Under such a clause unpaid preference dividends for earlier years are payable when the company is wound up, even though they have not been declared (a), and even though the company did not earn sufficient profits to pay them while it was a going concern. It is important that the arrears of dividend payable should be expressed to be calculated to the date when the preference capital is repaid; if the preference shareholders are merely entitled to 'arrears of dividend', the dividends are calculated only down to the commencement of the winding up. Among the decisions referred to are In re Crichton's Oil Company, (1902) 2 Ch. 86; Re W. Foster Son, Ltd., (1942) I A.E.R. 314(2), In re New Chinese Antimony Company. Limited, (1916) 2 Ch- 115; In re Springbok Agricultural Estates, Limited, (1920) I Ch. 563; In re Wharfedale Brewery Co. Ltd., (1952) Ch. 913; and Re E. W. Savery, Ltd., (1951) 2 A.E.R. 1036; (10) Re Walter Symons, Ltd., (1934) Ch. 308; C) has been quoted by Palmer as authority for the position that where the Memorandum provided that the preference shares should confer a right to a fixed cumulative preferential divi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... legal rights, which may be and normally are attached to all shares, he points out, are broadly classifiable into three groups: (1) rights in relation to the payment of dividend (income rights); (2) rights of voting at company meetings (voting-rights); (3) rights to the return of capital on an authorised reduction of capital or on a winding up (capital rights). The most important class is usually that where preferential rights are conferred; the shares concerned may be termed preference shares. As pointed out in Alliance Perpetual Building Society v. Clifton. (1962) 1 W.L.R. 1270 (10) whether shares are ordinary or preference shares may be a question of construction (p. 469). He concludes : . . .the preference share which combines both equity and fixed interest characteristics is a somewhat unique anomally in business finance which must continue to give rise to problems and apparent injustices for investors, and as such is a security which can hardly reflect credit on the law under which it has been evolved and which continues to sanction existence (p. 519). (12) The problem of preference shareholders can arise in a variety of contexts. One such is the reduction of capita ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... statutory provision), or (perhaps) where there is an independent agreement between them and the company that capital will not be reduced without their consent, that they can raise the objection that their rights are not being strictly observed. This vulnerability of preference shareholders who have no such rights of participation is sometimes overcome in quoted companies by the use of the so-called Spens formula ', viz., a provision in the memorandum or articles or terms of issue that where preference shares are paid off, the prize should be tied to the quoted market value at the time and the preference shareholders should have voting rights on the resolution for reduction. Where preference shares rank pari passu with ordinary shares in the return of capital on a winding up, any cancellation of shares should bear upon both classes rateably. Even though the actual amount (though not the percentage rate) of a fixed dividend on the preference shares will be thereby reduced, the preference shareholders have no grounds of objection, because their class rights are not being infringed. (13) Pickering regards three principles as basically established and quotes from three de ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... le only to discover that they could be paid off at any time (when the capital itself was reduced) without their consent, which was held to be unnecessary by the House of Lords in the Scottish Insurance Corporation Ltd. v. Wilsons and Clyde Coal co. Ltd., (1949 A.C. 462) (14) and Prudential Assurance Co. v. Chatterley-Whitfield Collieries Ltd., (1949 A.C. 512) (17). The Committee was not in favor of any alteration of the law, which may have the effect of retrospectively altering contractual rights of some shareholders; they did not see sufficient justification for that. course (para 195 of the Report). There was no question raised about the position which is different, where the rights of preference shareholders are set out in the Memorandum or Articles of Association; the said bargain alone would govern, subject, however, to one question, namely, whatever it is opposed to statue and hence invalid. (15) The outside investor may be induced to subscribe for preference rather than ordinary shares by reason of the bargain offered; such investor has usually little knowledge of the company's business, has no wish to participate in the company's management and is keen only ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... set out once again, the words of Section 511 excluding those that do not apply to the present case : ....the assets of the company shall on its winding up, ... unless the articles otherwise provide, be distributed among the members according to their rights and interests in the company. (20) The rights and interests of preference shareholders, who rank below the debenture holders, are governed by the Articles and there can be no impediment in the Article being applied unless the same is contrary to any provision of the Act. Section 9 of the Act provides that save as expressly provided in the Act the provisions in the Act shall have effect notwithstanding anything to the contrary contained in the Memorandum of Association of the company. If Section 205 of the Act does not apply to the instant case then there is no question of there being any provision in the Act contrary to the Articles. If Section 511 applies, it will specifically govern the case of preference shareholders being paid dividend also in terms of the contract as evidenced by Article 7 read above. Section 511 is the specific provision-applicable to voluntary winding up and in relation to this specific aspect ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... where the question arose whether ordinary shareholders were entitled to set off call against repayment of capital contributed and payment of arrears of dividends to preference shareholders for money due to them as preference shareholders. Referring to the English authorities, which were cited before him, K. K. Desai. J. formed the impression from those authorities that the question was not of law, but of facts to be determined on a true construction and effect of the provisions in the Memorandum of Association and the Articles of Association as regards the rights of shareholders of each class. Referring to similar words, as in the present case, payment of capital and arrears of dividends (whether declared or undeclared) up to the commencement of the winding up, in priority over the holders of the ordinary shares, it was observed that the prohibition against payment of dividends out of assets other than profits did not arise in a winding up. (24) Oil behalf of the seventh respondent it was urged with reference to Section 2(22) of the Income Tax Act, 1961 that distribution, on liquidation, of accumulated profits of any past year or even the current profits of the company ..... 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