Failure to redeem – payment defaults and redeemable preference shares

Redeemable Preference Shares (REDP’s) are generally thought of as hybrid securities issued pursuant to the Corporations Act 2001(Cth) (Act) to provide for redemption (cancellation) on the happening of a particular event, or at a party’s election.

Whilst their flexibility makes them an attractive tool, significant legal issues can arise if they cannot be redeemed because a term provides for payment of an amount of money which cannot be repaid or otherwise will cause a breach of the Act.

What exactly are redeemable preference shares?

Section 9 of the Act provides that a Redeemable Preference Shares is:

 “a preference share in a body corporate that is, or at the body’s option is to be, liable to be redeemed”.

It is generally considered that REDP’s are hybrid securities because they have characteristics akin to both debt and equity.  REDP’s are also known as Convertible Preference Shares.

Standard share class codes

ASIC lists “REDP” as the standard share code for Redeemable Preference Shares in addition to defining a range of other standard share codes which are used to describe the various different classes of shares.

What is important to understand is that the rights and entitlements associated with those shares are not generic, but can be defined by the members passing a special resolution of the Company or by amending the Constitution to include the rights and obligations associated with those shares.  Therefore the codes may be standard, but the rights and obligations usually aren’t.

Power to issue REDP’s

Section 254A of the Act provides for the issue of bonus, partly paid, preference and Redeemable Preference Shares.  In particular section 254A(3) provides that:

“Redeemable preference shares are preference shares that are issued on the terms that they are liable to be redeemed.  They may be redeemable

  • at a fixed time or on the happening of a particular event; or
  • at the company’s option; or
  • at the shareholders option”.

General requirements for issue and redemption

Further requirements for Redeemable Preference Shares are provided in Part 2H.2 of the act and sections 254J254L.

  • the redemption of shares can only be in accordance with the terms of their issue – s254J;
  • a company can only redeem Redeemable Preference Shares if the shares are fully paid up and out of profits of the proceeds of a new issue of shares made for the purpose of redemption – s254K;
  • section 254L describes the consequences of contravening the provisions dealing with Redeemable Preference Shares.

Redemption must be out of profits or the proceeds of a new issue

Section 254k(a) of the Act provides that REDP’s may only be redeemed out of profits or the proceeds of new issue of shares which are made for the purpose of redemption.   It therefore would be likely that a situation could arise where future profits do not materialise and a company is not in a position to raise capital for the purposes of making the redemption.

How can defaults be characterised?

Whether there is a default will largely depend on the terms of issue and the rules for redemption which apply to the REDP’s.  In Federal Commissioner of Taxation v Coppleston [1981] FCA 166 (Coppleston) a situation involving defaults on REDP’s was described as a “default in the payment of dividends” and “default on redemption”.  Coppleston provides guidance on the characterisation of unmet obligations associated with REDP’s issued pursuant to section 254(k).

It was said by Bowen, CJ that:

In Re Holders Investment Trust, at p.587, Megarry J. referred to a contention of the company that if there were no funds available (within the terms of s.58(1) of the Companies Act 1948 (UK), which was the corresponding section to s.61(3) of the Companies Ordinance) the company would not be in default under an article requiring it to redeem redeemable preference shares on a given date.[1]

In considering the effect a similar provision ‘subject to’ it was said:

We consider, therefore, that we should approach the matter as a question of principle.  When considering the articles of the company the reference to the Ordinance in clause 1C(3)(i) adds nothing. That condition exists even if not expressly stated. Both parties contracted on the basis of the law and part of that law is s.61 of the Companies Ordinance. The parties cannot be presumed to have assumed obligations which it is unlawful for one of the parties to fulfil. It is not a case where supervening legislation operates to make the fulfilment of its obligations by one party unlawful. Rather, the parties are contracting on the basis of a given law. In these circumstances, failing the availability of one or both of the funds specified in s.61(3), the company is not in default under its contract with the holders of redeemable preference shares if it fails to redeem after receipt of the requisite notice.

Can amounts owing give rise to a provable debt in winding up?

In the case of Whitby Land Company Pty Ltd v Li, in the matter of Whitby Land Company Pty Ltd [2014] FCA 806 (Whitby Land) dealt with an application to set aside a creditors statutory demand for payment because of a failure by a company to redeem redeemable preference shares by the due date.

The terms of the REDP’s were as follows:

  • the face value of each Redeemable Preference Share shall be one dollar (AU$1.00);
  • the Redeemable Preference Shares shall be redeemed for an amount equal to their face value of AU$1.00 (being AU$1,000,000 in total for the Investment) plus an amount equal to an annual return of 20% on their face value pro rata to the date of redemption of the Redeemable Preference Shares;
  • the Redeemable Preference Shares must be redeemed by the Company within 13 months of receipt of the Investment, the date being at the sole discretion of the Company, provided that should the development of the Property be delayed for any reason beyond the Company’s direct control the Company may at its election extend the period for redemption for a further period of up to 6 months;
  • redemption of the Redeemable Preference Shares and payment of the amount due upon this (being the sum of the Investment plus an amount equal to an annual return of 20% on this sum) shall be paid in priority of any capital return to the other shares of the Company.
  • the Redeemable Preference Shares shall have no voting rights whatsoever concerning the Company.

In making the application to set aside the statutory demand, it was claimed by the company that there was a genuine dispute as to the existence of the debt because there was a “plausible contention requiring investigation.’[2]  The company had not made any profits and nor were any funds available from any further share issues.  It was said by Siopis J at 14, that …..Mr Zusman’s contentions do not demonstrate an incontrovertible proposition that, in those circumstances, the failure of a company to redeem preference shares gives rise to an enforceable debt at the instance of the aggrieved shareholder for the amount due to be paid by way of redemption’.  The inference being that an unqualified obligation to redeem would highlight the inconsistency in section 254k.

The inherent inconsistency in section 254K

Section 254k of the Act provides that:

“A company may only redeem redeemable preference shares:

  • if the shares are fully paid-up; and
  • out of profits or the proceeds of shares made for the purposes of the redemption”.

A contravention of section 254k by a person dishonestly involved in breaching this section is provided for in section 254L(3) of the Act.

Therefore if the terms of issue of REDP’s create an unqualified obligation to redeem then it has been said that difficult questions of construction may arise[3].  On the one hand the terms of issue of REDP’s may create an obligation to redeem, however on the other, if redeemed a person involved in doing so may be liable to criminal liability or a breach of section 588G of the Act.

Because of the operation of section 254k, an unsatisfied payment obligation because of a failure to redeem, is not a debt enforceable against a company.  In the above circumstances an attempt to enforce the payment of an amount owing by serving a creditors statutory demand for payment can be defended by arguing that there was a genuine dispute as to the existence of the debt because the circumstances gave rise to a plausible contention requiring investigation.

It was said by Siopis J in Whitby Land that the only remedy may be a winding up on ‘just and equitable grounds’ contained in section 461k.

Provided that the terms of issue of REDP’s do not create a debt nor a breach of contract, then an obligation which would be recognisable under a winding up pursuant to section s553 of the Act has not arisen –  (debts or claims that are provable in winding up).[4]

Takeaways

The case of Whitby Land highlights the need to carefully consider the implications of issuing redeemable preference shares and whether the terms of issue create a positive obligation to redeem.

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Footnotes

[1] This was the equivalent of Section 254A at the time.
[2] Eyota Pty Ltd v Hanave Pty Ltd (1994) 12 ACSR 785
[3] Kandelka Management Pty Ltd v Pisces Group Ltd [2009] FCA 1379, per Lindgren J at 73.
[4] Heesh v Baker [2008] NSWSC 711 at 64.

Links and further references

Legislation and interpretative decisions

Australian Taxation Office, Guide to debt and equity tests in Division 974;

Corporations Act 2001 (Cth);

Income Tax Assessment Act 1997 (Cth).

Cases

Beck v Weinstock [2010] NSWSC 1068

Capel Finance Ltd [2005] NSWSC 286 (4 April 2005)

Federal Commissioner of Taxation v Coppleston [1981] FCA 166

Heesh v Baker [2008] NSWSC 711

Kandelka Management Pty Ltd v Pisces Group Ltd [2009] FCA 1379

Whitby Land Company Pty Ltd v Li, in the matter of Whitby Land Company Pty Ltd [2014] FCA 806 (28 March 2014)

Related articles

What is a Preference Share?

Redeemable Preference Shares

Shareholder disputes – the fight for control

Further information

If you need advice on issuing or redeeming redeemable preference please contact us for an obligation free and confidential discussion.

Malcolm Burrows Lawyer BrisbaneMalcolm Burrows B.Bus.,MBA.,LL.B.,LL.M.,MQLS.
Legal Practice Director
Telephone: (07) 3221 0013
Mobile: 0419 726 535
e: mburrows@dundaslawyers.com.au

Disclaimer

This article contains general commentary only.  You should not rely on the commentary as legal advice.  Specific legal advice should be obtained to ascertain how the law applies to your particular circumstances.

Dundas Lawyers
Street Address Suite 12, Level 9, 320 Adelaide Street Brisbane QLD 4001

Tel: 07 3221 0013

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