What is a Preference Share?

Preference shares (Preference Shares) are a class of share that gives the holders some right or preference over another class of shares.  A Preference Share is often thought of as a ‘hybrid’ security, as it has features of both debt and equity.  Like ordinary shares, Preference Shares are issued by a company at the time of issue, or may be capable of being purchased on the market.  Pursuant to section 254A(2) of the Corporations Act 2001 (Cth), a company can only issue Preference Shares if the rights which attach to such shares are set out in the company’s constitution, or have been approved by a special resolution of the company.  A company does not have to be listed on a stock exchange to issue preference shares.

Benefits of Preference Shares

The ASX lists the benefits of investing in Preference Shares as:

• the investor receives income in the form of dividends;
• the investor may receive tax benefits if the dividends paid on preference shares have franking credits attached;
• the investor ranks ahead of ordinary shareholders for the payment of dividends; and
• the investor ranks ahead of ordinary shareholders for the recovery of capital if the company becomes insolvent.

Things to note before considering Preference Shares

The features and risks of Preference Shares can vary significantly, so it is important to read the information about them carefully.  Elements to note are:

• the dividend rate – the dividend rate is usually set at the time of issue and expressed as a percentage of the share’s face value;
• the risk associated with the company – if a preference share offers unusually high returns, it may be because the market thinks there is a risk the company will default on its payment obligations;
• whether the dividend is fixed or floating – if a Preference Share pays “floating” dividends, the payments vary in line with the market interest rate, however, if the Preference Share pays “fixed” dividends, the payments do not vary;
• whether the dividend is franked – a franking credit is a  non-cash  amount  that  must  be  added  to  an investor’s taxable income, but the credit can be used to offset the tax payable on the investor’s earnings; and
• if and when the Preference Shares convert into ordinary shares – most preference shares convert into a fixed dollar value of ordinary shares, however, some Preference Shares give the issuer the option of paying cash (redeeming the Preference Shares) instead of converting Preference Shares into ordinary shares.

Common issues involving Preference Shares

An investor may be liable for capital gains tax if they sell their Preference Shares for a higher value than they acquired them for.  In the case of listed securities, a related risk is that if an investor sells their Preference Shares on the market prior to maturity, they will only receive the market price, and this may be less than the face value paid to acquire the shares.

Links and further references

Cases

Beck v Weinstock [2013] HCA 15 – the High Court held that it is possible for a company to only have members who hold Preference Shares, as there is no requirement under the Corporations Act 2001 (Cth) to have ordinary shares on issue before Preference Shares can be issued.

Legislation

Corporations Act 2001 (Cth)

Other links

ASX, Module 5: Preference Shares, March 2013

Further information about Preference Shares

If you need assistance with Preference Shares, please telephone me for an obligation free and confidential discussion.

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.

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