As per Indian company law, there are two types of shares that can be issued by the companies- equity shares and preference shares. Preference shares are those that which entail a preferential right to dividend, and to the proceeds of liquidation at winding up. Shares other than this are equity shares regardless of whether they have differential rights as to voting, dividend etc.
Preference shares cannot be issued on the perpetual basis as per company law. Company law prohibit perpetual preference shares. These shares have to be redeemed within an outer time limit of 20 years from their issue. Preference shares can also be converted into equity shares. Issuers issue preference shares with an element of optional or mandatory conversion into equity shares either partially or fully.
Company that issues preference share also agree to pay dividend on preference shares either at a specific rate or in terms of a pre-agreed formula.
Dividend along with the mandatory redemption requirement makes preference shares look like bonds - after all, bonds have an agreed tenure, and an interest element. However, it is pertinent to note that dividend, unlike interest, may be paid only from profits.
Redemption of preference shares is made from profits or balances in the securities premium account or a fresh issue of shares. Bonds carry obligation to redeem. Infact this redemption is an integral contractual obligation and one need not make profits or have securities premium balances to redeem debt.
In order to mobilize foreign investment by issuing preference preference shares, the Government of India (GOI) had initially permitted issuance of equity shares, preference shares, convertible preference shares by Indian companies to persons resident outside India in respect of financial projects / industries.
On 8th June 2007, The Reserve Bank of India modified the rules and regulations valid for foreign investment in preference shares. As per the revised guidelines, foreign investment from the issue of fully convertible preference shares would be considered as a portion of the share capital that would be inclusive in calculating the sectoral caps on foreign equity.
Influx of foreign investment from the issue of non-convertible, optionally convertible or partially convertible preference shares, would be regarded as debt and will demand to be in accordance with the guidelines/caps relating to External Commercial Borrowings (ECB).
Foreign investment in non-convertible, optionally convertible, partially convertible preference shares as on and upto 30th April 2007 would remain outside the sectoral cap until it achieves their current maturity.
Those preference shares that can be converted mandatorily into equity, would be treated as part of the share capital. These shares would be eligible to be issued to persons resident outside India under the Foreign Direct Investment scheme.
Funds for foreign investments from the issue of non-convertible, optionally convertible or partially convertible preference shares that would be obtained after1st May 2007, would be regarded as debt and would be demanded to be in accordance with ECB guidelines / caps. All standard norms that are relevant to ECBs will be implemented to such preference shares.
As per the above modifications, investments in optionally convertible/ partially convertible or redeemable preference shares passed by Indian companies on or upto April 30, 2007, would go on until its current maturity.
The government received many representation with respect to above guidelines. There were many entities who claimed that this guidelines has effected their business plans as they were at an advanced stage of issuing preference shares. Due to this representation government has decided that where verifiable and effective steps had been taken prior to April 30, 2007 in relation to issuance of such shares, exemption could be granted from the purview of the revised guidelines.
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