Preference Shares – emergency funding mechanism in light of COVID-19?

In the wake of the economic impact of the COVID-19 pandemic, many companies will undoubtedly need to consider raising additional capital.  Gerry Cawson discusses the considerations for a proprietary limited company that is seeking to raise capital by the issue of preference shares.

Freedom to raise capital

The ability of a proprietary limited company to raise further capital typically depends on three things:

  1. the terms of its constitution;
  2. the terms of any Shareholders Agreement applying to the company; and
  3. any rights of a third party under pre-existing securities or contractual arrangements (such as existing loan agreements).

It is common for each of these to place restrictions on the general power of directors to raise capital by incurring debt or issuing shares or other securities.  Irrespective of the terms of these documents, the Corporations Act also includes various restrictions on the ability of a company to issue shares, particularly preference shares.

What is a preference share?

Preference shares are a class of share that gives the holders some right or preference over another class of shares in the company.  They are typically used by institutional investors and those with bargaining power over existing shareholders (such as those investing when a company is in a position of cash flow distress) as they provide a mechanism to improve the risk profile of their holders over the holders of ordinary shares.

A preference share may only be issued by a company if the rights attached to the preference share with respect to repayment of capital, participation in surplus assets and profits, cumulative and non-cumulative dividends, voting, and priority of payment of capital and dividends over other classes of shares are set out in the company’s constitution (if any) or have been otherwise approved by special resolution of the company.

Approval for issues of preference shares

The creation of a class of preference shares and an issue of those shares is taken to vary the rights of any shares already issued by the company, unless the terms of issue of those preference shares are set out in the constitution of the company (or another document lodged with ASIC).  In addition, an issue of additional preference shares in the same class (even if they rank equally) is also taken to be a variation of the class rights of those existing preference shares on issue, unless the issue is authorised by the terms of issue of the existing preference shares or the company’s constitution in force when the existing preference shares were issued (‘Pre-Existing Authorisation‘).

What’s required to approve a variation?

So, in the absence of a Pre-Existing Authorisation, an issue of preference shares must, therefore, be approved by special resolution of the Company and any variation of class rights must be approved in accordance with whatever procedure is set out in the company’s constitution (if any).  If the company doesn’t have a constitution or it doesn’t include a relevant procedure, the approval for the variation must be approved by a special resolution of the company and by a special resolution of those members that hold shares in the class being varied (or by the written consent of members with at least 75% of the votes in the class).

What are the practical considerations?  

In the absence of a Pre-Existing Authorisation, the use of preference shares to address emergency funding requirements may be slower than you’d like because of the time needed to call and hold the relevant member meetings.  In addition to the need to call and hold shareholder meetings to obtain the various approvals, the Corporations Act provides that unless all members of the relevant class of securities agree to the relevant resolution (or alteration of their class rights), members that together hold at least 10% of the votes than can be cast in the class being varied may, within one month of the variation, apply to the court for the variation to be set aside on the basis that it unfairly prejudices the applicant.  If the court isn’t satisfied of this the variation will be upheld.

If you are considering raising capital for your company (whether because of COVID-19 or to take advantage of exiting opportunities for growth), please speak to Gerry Cawson or one of our award-winning transaction lawyers.  We’d be happy to bring to bear our experience as one of the country’s most active transaction teams to guide you through the process.