Shareholders’ rights; putting the interest of parties into equilibrium


Abstract

In 2014, Petroliam Nasional Berhad (“Petronas”) paid RM26 billion in dividends to the company’s main shareholder; the Malaysian Government. The said dividend was 50% of its profit after tax. This year, Petronas had committed to pay the same amount to the Government. However, with the oil price heading to the abyss, the policy of paying the same amount to its shareholders may hit the profitability of the company. Surely this policy cannot be sustained if the oil price stays or even lower than this level. It is a grave concern that the company may have to lessen its reserves; putting the company not only at risk but it also put the company at a disadvantage if the company requires expanding in the future. Although it is good that the company rewards its shareholders, the company needs to balance the interest of its shareholders and the interest of the company. In this Article, I will touch on shares, shares, dividend, and the debacle of shareholders versus company’s interest.

Introduction

When you buy a share in a company, you have a slice of ownership in a company. A shareholder will be given a certificate of shares which is a document that enable a shareholder to show a good prima facie title of his shares in a company.

Section 132D(1) CA 1965, stated that the directors must get an approval from the company in the general meeting before the company can issue shares. Issuance of shares refers to the process starting from the prospectus until the entry of the share in the company’s register. Being an asset of a company, share capital must be reflected in the balance sheet. Hence, share capital must have a real value attached to it. A company cannot give the share with first securing the payment for the said shares.  However, section 54 (2) (b) CA 1965, seems to allowed a company to give its shares to the shareholders for consideration other than cash.

What is the meaning of a “share”?

Section 4 of the Companies Act 1965 (“CA 1965”) defined shares as:-

Share in the share capital of a corporation and includes stock except where a distinction between stock and shares is expressed or implied.

Meaning, you are one of the owner of the company. However, one must remember the Salomon principle whereby the owner and the company are two separate entities. Hence, you may be the owner of the company but you do not have a direct control over day-to-day management of the company.

Section 98 of the CA 1965 explained the nature of shares as “…movable property, transferable in the manner provided by the articles, and shall not be of the nature of immovable property”.

CA 1965 describes shares as movable properties and transferable from one shareholder to another. Although shares are transferable, the liquidity of the shares; how easy a shareholder to dispose his shares, depends very much on the type of the company. For a private company, section 15(1)(a) of the CA 1965 restricts the right to transfer the shares. For public companies, it is much easy for the shareholders to offer and to sell their shares to the public through the Bursa.

It is natural for any one making an investment; they would like to enjoy the return from their investment. For example, if you buy a unit in Amanah Saham Bumiputra (“ASB”), you are entitled for a dividend. The same when you invest in a company, you expect the company to share the company’s profit with the shareholders in paying the dividend. Your entitlement for dividend depends on what type of shares that you are holding.

Let us see what different type of shareholders and what they can expect from their investment. In a limited company, a share gives the holder the right to claim from the company the following rights:-

(a)    Distribution rights: rights to receive dividends, rights to repayment of the principal or any surplus asset of the company on a winding up.

(b)    Control rights: shareholders have some degree of control over the management of the company’s affairs; that is the right to vote on decisions affecting the company during the Annual General Meeting or Extraordinary General Meeting. The most important power of the shareholders is the power to appoint or remove the company’s directors.

In general, there are two types of shares.

 Shares
(1) ordinary
(2) Preferential
Cumulative
- non cumulative

                                                                                                               
We shall look at each type of shares briefly and look at what are the rights entails each class of shares.

Preference shares

Section 4 CA 1965 defined preference shares as shares that does not entitled its holders the right to vote at AGM or any right to participate beyond a specified amount in any distribution whether by dividend, or on redemption, in a winding up.

However, the holder of preference shares will enjoy the following rights:-

(a)   Fixed dividend;
(b)   During winding up, preference shareholders will be able to recoup its principal in priority to ordinary shareholders.

However, the holder of preference shares is not allowed to vote except when the company did not pay the dividend to the preference shareholders.

Cumulative preference shares

Preference share may be cumulative or non cumulative. Cumulative preference shareholder may carry forward their entitlement to a distribution from this year to next year.

Non -cumulative preference shares

The holder of non-cumulative preference shares is entitled for the dividend specified for the said year. However, if the company does not declare any dividend for the non-cumulative preference shareholders for this year, the shareholder cannot accumulate the non-payment of this year’s dividend to the next year.

Participating preference shares

The holder of participating preference shares are entitled to participate in the company’s profit in excess to the fixed dividends allocated for the preference shares. The right to the excess fixed dividend must be clearly stated in the company’s memorandum.

Redeemable preference shares

If the company’s article authorizes it, a company may issue a redeemable preference shares. Meaning, prior to winding up, a company may make a repayment of the principal to the preference shareholders. 
  
Ordinary shares

Unlike the preference shares, there is no specific definition of ordinary shares. It seems that anything that is not preference shares is an ordinary shares. Despite the lack of safety to the dividend payment, the ordinary shareholders has the special rights given to attend general meeting and exercise one vote per share on a poll on any resolution in a general meeting. The shares that you buy at the stock market are ordinary shares.

In terms of priority, the ordinary shareholders are the last in the pecking order. If the company is in liquidation, the ordinary shareholders will be the last to be compensated. After the creditors have been paid, the preference shareholders, the shareholders will be paid the full value of the shares if there is anything left from the company’s assets.

3. Class Rights and variation of rights

Section 65 (1) of the CA 1965 stated that:-

If in the case of a company the share capital of which is divided into different classes of shares provision is made by the memorandum or articles for authorizing the variation or abrogation of the rights attached to any class of shares in the company, subject to the consent of any specified proportion of the holders of the issued shares of that class or the sanction of a resolution passed at a separate meeting of holders of those shares, and in pursuance of the said provision the rights attached to any such class of shares are at any time varied or abrogated the holders of not less in the aggregate than ten per centum of the issued shares of that class, may apply to the Court to have the variation or abrogation cancelled, and, if any such application is made, the variation or abrogation shall not have effect until confirmed by the Court.

A company under section 65 (1) CA 1965, and under its memorandum and article is at liberty to give different classes of shares differs in rights, benefits, disabilities, or other matters like the following matters:-

(a)   voting;
(b)   dividends;
(c)    return of capitals;
(d)   other matters.

Variation of class right

The right under classes of shares only arises if the class rights are created in the memorandum or article of the company. Variation of rights assumes the existence of the right, then the rights are varied, and subsequently the variation continued to be enforceable.

Provision of class rights in the memorandum

If the memorandum of a company confers class rights, we may argue by virtue of section 21 (1A) CA 1965 that by passing special resolution, we may alter the memorandum and subsequently amending the class rights.

Noteworthy, section 21 is a general provision to alter the memorandum; including the provisions on class right. However, a general provision cannot be used to alter specific provision of the memorandum. The alteration may be prohibited if there is a specific provision in the memorandum that prohibits the alteration of class rights. Furthermore the new inclusion of subsection (1B) to the Section 21 stated that:

Nothing in subsection (1A) permits the alteration or deletion of a provision of the memorandum that relates to rights to which only members included in a particular class of members are entitled.

If the rights to certain class of members are provided in the article of the company, the rights can only be altered by way of special resolution (section 31(1) CA 1965). However, when the amendments touches on the class rights, Section 21 (1B) of the Act provided that the amendments can only be varied with the consent of the class concerned.

Statutory Protection

Section 65 (1) CA 1965 – variation or abrogation affecting of class rights holders can be done if a specified proportion of the holders of the shares consented or pass a special resolution. Holders of class shares of not less than 10% may apply to the High Court to cancel the variation of abrogation.

For the best interest of the company

How many times we hear the arguments that the individual or minority interest must be sacrificed for the best interest of the majority. It happens in a country, it happens in a community, and it happens in a company.

In 2013, Apple Inc has more than $100 billion in the Bank. The company wanted to return $45 billion to shareholders over three years. However, the shareholders want more. David Einhorn, an activist hedge fund manager wanted the company to return lot more through new class of preferred stock. The management of the company must explain to the shareholders why the money should be in the bank rather than redistributed to the shareholders.

The company needs to balance the redistribution of profit to the shareholders and the need to grow the company. The company needs to understand that the shareholders would expect to enjoy the return for their investment in the company. It is from the investors money that the company able to use it as capital to grow. The company must protect the interest of the shareholders especially the minority shareholders. It is reputational hazardous if the shareholders have to enforce their rights at the court of law.


At the same time, the shareholders need to understand, the reason why they invest in a company in the first place. If the intention is to gain sustainable dividend, then a reasonable payment of dividend every year is a good investment to the shareholders. We do not want to milk the cash cow excessively for short-term profit and killing the cash cow in the process.

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