Section 4(1) of the Malaysian Companies Act 1965 (the Act) defines “preference share” as a share by whatever name called, which does not entitle the holder thereof to the right to vote at a general meeting or to any right to participate beyond a specified amount in any distribution whether by way of dividend, or on redemption, in a winding-up or otherwise.
Under Section 66(1) of the Act, no company shall allot any preference shares or convert any issued shares into preference shares unless there is set out in its memorandum or articles the rights of the holders of those shares with respect to repayment of capital, participation in surplus assets and profits, cumulative or non-cumulative dividends, voting, and priority of payment of capital and dividend in relation to other shares or other classes of preference shares.
Preference shares can be classified into various categories, as follows:
(a) Cumulative or non-cumulative preference shares
A cumulative preference shareholder is entitled to receive a fixed cumulative preference dividend right. If in any year dividend is not paid, the cumulative preference shareholder is entitled to have the equal amount of the unpaid dividend added to the dividend to be paid in the following year(s).
Non-cumulative preference shares, on the other hand, entitle the holder to a dividend at a fixed rate only in the years where a dividend is declared and paid. A failure to pay the dividend does not carry the obligation to meet the deficiency in the ensuing year(s).
(b) Participating or non-participating preference shares
Unlike the non-participating preference shares, participating preference shares entitle the holder to a return in excess of the stated fixed preference dividend rate by participating in the distribution of profits available to ordinary shareholders.
(c) Redeemable or irredeemable preference shares
Section 61(1) of the Act provides that a company may, if so authorised by its articles, issue preference shares which are, at the option of the company are to be liable to be redeemed and the redemption shall be affected only on such terms and in such manner as is provided by its articles.
Section 61(3) of the Act provides that the preference shares shall not be redeemed: (a) except out of profits which would otherwise be available for dividend, or out of the proceeds of a fresh issue of shares made for the purposes of the redemption; and (b) unless they are fully paid up.
Irredeemable preference shares, on the other hand, are not entitled to be redeemed.
(d) Convertible or non-convertible preference shares
Unlike non-convertible preference shares, convertible preference shares allow or require the preference shares to be converted into ordinary shares at the end of the term or upon the happening of a particular event.
In his paper entitled “Shariah Compatible Preference Share: A Suggested Formula and Rationale”, Prof Mohammad Anas Zarqa said:
“The main Fiqh objection to preference shares are two: Firstly, Muslim jurists are agreed that a partnership contract should not contain provisions that may occasionally lead to the suspension of profit sharing among partners.
Secondly, on liquidation of the company, preference shareholders may receive the full par value of their shares, in precedence over ordinary shareholders. Thus, they virtually stand as lenders (who can reclaim their principal) rather than as partners. From Fiqh point of view, if they are to be considered lenders they may not receive dividends in the first place, they can only get back their principal. If they are partners, they may not have preference over other partners, i.e., over ordinary shareholders.”
The Malaysian Securities Commission (SC) Shariah Advisory Council (SAC), however, ruled that non-cumulative preference shares are permissible based on tanazul, where the right to profit of the ordinary shareholder is willingly given to a preference shareholder.
Tanazul is agreed upon at an annual general meeting of the company which decides to issue preference shares in an effort to raise new capital.
As it agreed at the meeting to issue preference shares, this means that ordinary shareholders have also agreed to give priority to preference shareholders in dividing the profits, in accordance with tanazul.
In the context of preference shares, tanazul means surrendering the rights to a share of the profits based on partnership, by giving priority to preference shareholders. It is also known as isqat haq in Islamic jurisprudence.
It is to be noted that some Shariah scholars are of the view that the ordinary shareholders can only surrender their rights to a share of the profits, based on partnership, by giving priority to preference shareholders upon the dividend is being declared by the company.
Contrary to SAC’s view, such tanazul or surrender of rights cannot be given upfront and must be given upon each declaration of dividend by the company.
Although the SAC generally recognizes the concept of preference shares, it however does not recognize the concept of cumulative preference shares.
In a conventional situation for preference shares with cumulative feature, preferred dividends that are missed in a given year are carried forward in arrears, to be paid in later years. This is objectionable from an Islamic point of view, and that is why the SAC disapproves of this feature.
To better understand the foregoing, let’s look at the following illustration:
Term of investment :
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Seven years
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Rate of dividend :
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8% cumulative
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Term of investment :
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Seven years
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Projected rate of dividend over term of investment :
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8% x seven years = 56%
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Proportionate annual dividend :
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56% ÷ seven years = 8%
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Special features :
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Any unpaid dividend in a particular year will be carried forward to the next year(s) as the dividend is spread and calculated over the life span of the investment
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. References are available on request from the writer.