Define Preference Shares. What Are the Different Types of Preference Shares? | 12th HSC S.P. Chapter 2
The question "Define Preference Shares. What are the different types of Preference Shares?" is one of the easiest and highest-scoring 8-mark long answer questions from Maharashtra State Board (MSBSHSE) 12th Standard HSC Secretarial Practice (S.P.) Chapter 2: Sources of Corporate Finance. In the HSC Board Examination, this question regularly appears in Question 8 (Answer the Following) for 8 Marks. Because there are exactly 8 distinct types divided into 4 logical pairs, students who draw the classification chart and explain the 8 types easily score a full 8 out of 8 Marks! Below is the complete model answer aligned with the latest Balbharati Textbook.
Board Examiner Marking Scheme (8 Marks):
1. Meaning & Legal Definition of Preference Shares (Section 43): 2 Marks
2. Classification Chart & Explanation of all 8 Types: 6 Marks
Topper's Tip: Always draw the 4-Category Classification Table right after the definition before explaining the 8 points!
1. Meaning and Definition of Preference Shares
Meaning of Preference Shares
As the name indicates, Preference Shares are those shares which enjoy certain preferential rights (priorities) over equity shares. They are a safe source of owned capital preferred by cautious investors who want a steady, fixed return with low risk. Preference shareholders are co-owners of the company, though they do not carry normal voting rights.
Legal Definition (Section 43(b) of the Companies Act, 2013)
According to Section 43(b) of the Companies Act, 2013, a Preference Share is one which carries the following two preferential rights over equity shares:
- Preferential Right as to Payment of Dividend: A preferential right to receive dividend at a fixed rate (either a fixed amount or an amount calculated at a fixed rate) during the lifetime of the company, before any dividend is paid to equity shareholders.
- Preferential Right as to Return of Capital: A preferential right to the repayment of paid-up capital in the event of winding up (liquidation) of the company, before any capital is returned to equity shareholders.
2. Classification Chart: 8 Types of Preference Shares
Preference shares are classified into 8 distinct types under 4 main bases of classification:
| Sr. No. | Basis of Classification | Types of Preference Shares (8 Types) |
|---|---|---|
| A. | On the Basis of Accumulation of Dividend | 1. Cumulative Preference Shares 2. Non-Cumulative Preference Shares |
| B. | On the Basis of Participation in Surplus Profit | 3. Participating Preference Shares 4. Non-Participating Preference Shares |
| C. | On the Basis of Convertibility into Equity Shares | 5. Convertible Preference Shares 6. Non-Convertible Preference Shares |
| D. | On the Basis of Redemption (Repayment of Capital) | 7. Redeemable Preference Shares 8. Irredeemable Preference Shares |
3. Detailed Explanation: Different Types of Preference Shares
1. Cumulative Preference Shares
Cumulative Preference Shares are those shares on which the dividend goes on accumulating (adding up) until it is fully paid. This means that if the company fails to pay dividend in any one or more years due to inadequate profit, the unpaid dividend gets accumulated as "Arrears of Dividend". These arrears must be paid out of future profits in subsequent years before any dividend is paid to equity shareholders. Note: All preference shares issued by a company are always presumed to be Cumulative Preference Shares unless stated otherwise in the Articles of Association.
2. Non-Cumulative Preference Shares
Dividend on Non-Cumulative Preference Shares does not get accumulated. It means the dividend on these shares can be paid only out of the profits of that particular year. The right to claim dividend will lapse (expire) if the company does not make profit in that particular year. If dividend is not paid in any year, it is lost forever and cannot be claimed in future years.
3. Participating Preference Shares
The holders of Participating Preference Shares are entitled to participate in the surplus profit besides (in addition to) their fixed preferential dividend. Surplus profit refers to the extra profit remaining after paying the fixed dividend to preference shareholders and a certain fixed limit of dividend to equity shareholders (as specified in the Articles of Association). They may also be entitled to participate in surplus assets at the time of winding up.
4. Non-Participating Preference Shares
The preference shares are deemed to be Non-Participating Preference Shares if there is no clear provision in the Articles of Association. These shareholders are entitled to receive only the fixed rate of dividend prescribed in the issue terms and have no right to share in any surplus profit or surplus assets of the company.
5. Convertible Preference Shares
The holders of Convertible Preference Shares have a right to convert their preference shares into equity shares within a certain fixed period, if approved by passing a Special Resolution. Once converted, they lose their preferential status and enjoy all the rights and benefits of equity shareholders.
6. Non-Convertible Preference Shares
Non-Convertible Preference Shares are those shares which cannot be converted into equity shares at any time during their tenure. Unless the Articles of Association or terms of issue explicitly state otherwise, all preference shares are assumed to be non-convertible.
7. Redeemable Preference Shares
Shares which can be redeemed (repaid) after a certain fixed period of time during the lifetime of the company are called Redeemable Preference Shares. A company limited by shares, if authorized by its Articles of Association, issues redeemable preference shares. Under Section 55 of the Companies Act, 2013, such shares must be redeemed out of divisible profits or out of the proceeds of a fresh issue of shares made for the purpose of redemption (within a maximum period of 20 years).
8. Irredeemable Preference Shares
Shares which cannot be redeemed during the lifetime of the company are known as Irredeemable Preference Shares. The money invested in these shares is repaid only at the time of winding up (liquidation) of the company. Important Legal Provision: As per Section 55(1) of the Companies Act, 2013, a company in India cannot issue Irredeemable Preference Shares.
Quick Memory Trick to Remember All 8 Types in the Exam
Memory Shortcut (4 Opposite Pairs — "C-P-C-R"):
Never memorize 8 separate names! Just remember 4 keywords ("CPCR") and add "Non-" / "Ir-" for the opposite pair:
1. Cumulative & Non-Cumulative (About Unpaid Dividend Accumulating)
2. Participating & Non-Participating (About Sharing in Surplus Profit)
3. Convertible & Non-Convertible (About Converting into Equity Shares)
4. Redeemable & Ir-Redeemable (About Repayment of Capital During Lifetime)
Key Concept Summary for Objective Questions (Q.1)
- Default Nature of Preference Shares: Unless the Articles of Association state otherwise, all Preference Shares are deemed to be Cumulative, Non-Participating, and Non-Convertible.
- Maximum Tenure (20 Years): Under Section 55 of the Companies Act, 2013, a company cannot issue preference shares redeemable after 20 years from the date of issue (except up to 30 years for infrastructure companies).
- Prohibition on Irredeemable Preference Shares: Under the Companies Act, 2013, Indian companies are prohibited from issuing Irredeemable Preference Shares.
- Condition for Redemption: Preference shares can be redeemed only if they are fully paid-up. Partly paid-up preference shares cannot be redeemed.