- Preference shares defined for the purposes of the Pilot Scheme
- Holders will have limited voting rights and will only be entitled to vote in certain matters
- Preference shares under the Pilot Scheme are not as comprehensive as the generally accepted concept of preference shares
On November 30, 2013, the State Council issued the Guideline on Launch of the Preference Shares Pilot Schedule (“Guideline”), based on which the China Securities Regulatory Commission (“CSRC”) released the drafted “Administrative Measures for Preference Shares Pilot Scheme” on December 13, 2013 (“Administrative Rules”, together with the Guideline, the “Pilot Scheme”). “Preference shares” have been adopted by the company laws in many jurisdictions including the US, Cayman Islands and British Virgin Islands. The Guideline and the Administrative Rules intend to incorporate this concept into the PRC company law system. This article provides the general principles of the “preference shares” under the Pilot Scheme.
Highlights of the Pilot Scheme
Under the Pilot Scheme, “preference share” is defined as a type of share whose holders shall have preference over ordinary shareholders in distribution of the company’s profits and assets, but shall be restricted in participation in the company’s decision-making and management, e.g., voting rights. Even though the definition does not prohibit the other preferences or privilege attached to the preference shares that are stipulated in the company’s articles of association, the fundamental character of the preference share under the Pilot Scheme is the distribution preference.
Rights and Limitations
Preference shares have preference and priority over ordinary shares to obtain the distribution of the company’s profits or remaining assets, meaning the company shall not distribute profits or remaining assets to ordinary shareholders until the agreed dividend or liquidation value to preference shareholders is fully paid. The company is allowed to further explore the distribution preference in the company’s articles of association. However, during the pilot period, issuers may not issue preference shares with different rankings for distribution but may issue preference shares with different rights in respect of other terms.
According to the Pilot Scheme, preference shareholders will have limited voting rights and will only be entitled to vote for the following matters:
- Amendments to the provisions related to the preference shares in the company’s articles of association;
- Decrease of company registered capital in excess of 10% of the total registered capital of the company;
- Company mergers, acquisition, dissolution or a change to the company incorporation form;
- Issuance of preference shares; and
- Any other matters stipulated in the article of association of the company.
There are also certain exceptions to the voting limitations and, under certain circumstances, the voting rights of the preference shareholders may be resumed or revived. In the case that a company has not paid the agreed dividend to preference shareholders for three accounting years cumulatively or two accounting years consecutively, the voting rights of the preference shareholders shall be resumed or revived until their respective dividend has been fully paid up. During such period of time, the preference shareholders shall have the equivalent rights to the ordinary shareholders.
Under the Pilot Scheme, the qualified issuers of the preference shares are the listed companies and non-listed public companies (subject to certain requirements). Opposed to the normal concept applied in the other jurisdictions, private companies in China are not allowed to issue any preference shares.
A listed company is allowed to issue preference shares by ways of public offering or private placement (where investors are less than 200). The listed company is required to meet one of the following conditions to initiate a public offering of the preference shares:
- The company’s ordinary shares are qualified as Shanghai Stock Exchange 50 index components;
- The preference shares are issued for the purpose of acquisition or merge with other listed companies; and
- The preference shares are issued for the purpose of redemption of the ordinary shares.
Similarly to the public offering of ordinary shares, public offering of preference shares will be subject to certain other requirements, such as the company being able to show profit for three consecutive years, satisfy profit distribution requirements stipulated by laws and have a specific purpose for the usage of the proceeds, etc. The preference shares issued by public offering should also have a fixed dividend rate, with the dividends being mandatorily distributed and cumulative. Moreover, the numbers of preference shares will be limited to 50% of all ordinary shares of the company and the funding proceeds generated from the offering shall be less than 50% of the company’s net assets before the issuance. In the event that the preference shares are convertible into ordinary shares, the conversion rights shall not be exercised within 36 months after the issuance.
Non-listed public companies are only allowed to issue the preference shares though private placement and they may apply for private placements of preference shares through the National Equities Exchange and Quotations, the so-called “third board”, which is an equity exchange system for small and medium-sized enterprises.
The companies issuing the preference shares shall also comply with the general requirements of the recording, trading and information disclosure stipulated by the CSRC and the stock exchange.
Mergers and Acquisition
Preference shares can be used as consideration in a merger or acquisition transactions and restructuring deals. A tender offer for a listed company must be extended to all shareholders, including the holders of preference shares, but different terms may be offered to the common shareholders and preference shareholders.
According to the Pilot Scheme, qualified investors for preference shares would include the approved financial institutions and their wealth management products, qualified foreign institutional investors, as well as the companies, partnerships and individual investors with assets of at least RMB 5 million in their investment accounts.
In case that there is any limitation to the percentage of foreign investment, such percentage shall be calculated by aggregating the number of both preference shares and ordinary shares held by such foreign investor.
In conclusion, the concept of “preference shares” under the Pilot Scheme is not as comprehensive as the generally accepted concept of “preference shares” and only provides limited flexibility to the public companies. The private companies still need to follow the basic principle under the PRC company laws that the shareholders shall have same rights. However, the launch of the Pilot Scheme is a positive step, providing both public companies an additional way of financing, while diversifying investment channels for investors. Please note that such regulation is an exposure draft at this stage and thus has no legal effect. It is to be expected that a final version will be officially promulgated within months