Submission on the Companies (Clarification of Dividend Rules in Companies) Amendment Bill

Introduction

The explanatory note accompanying the (private member’s) Bill states that:

• there is currently doubt about the ability of a company constitution to provide for ‘dry shares’ (shares which do not carry dividend rights in prescribed circumstances); and
• the classic example is shares in a co-operative where the holder ceases supplying the co-operative.

However, the explanatory note continues by stating that the issue is broader than this – and that the uncertainty arises because of the interplay between sections 36 and 53 of the Companies Act.

As a fix, the Bill proposes to add a “for the avoidance of doubt doubt” tag-on to section 53(2) that nothing in that subsection prevents the constitution of a company providing that shares in a class do not confer a right to receive dividends in the circumstances specified in the constitution.

Divergence of views?

I noted that there appear to be two schools of thought:

1. constitution can provide: that a company constitution can provide for different entitlements – but section 53 of the Companies Act makes it clear that the Board must not authorise a dividend in respect of some shares only in a class / at a different value per share for some shares in a class (i.e. the directors do not have a discretion to “stream” dividends by paying different entitlements – but can do so if it is prescribed by the constitution); or
2. constitution cannot override section 53: that the effect of section 53 is that it is not possible to provide for different entitlements – even by specifying for them in the constitution.

My view, and I think the view which is shared by a number of experienced lawyers practising in this area, is that the first school of thought is the correct one.

Whilst the use of co-operatives is not confined to the rural economy, the first approach is at the heart of the wet share / dry share dichotomy that is commonly found in co-operative companies. And this approach also underpins the approach taken in the drafting of constitutions of companies that are not co-operatives – to provide for the automatic reclassification of shares into those in a different class if the shareholder’s circumstances change.

Typically a change of circumstances will be those where the shareholder ceases/resumes trading with the company. But, conceptually, the shareholders should be free to contract for other trigger events (for example where a working shareholder becomes a passive investor).  Amongst other things, the process of providing (hard-wiring) the knock-on impact of such changes into the constitution promotes transparency about the circumstances in which a shareholder’s entitlements will change.

From this, it is logical that only if section 53 is an irrevocable rule which cannot be overridden by the constitution – that there is a problem that needs fixing.

However, there does not appear to be an impediment in the Companies Act that prevents a constitution from specifying that shares of a certain class have reduced or enhanced rights – based on a trigger event.

Concluding comments

The effect of a constitution is that of a contract between the company and each shareholder (and the shareholders amongst themselves). Accordingly, if shareholders can contract to subscribe or purchase shares in different classes with different entitlements, then there does not seem to be any good reason why they should they not be able to contract for shares of the same class with different entitlements.

Only if my view and (anecdotally) that of a number of other experienced lawyers is wrong (and the second school of thought is shown to be correct) then the thinking which appears to underpin the Bill becomes relevant.

That is the ability to “stream” dividends is consistent with enabling shareholders to have the necessary freedom to contract for such arrangements as between themselves.  In short, if shareholders can agree to take up shares in different classes with different earnings entitlements – why should they not be able to agree to take up shares of the same class with differing entitlements?