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Unit 5: Redemption of Preference Shares

5.2.2 Capital Redemption Reserve Account Notes

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Caution Capital redemption reserve account is created under Section 80 which states that
it should be treated as paid up capital. When redeemable preference shares are redeemed
from out of those profits which are otherwise available for dividend (mentioned above),
these profits are transferred to capital redemption reserve account.

Capital Redemption Reserve Account is utilised by the company in paying up unissued shares
of the company to be issued to existing members of the company as fully paid bonus shares. In
other words, this reserve is non-distributable and only fully paid bonus shares can be issued
from this reserve. If this reserve is distributed among shareholders as profit, it will entail a
reduction of capital which will adversely affect the interest of third party (creditors).

No redemption of partly paid up preference shares until they are fully paid

As per Section 80(a) (mentioned above) there will be no redemption of such a redeemable
preference shares which are not fully paid. The purpose of this Section is only to protect the
interest of third party (creditors). Whenever a third party gives loans and advances to the
company they look for security. This security is not only in existing assets but also in prospective
amount of assets to be received in future. Thus, when preference shares are partly paid up, the
uncalled amount of capital on partly paid up shares can always be called up by the company and
by the liquidator at the time of its liquidation under conditions of the contract. If Section 80 of
Companies Act allows the redemption of partly paid redeemable preference shares, it would
mean the replacement of equivalent amount either by the proceeds of fresh issue of shares, or by
the capital redemption reserve account. This will deceive the creditors whose calculations are
based on the nominal value of shares at the time of advancing the loans or extending the credit
facilities. Thus, in order to protect the interest of creditors, it was felt necessary that it is not paid
up amount of redeemable preference shares, but the nominal value of shares that requires
replacement. Thus, in order to protect the interest of creditors, Section 80 of the Companies Act
makes it compulsory that no partly paid up preference share will be redeemed unless they are
fully paid up. This will automatically replaces that amount (fully paid up) on which creditors’
calculation are based.

Remedy for redemption of preference shares at the time of failure of the company

If a public company fails or is unable to redeem its redeemable preference shares by a certain
date fixed for redemption, the following remedies will be available to the shareholders:

(i) If redeemable shares are issued and redeemable at the option of the company, shareholders
can have no grievance.
(ii) If the shares are redeemable after the expiry of a particular period, possibly an order for
liquidation may be obtained against the company on the just and equitable ground.
Preference shareholders are not the creditors of the company and therefore, they cannot
sue for the money due on the shares undertaken to be redeemed and cannot, as a right,
claim a return of their share money except in liquidation.

Premium on Redemption of Preference Shares

If the redeemable preference shares are redeemable at a premium, the amount payable on the
redemption of preference share can be provided either out of the share premium received from
the fresh issue of shares, or from the profits of the company whether it is a capital profit or
revenue profit.

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