FRENCH CJ.
Introduction
Companies raise capital by the issue of shares and in a variety of other ways. The shares in a company may be divided into different classes with different rights attaching to them. Preference shares confer priorities on their holders, over ordinary shareholders, with respect to dividends or repayment of capital or voting rights or combinations of those things. They can be used to raise additional capital for a company or to raise original capital or for other purposes.
In this appeal, which represents a particular aspect of a wide-ranging and complex family dispute, it is said that preference shares in a company cannot validly be issued unless there are ordinary shares already issued. The issue of redeemable preference shares to the appellant's mother was said to have been invalid for that reason. The right to redeem the shares in the absence of issued ordinary shares was also said to offend against the principle of the maintenance of capital. The arguments are based largely upon historical grounds relating to the original purpose of preference shares, which was to raise additional capital for companies, and implications derived from longstanding legislative restrictions on the reduction of capital.
The arguments of the appellant rest upon an unduly narrow view of the legitimate purposes for which preference shares can be used. They also seek to draw an unwarranted implication limiting the powers of companies with respect to the issue and redemption of such shares by reference to a generalised conception of the statutory policy in favour of the maintenance of capital. For the reasons that follow the appeal should be dismissed with costs.
Facts and procedural background
LW Furniture Consolidated (Aust) Pty Ltd ("LWC") was incorporated on 30 April 1971. Article 3 of the articles of association ("the Articles") stated that its capital was $20,000.00, divided into twenty thousand shares of one dollar each. Its shares included fourteen classes designated "A" to "N". Classes "A" to "D" were described as "preference shares" comprising:
"5 'A' 5% Convertible Preference Shares, 5 'B' Redeemable Preference Shares, 10 'C' Redeemable Preference Shares, 10 'D' Redeemable Preference Shares".
Article 3 also provided for 1,997 of each of the remaining ten classes designated "E" to "N" and described as "ordinary shares".
None of the shares in classes "A" to "D" carried voting rights. The founding directors of the company were Leo and Hedy Weinstock. Leo, as one of the subscribers to the memorandum of association ("the Memorandum"), held four of the "A" class shares and the other subscriber, a solicitor, Brian Nagel, held the remaining "A" class share on trust for Leo. Leo had the right during his life and while he held at least four of the "A" class shares to convert them to five per cent preference shares carrying voting rights at general meetings of the company. At some time or times Hedy was issued with a total of eight "C" class shares. Leo and Hedy's children, Amiram Weinstock and Tamar Beck, were each issued a single "C" class share. Two "D" class shares were issued to a company associated with Amiram. The arrangements were designed to reduce death and estate duties payable on the death of Leo.
Leo died in 2003 and Hedy on 6 July 2004. At the time of Hedy's death the issued shares in the company were:
• Five "A" 5% convertible preference shares, of which four were held by Leo's estate and one by Mr Nagel.
• Ten "C" redeemable preference shares, of which eight were held by Hedy and one each by Amiram and Tamar.
• Two "D" redeemable preference shares held by a company connected with Amiram.
No ordinary shares were ever issued.
Amiram and Tamar were appointed as directors of LWC in June 1973. As appears from the judgment in the related appeal, both Amiram and Tamar had ceased to be directors at the commencement of the annual general meeting of LWC in December 1973, a consequence of the provisions of the Articles of which they were evidently unaware. They continued to act as directors until 1982 when Tamar resigned. Amiram continued thereafter and purported to appoint his wife, Helen, as a director in 2003. Amiram's status as a director of the company was not in issue in these proceedings.
At some time after Hedy's death, Amiram, acting as a director of LWC, purported to pass a resolution redeeming, for one dollar each, the eight "C" class shares which his mother had held at her death. Although there was no company minute to that effect, the primary judge, Hamilton AJ, found a clear statement in a letter written by Amiram to be "sufficient evidence of the requisite resolution."
In 2007, Tamar commenced proceedings in the Equity Division of the Supreme Court of New South Wales making a large number of claims against Amiram, Helen and LWC, among others. Those proceedings have led to this appeal. Most of the claims were resolved by agreement and consent orders were made by Hamilton AJ. The issues remaining for determination by his Honour related to the eight "C" class shares in LWC that were held by Hedy at her death on 6 July 2004.
On Tamar's application, Hamilton AJ made a declaration that the eight "C" class shares held by Hedy at her death were not preference shares within the meaning of the Companies Act 1961 (NSW) ("the 1961 Act") at the times they were issued, nor within the meaning of the Corporations Act 2001 (Cth) ("the 2001 Act"), and that they were not able to be redeemed under the 2001 Act. His Honour declared the resolution purporting to redeem the shares and their purported redemption to be void and of no effect. He made orders for the rectification of the register of LWC to record Hedy as continuing to be the holder of the shares on and from the date of the purported redemption. Amiram, Helen and LWC were ordered to pay Tamar's costs.
Amiram, Helen and LWC appealed to the Court of Appeal. By majority (Handley AJA, Giles JA concurring, Young JA dissenting) the Court allowed the appeal, set aside the orders made by Hamilton AJ, and substituted a declaration that the eight "C" class shares held by Hedy were redeemable preference shares which were validly redeemed by the company on or about 29 July 2004. Tamar was ordered to pay the costs of the appeal and also the costs of Amiram, Helen and LWC in the hearing in the Equity Division.
On 10 February 2012, this Court (Gummow and Heydon JJ) granted Tamar special leave to appeal from the whole of the judgment and order of the New South Wales Court of Appeal.
The decisions at first instance and on appeal
The primary judge held that it was an essential quality of a preference share that it confer an advantage over another class of share. Neither the 1961 Act nor the 2001 Act contemplated that preference shares could validly be issued on the basis that they conferred a preference over unissued ordinary shares. If the only issued shares were redeemable preference shares which could at appropriate times be redeemed, the company could be left without issued shares and the basic rule against the reduction of capital thereby circumvented. His Honour concluded that preference shares could not be created unless there had been issued, at the time of their creation, shares over which they had preference, as to capital or as to dividend or as to both. His Honour appears to have relied upon implications limiting the powers conferred by the 1961 and 2001 Acts for provision to be made in company constitutions relating to the issue and redemption of preference shares.
In the Court of Appeal, Handley AJA, with whom Giles JA agreed, held that the power conferred on the directors by Art 4 of the Articles to issue new shares from available nominal capital could be exercised at all times. It was not affected by the state of the company's share register. The directors validly in office could have issued ordinary shares at all times and could still do so, subject to the equitable constraints derived from the fiduciary nature of their power.
Handley AJA held that it must follow that the "C" and "D" class shares were validly issued and conferred on their holders the preferential rights defined in the Articles. Those rights would remain potential only, without effective content, unless and until the directors issued ordinary shares. His Honour held there was nothing unusual about that situation. The preferential right to a dividend was dependent on the company earning divisible profits and the decision of the directors to declare a dividend. Until then the right was potential only.
Young JA in dissent said that although the history of the concept of the preference share in Australia and other jurisdictions provided little assistance, it pointed in one direction, namely that a preference share is one which has preferred rights over another class of share. If there is no other class of share, there cannot be a preference share. Unissued shares have no existence. If preference shares confer preferred rights over something else, that something else must exist. In the event, his Honour came to the same conclusion as the primary judge.
The grounds of appeal
The sole ground of appeal to this Court is that:
"The Court below erred in holding that eight C class shares in [LWC] were redeemable preference shares for the purposes of the Corporations Act 2001 (Cth) notwithstanding that there were never any other shares on issue in [LWC] by reference to which the C class shares conferred a preference."
Consideration of this appeal begins with the company's constitution, specifically the Articles.
The Memorandum and the Articles
The objects of LWC, set out in the Memorandum, included "[t]o raise money by the issue of shares in the capital of the Company and/or otherwise". That the object encompassed the issue of preference shares in advance of the issue of ordinary shares was suggested by the subscription clause, which showed that Leo and Mr Nagel had subscribed for "A" class convertible preference shares.
Articles 3(2) to 3(5) of the Articles defined the "rights privileges and conditions" attached to each of the share classes "A" to "D". The rights, privileges and conditions attached to the ten "C" class redeemable preference shares were set out in Art 3(4). They were to rank, with respect to return of capital in a winding up and in a reduction of capital, next after the "A" class convertible preference shares and the "B" class redeemable preference shares. Otherwise, but pari passu with any "D" class redeemable preference shares, they would also rank in priority to all other shares in the capital of the company. They conferred on their holders:
"the right to receive such dividends as may be declared thereon pursuant to Article 101 hereof and subject to the provisions of sub-clause (3) of that Article shall rank as regards such dividends pari passu with the Ordinary Shares in the Company. Such dividends (if any) shall be non-cumulative."
They did not carry the right to any further participation in surplus profits or assets. They were liable to be redeemed at par value on or before 30 June 2016. They were also to be redeemed upon the death of their holder, with payment to be made to the holder's personal representatives.
Article 4 provided for the issue and allotment of unissued shares on such terms and conditions and at such times as the directors thought fit. Article 5 provided for the issue of preference shares:
"Subject to the provisions of section 61 of the [1961] Act the Company may issue preference shares which are or at the option of the Company are to be liable to be redeemed and such power may be exercised by the directors."
Article 101 empowered the directors to declare dividends. It conferred upon the directors, subject to the provisions of Art 3, and until the death of Leo and Hedy, an absolute discretion in the determination from time to time of the rate of dividend, if any, to be paid in respect of shares in the classes "B" to "N" inclusive.
The preference which the "C" class shares conferred was a priority over ordinary shares with respect to the return of capital in a winding up or upon a reduction of capital. There was nothing express in the Memorandum or the Articles to prevent the issue of preference shares in the absence of issued ordinary shares. The power to issue preference shares was widely expressed, as was the power to issue shares generally. The limitation propounded by Tamar depended upon the meaning of the term "preference share" as used in the 1961 Act and in the Articles by reference to the history of such shares. The further propounded limitation was that such shares could not be issued as redeemable preference shares or redeemed absent the existence of issued ordinary shares. That limitation was based upon the principle of the maintenance of capital. The questions raised are in part questions of the construction of the relevant companies legislation. It is necessary first to consider the history of the preference share, which was said by Tamar to be relevant to the construction question.
The evolving character of the preference share
The preference share emerged in the United Kingdom in the 18th and 19th centuries out of the need for private infrastructure corporations to raise capital to fund the completion of projects for which inadequate initial capital had been subscribed. To induce investors to provide that additional capital, shares were issued which attracted preferential dividend rights. The term "preference share" was not always used. Designations such as "active", "county", "profitable", "new" and "privileged" were also used to describe such shares.
Although initially "a device for emergency finance" directed to raising additional capital, over time the preference share was put to wider uses including the retirement of debt. It came to confer priorities in relation to dividends, capital and voting rights in different combinations. The variety of its uses and the priority rights it conferred made a narrow legal definition elusive. What all preference shares had in common, however, was that they conferred upon their holders one or more entitlements in priority to the holders of ordinary shares.
In the first half of the 19th century in the United Kingdom, the authority to issue preference shares and to create the priorities they conferred was to be found in specific purpose statutes. Later, the source of that authority was to be found in the constitutions of the companies creating such shares, read with general companies legislation. That general proposition was reflected in the observation of Lord Simonds in Scottish Insurance Corporation Ltd v Wilsons & Clyde Coal Co Ltd:
"subject to any relevant provision of the general law, the rights inter se of preference and ordinary shareholders must depend on the terms of the instrument which contains the bargain that they have made with the company and each other."
Authority to issue preference shares did not have to be spelt out in a company's constitution. A provision authorising an increase in capital by the issue of new shares "with such rights and privileges, or with such restrictions and on such terms and conditions as the company in general meeting directs" was sufficient to support the issue of shares giving priorities over other shareholders. The nature of the priority authorised by the articles might be limited to priority in dividends or extend to a priority in repayment of capital out of the assets. It might also be a priority in voting rights.
Consistently with the original and predominant purpose of the preference share, its consideration in textbooks and judicial decisions, particularly in the 19th century and early 20th century, was linked to its use as a means of increasing capital. That was a use which occurred when there were already in existence ordinary shares representing the ordinary capital of the company. That may have been implicit in Palmer's reference, in the first edition of his book on company precedents published in 1877, to "creating shares having a preference over those already issued" when distinguishing preference shares from shares with deferred rights. In any event, as pointed out by the respondents, even in its first edition, Palmer's book supported the proposition that preference shares of various kinds were in use at the time of its publication.
Tamar referred, in written submissions, to s 14 of the Companies Clauses Act 1863 (UK), which conferred an entitlement on preference shareholders to a preferential dividend out of profits in priority to "the ordinary shares and ordinary stock of the company". The latter term was said to relate to the issued capital of the company. That is not surprising given that s 14 complemented s 13, which was concerned with the issue of preference shares to raise additional capital. Moreover, as the respondents pointed out, ss 13 and 14 of the Companies Clauses Act 1863 applied only to companies whose authority to raise preference shares was expressly conferred by private Acts of Parliament passed for that purpose. Tamar also relied upon the observation by Cotton LJ in In re Brighton and Dyke Railway Co that preference shares were "defined" by s 14. That observation was made in the context of the particular statute. It did not purport to be of general application.
A broadening of the purpose of the preference share was its use to raise ordinary capital. In Palmer's first edition there is a precedent for a clause dividing the original capital of a company into several classes of shares, including preference shares and deferred shares. Further, in British and American Trustee and Finance Corporation v Couper, Lord Macnaghten held that there was nothing in the Companies Act 1862 (UK) or in any other Act requiring the memorandum of a company to contain any reference to the rights of shareholders in the capital of the company inter se. On that basis he said:
"The division of the capital into shares of a certain fixed amount which must appear in the memorandum would not be altered or affected by issuing some of the shares as preference shares."
The respondents also pointed to the decision of Chitty J in In re Floating Dock Company of St Thomas Ltd, which was decided shortly after British and American Trustee and Finance Corporation. Chitty J approved a capital reduction resulting in the cancellation of ordinary and second preference shares and leaving in place only first preference shares.
The proposition that there was an implied condition in a company memorandum that all shareholders were to have equal rights unless the memorandum itself showed the contrary was also rejected by Lindley LJ, in delivering the judgment of the Court of Appeal in Andrews v Gas Meter Co. Andrews concerned the validity of preference shares issued in order to raise new capital, which was to be treated under the articles as part of the original capital. That decision was relied upon by the Supreme Court of New Zealand in 1913 for the extended proposition that part of the original capital of the company could be raised by the issue of preference shares. The New Zealand decision in turn was applied by this Court in Rofe v Campbell, in which the plurality said:
"An express power contained in the articles is enough to enable the directors to issue capital as preference shares … but the power must be given to them by the articles expressly or by necessary intendment."
The Privy Council reversed that decision, primarily on the construction of the relevant memorandum and articles. In so doing, however, and consistently with the decision of this Court, their Lordships summarised the relevant law:
"If nothing is said in the memorandum, the articles of association may provide for the issue of the authorized capital in the form of preference shares; if the articles do not so provide, or do provide for equality inter socios, the power to issue preference shares may be obtained by alteration of the articles."
In that case there was no express provision in the articles of the company for preference shares as part of the original capital, but there was express provision for the future issue of such shares.
Once it is accepted that preference shares were able to be issued, long before the enactment of the 1961 Act and the formation of LWC, to raise part of the original capital of a company, the historical rationale for the proposition that a share issued, absent the issue of ordinary shares, could not be designated as a "preference share" within the meaning of the 1961 Act and the 2001 Act, is weakened to the point of extinguishment. The variety of purposes for which preference shares could be used, the variety of rights which could attach to them, and their availability as a means of raising original capital, lead to the rejection of the historical argument advanced by Tamar in support of the proposition that the "C" class shares held by Hedy prior to her death were not preference shares when issued.
Against that background it is necessary to have regard to the companies legislation relevant to the issue and redemption of preference shares in LWC.
The statutory framework
At the time that LWC was incorporated, the 1961 Act was in force. Section 61 of that Act provided that, subject to that section, a company having a share capital could, if so authorised by its articles, issue preference shares liable to be redeemed at the option of the company, the redemption to be effected only on such terms and in such a manner as provided by the articles. Redemption would not be taken as reducing the amount of authorised share capital of the company. Section 61(3) provided that the shares were not to be redeemed 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, nor could such shares be redeemed unless fully paid up.
Where redeemable preference shares were redeemed otherwise than out of the proceeds of a fresh issue, s 61(5) required that, out of the profits which would otherwise have been available for dividend, a sum equal to the nominal amount of the shares redeemed be transferred to a reserve called the "capital redemption reserve". The provisions of the 1961 Act relating to the reduction of the share capital of a company applied, except as provided in s 61, as if the capital redemption reserve were paid up share capital of the company. That being said, the redemption of redeemable preference shares out of profits otherwise available for dividends was a reduction of capital, albeit offset by the crediting of the nominal value of the shares redeemed to the capital redemption reserve. The ancestry of s 61 can be traced back to s 46 of the Companies Act 1929 (UK), which was the first general companies legislation in the United Kingdom to provide for the issue of redeemable preference shares. Similar but not identical provision was made by s 149 of the Companies Act 1936 (NSW).
Tamar submitted that the requirements in s 149 of the 1936 Act for a special resolution for the issue of redeemable preference shares and that the company balance sheets set out what part of the issued capital consisted of such shares assumed the prior issue of ordinary shares. However, as the respondents pointed out, there was no limit expressed in the 1936 Act as to what might be agreed by a special resolution under s 149 nor any constraint on a company's ability to determine what part of its capital was to be redeemed. Neither the 1936 Act, the 1961 Act, nor its successors up to and including the 2001 Act, proscribed the issue of redeemable preference shares in the absence of issued ordinary shares. The Companies Act 1981 (UK) included a specific provision that prohibited the issue of redeemable shares at any time when there were no issued shares of the company which were not redeemable. That provision has not been replicated in Australia.
Section 66 of the 1961 Act required specification in the company constitution of the rights attaching to preference 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. The 1961 Act did not contain any definition of preference share or redeemable preference share. Nevertheless, the Act indicated the generic character of the "preference share", encompassing shares defined by a variety of priority rights and issued for a variety of purposes. Nothing in the Act excluded from the concept of preference share, shares issued in the absence of issued ordinary shares. And as already observed, nothing in the history of the preference share supports such an exclusion.
The Companies (Application of Laws) Act 1981 (NSW) applied the provisions of the Companies Act 1981 (Cth) as a law of New South Wales known as the Companies (New South Wales) Code from 1 July 1982 to the exclusion of the Companies Act 1961. The Companies Code was superseded by the Corporations Act 1989 (Cth), found to be invalid in New South Wales v The Commonwealth. The 1989 Act was succeeded by the Uniform Legislation Scheme which came into effect in New South Wales in 1991 as the Corporations Law. The 1961 Act was eventually repealed by the Statute Law (Miscellaneous Provisions) Act 2008 (NSW). Even assuming that some of the "C" class shares issued to Hedy were issued when the Companies Code or the Corporations Law were in effect in New South Wales, it has not been suggested that there was any material difference in the provisions of those statutory regimes or in any transitional provisions which would differentiate the power to issue preference shares or redeemable preference shares under those regimes from the power to issue shares under the 1961 Act.
Before turning to the 2001 Act it should be noted that the Articles were affected by legislative change in 1998. In 1998 the requirement that company constitutions define an authorised share capital was removed by the Company Law Review Act 1998 (Cth). That requirement was removed because it no longer served the purpose of allowing the creditors of a company to assess the size of its business undertaking. The concept of par value was also abolished as an "arbitrary monetary denomination attributed to the shares", not representing their true value, and potentially "misleading to an unsophisticated investor." Section 1427(1) of the Corporations Law, inserted by item 11 of Sched 1 to the Company Law Review Act 1998 (Cth), repealed any provision of a company constitution stating the amount of the company's share capital and dividing it into shares of a fixed amount. There was no submission that that provision made any difference to the outcome of this appeal.
At the time of Hedy's death, the 2001 Act was in force. Section 124 of that Act sets out the legal capacity and powers of a company, including the power to "issue and cancel shares in the company". Section 254A(1) provides that a company's power under s 124 to issue shares includes the power to issue:
"preference shares (including redeemable preference shares)".
As with s 66 of the 1961 Act, s 254A(2) of the 2001 Act provides that a company can issue preference shares only if the rights attached to them with respect to repayment of capital, participation in surplus assets and profits, cumulative and non-cumulative dividends, voting and priority of payment of capital and dividends in relation to other shares or classes of preference shares are set out in the company's constitution or have been otherwise approved by special resolution of the company. As with s 66 of the 1961 Act, s 254A(1) of the 2001 Act uses the term "preference share" in a generic sense. The term itself is not defined.
Section 254A(3), which defines redeemable preference shares, provides:
"Redeemable preference shares are preference shares that are issued on the terms that they are liable to be redeemed. They may be redeemable:
(a) at a fixed time or on the happening of a particular event; or
(b) at the company's option; or
(c) at the shareholder's option."
Part 2H.2 of the 2001 Act is entitled "Redemption of redeemable preference shares". Section 254J requires that a company redeem redeemable preference shares only on the terms on which they are issued. On redemption the shares are cancelled. By s 254K a company can only redeem such shares if they are fully paid up and out of profits or the proceeds of a new issue of shares made for the purpose of the redemption.
The 2001 Act, like its predecessors, provides mechanisms for the protection of the capital of a company in the event of the redemption of redeemable preference shares. There is nothing in the Act which would exclude from the concept of "preference share" a preference share issued in the absence of issued ordinary shares. Nor is there anything in the Act to proscribe the redemption of redeemable preference shares in the absence of issued ordinary shares.
Redemption and the maintenance of capital
Tamar submitted, in effect, that the concept of a redeemable preference share issued in advance of the issue of ordinary shares was inconsistent with the principle that the share capital of a company should be maintained unless the court sanctioned its reduction. The prohibition on the reduction of a company's capital appeared in the Companies Act 1862 (UK). It was relaxed by the Companies Act 1867 (UK), which allowed for reduction of capital to be approved by the court. The rationale of the restriction as explained in the House of Lords in Trevor v Whitworth was that persons dealing with a company were entitled to assume that no part of the capital put into the company had later been paid out except in the legitimate course of business. Consistently with the restrictions on the reduction of capital, the provisions of the Companies Act 1929 (UK) and its Australian descendants required that redemption of redeemable preference shares be out of profits or the proceeds of a fresh issue of shares. Those requirements and that of a capital redemption reserve fund being applicable only to preference shares, it was submitted for Tamar that there was an implication that the holders of ordinary shares would continue to exist and continue to hold the capital of the company.
The specific protections of company capital which attach to the redemption of redeemable preference shares do not logically require that such shares only be brought into existence after ordinary shares have been issued and only redeemed while there are ordinary shares in existence. It is a bridge too far to infer from the statutory scheme under either or both of the 1961 Act and the 2001 Act that there is some implied limitation of the kind propounded on behalf of Tamar affecting the issue and redemption of redeemable preference shares but not stated in the respective statutes and not to be found expressly or by implication in the constitution of the company. It may be accepted, as was submitted by the respondents, that the prospect of capital being returned to shareholders other than in accordance with the 2001 Act is not created or heightened by the circumstance that a company has only preference shares on issue at a particular point in time.
The submissions on behalf of Tamar as to the issue and redemption of the redeemable preference shares should not be accepted.
Conclusion
For the preceding reasons the appeal should be dismissed with costs.