Preference shares -- keeping it simple

[stockton]

Regards redemptions you've got things back to front. Under the CA all prefs are irredeemable unless prior to their issue the articles state that they are redeemable subject to the appropriate conditions.

Chris.

So now we have a nice, neat and simple theory.
"Irredeemable" means "not redeemable - the opposite of redeemable".

Consequently Avivas intention was simply to apply the appropriate part of the Companies Act to redeem their preference shares (presumably we can use the word redeem because irredeemable does not mean "cannot be redeemed", but repay or similar synonym could equally well be used).

The problem with this theory is that If the matter is so simple it is difficult to see what was wrong with Avivas original announcement. Presumably the various institutions insisted that that was not the meaning that they ascribed to the word "irredeemable".

[ChrisNix]

Regards redemptions you've got things back to front. Under the CA all prefs are irredeemable unless prior to their issue the articles state that they are redeemable subject to the appropriate conditions.

Chris.

So now we have a nice, neat and simple theory.
"Irredeemable" means "not redeemable - the opposite of redeemable".

Consequently Avivas intention was simply to apply the appropriate part of the Companies Act to redeem their preference shares (presumably we can use the word redeem because irredeemable does not mean "cannot be redeemed", but repay or similar synonym could equally well be used).

The problem with this theory is that If the matter is so simple it is difficult to see what was wrong with Avivas original announcement. Presumably the various institutions insisted that that was not the meaning that they ascribed to the word "irredeemable".

Stockton,

Sorry if this is confusing.

The Aviva shares were not specified as redeemable prior to their issue nor were they specified as redeemable in the articles, Therefore they were never redeemable (aka irredeemable) under the appropriate part of the CA. Aviva were not relying on that section of the CA in their announcement.

Chris

[stockton]

Stockton,

Sorry if this is confusing.

The Aviva shares were not specified as redeemable prior to their issue nor were they specified as redeemable in the articles, Therefore they were never redeemable (aka irredeemable) under the appropriate part of the CA. Aviva were not relying on that section of the CA in their announcement.

Chris

Perhaps you should read my post again. Have you not realised that if one accepts your thesis about the meaning of "irredeemable", there is no need to define "redemption" or redeem ?

[GoSeigen]

Regards redemptions you've got things back to front. Under the CA all prefs are irredeemable unless prior to their issue the articles state that they are redeemable subject to the appropriate conditions.

Chris.

So now we have a nice, neat and simple theory.
"Irredeemable" means "not redeemable - the opposite of redeemable".

[...]

The problem with this theory is that If the matter is so simple it is difficult to see what was wrong with Avivas original announcement. Presumably the various institutions insisted that that was not the meaning that they ascribed to the word "irredeemable".

This is all correct, though there is not really a problem. I doubt any institutions quibble with the meaning of irredeemable -- that argument is only coming from amateurs as far as I can see. Most likely they simply overlooked capital reduction as a practical possibility, or assumed Aviva would give them a nod and a wink before doing anything like this.

GS

[stockton]

So now we have a nice, neat and simple theory.
"Irredeemable" means "not redeemable - the opposite of redeemable".

[...]

The problem with this theory is that If the matter is so simple it is difficult to see what was wrong with Avivas original announcement. Presumably the various institutions insisted that that was not the meaning that they ascribed to the word "irredeemable".

This is all correct, though there is not really a problem. I doubt any institutions quibble with the meaning of irredeemable -- that argument is only coming from amateurs as far as I can see. Most likely they simply overlooked capital reduction as a practical possibility, or assumed Aviva would give them a nod and a wink before doing anything like this.

GS

However, as recounted by Andrew Bailey, "irredeemable" does appear to be the problem.

[ChrisNix]

Can be repurchased subject to the appropriate conditions.

Cannot be redeemed without an amendment to the terms.

Consequently cannot be subject to a capital reduction without an amendment to the terms.

Stockton,

Your understanding of repurchases is accurate.

Regards redemptions you've got things back to front. Under the CA all prefs are irredeemable unless prior to their issue the articles state that they are redeemable subject to the appropriate conditions.

Chris.

ChrisNix wrote:
Stockton,

Sorry if this is confusing.

The Aviva shares were not specified as redeemable prior to their issue nor were they specified as redeemable in the articles, Therefore they were never redeemable (aka irredeemable) under the appropriate part of the CA. Aviva were not relying on that section of the CA in their announcement.

Chris

Perhaps you should read my post again. Have you not realised that if one accepts your thesis about the meaning of "irredeemable", there is no need to define "redemption" or redeem ?

Stockton,

If you read back through the thread what I said/meant was, "Under the CA all prefs are irredeemable unless prior to their issue the articles state that they are redeemable subject to the appropriate conditions: otherwise they are not redeemable pursuant to Part 18 Chapter 3 of the CA.

I'm not sure anything turns on the definition of "redemption" or "redeem"?

Chris

[GoSeigen]

However, as recounted by Andrew Bailey, "irredeemable" does appear to be the problem.

For amateur investors, whom he represents, yes. Not for institutions.


[Writing as OP on this thread] Please would posters be kind enough to heed the earlier moderation in this thread and stop arguing in circles on this matter, otherwise discussion is likely to be stopped completely. Those who still have an issue with "irredeemable" shares please read and understand the OP, or consult a legal or financial advisor. Of course posts of substance backed by some evidence are welcome from any poster.

GS

[Tara]

From the original post :

4. Three independent processes for repayment and cancellation of issued shares (including preference shares) are clearly described in Law:
-Redemption: repayment out of distributable profits
-Reduction of Capital: repayment out of capital
-Purchase out of Profits: repayment out of distributable profits


Can someone explain, if there are only the 3 ways as described above for the repayment and cancellation of preference shares, and taking LLPC as an example, is the correct position for repayment and cancellation of LLPC assuming a current market price of £1.50 as follows ?

1. Redemption : Not applicable and not allowed at any price ?
2. Reduction of Capital : Allowed at par price of £1, but only if 75% of Lloyds ordinary shareholders agree and a court also agrees ?
3. Purchase out of Profits : Allowed at the current market price of £1.50, and not below the current market price of £1.50, but only if 50% of Lloyds ordinary shareholders agree ? Or is it 75% of ordinary shareholders are needed ? And is this process just the same as a share buyback ?

And what about a tender offer for LLPC ? Is a tender offer just the same process as
Purchase out of Profits ?

[GoSeigen]

From the original post :

4. Three independent processes for repayment and cancellation of issued shares (including preference shares) are clearly described in Law:
-Redemption: repayment out of distributable profits
-Reduction of Capital: repayment out of capital
-Purchase out of Profits: repayment out of distributable profits


Can someone explain, if there are only the 3 ways as described above for the repayment and cancellation of preference shares, and taking LLPC as an example, is the correct position for repayment and cancellation of LLPC assuming a current market price of £1.50 as follows ?

1. Redemption : Not applicable and not allowed at any price ?
2. Reduction of Capital : Allowed at par price of £1, but only if 75% of Lloyds ordinary shareholders agree and a court also agrees ?
3. Purchase out of Profits : Allowed at the current market price of £1.50, and not below the current market price of £1.50, but only if 50% of Lloyds ordinary shareholders agree ? Or is it 75% of ordinary shareholders are needed ? And is this process just the same as a share buyback ?

And what about a tender offer for LLPC ? Is a tender offer just the same process as
Purchase out of Profits ?

Hi Tara, thanks for the questions.

1. Redemption. LLPC shares are irredeemable i.e. they were issued without any power to redeem. Therefore you are right, they will never be redeemed.
2. Reduction of capital. Is as you have stated.
3. Purchase of own shares. Purchases may be made following the authorisation of an ordinary resolution put to all members. The Companies Act requires purchased shares to be cancelled (except up to 10% of issued shares held in treasury) and the purchase to be funded from distributable profits. The terms of the purchase would involve some sort of lawful negotiation with the seller (which could be a tender process) i.e. it will be at a price where the seller is willing to sell and might be above or below £1.50. Yes, this is what is sometimes called a buyback in US terminology. Please check LBG Articles/Resolutions for the exact LLPC terms: the preceding is the typical situation.


GS
EDIT: Note that LLPC has a substitution clause too: the company has the absolute right without consent of holders to replace LLPC as a whole with Qualifying Non-innovative Tier 1 Securities at any time with approval of the regulator. Buyers might want to study the implications of this -- sorry, I can't help without further thought and research.

[ChrisNix]

Stockton,

Your understanding of repurchases is accurate.

Regards redemptions you've got things back to front. Under the CA all prefs are irredeemable unless prior to their issue the articles state that they are redeemable subject to the appropriate conditions.

Chris.

ChrisNix wrote:
Stockton,

Sorry if this is confusing.

The Aviva shares were not specified as redeemable prior to their issue nor were they specified as redeemable in the articles, Therefore they were never redeemable (aka irredeemable) under the appropriate part of the CA. Aviva were not relying on that section of the CA in their announcement.

Chris

Perhaps you should read my post again. Have you not realised that if one accepts your thesis about the meaning of "irredeemable", there is no need to define "redemption" or redeem ?

Stockton,

If you read back through the thread what I said/meant was, "Under the CA all prefs are irredeemable unless prior to their issue the articles state that they are redeemable subject to the appropriate conditions: otherwise they are not redeemable pursuant to Part 18 Chapter 3 of the CA.

I'm not sure anything turns on the definition of "redemption" or "redeem"?

Chris

Stockton.

It seems we have an agreed position on what irredeemable means in legal terms.

GS's excellent answer to Tara highlights the separate legal process of capital reduction.

Under the procedures set out in the CA all shares (ords and prefs) in a limited company can have have their capital reduced, and then have that amount paid to the shareholders. If all such capital is returned the shares are cancelled.

However, under 641 (6) this authority is subject to any provision of the company's articles restricting or prohibiting the reduction of the company's share capital.

Thus the default position for UK listed prefs is that they are reducible/cancellable. Some issues, such as NWBD, benefit from the protection of an article which requires a reduction of their capital to be subject to the prior sanction of 75% of the pref holders as a class.

I think much of the confusion in the market comes from participants tendency to use a shorthand where one size is used to fit all.

If one adopts a binomial classification, the vast majority of UK listed prefs (e.g. LLPC/LLPD) are freely cancellable, irredeemable shares.

The are quite a few which are freely cancellable and redeemable.

A small number (e.g. NWBD) are restricted cancellation, irredeemable shares.

The two BP prefs are freely cancellable and irredeemable, but the cancellation has to be made at a premium to the market price.

QED?

Chris

[Tara]

From the original post :

4. Three independent processes for repayment and cancellation of issued shares (including preference shares) are clearly described in Law:
-Redemption: repayment out of distributable profits
-Reduction of Capital: repayment out of capital
-Purchase out of Profits: repayment out of distributable profits


Can someone explain, if there are only the 3 ways as described above for the repayment and cancellation of preference shares, and taking LLPC as an example, is the correct position for repayment and cancellation of LLPC assuming a current market price of £1.50 as follows ?

1. Redemption : Not applicable and not allowed at any price ?
2. Reduction of Capital : Allowed at par price of £1, but only if 75% of Lloyds ordinary shareholders agree and a court also agrees ?
3. Purchase out of Profits : Allowed at the current market price of £1.50, and not below the current market price of £1.50, but only if 50% of Lloyds ordinary shareholders agree ? Or is it 75% of ordinary shareholders are needed ? And is this process just the same as a share buyback ?

And what about a tender offer for LLPC ? Is a tender offer just the same process as
Purchase out of Profits ?

Hi Tara, thanks for the questions.

1. Redemption. LLPC shares are irredeemable i.e. they were issued without any power to redeem. Therefore you are right, they will never be redeemed.
2. Reduction of capital. Is as you have stated.
3. Purchase of own shares. Purchases may be made following the authorisation of an ordinary resolution put to all members. The Companies Act requires purchased shares to be cancelled (except up to 10% of issued shares held in treasury) and the purchase to be funded from distributable profits. The terms of the purchase would involve some sort of lawful negotiation with the seller (which could be a tender process) i.e. it will be at a price where the seller is willing to sell and might be above or below £1.50. Yes, this is what is sometimes called a buyback in US terminology. Please check LBG Articles/Resolutions for the exact LLPC terms: the preceding is the typical situation.


GS
EDIT: Note that LLPC has a substitution clause too: the company has the absolute right without consent of holders to replace LLPC as a whole with Qualifying Non-innovative Tier 1 Securities at any time with approval of the regulator. Buyers might want to study the implications of this -- sorry, I can't help without further thought and research.

Thanks for the answers GoSeigen,

All clear with Redemption and Reduction of capital.

With the Purchase of own shares you say that the price offered might be below the current market price. Taking LLPC as an example, why would any offer by Lloyds for LLPC be below the current market price when holders of LLPC could sell in the market for a higher price ? Why would Lloyds ever offer a price below the market price ?

[GoSeigen]

Thanks for the answers GoSeigen,

All clear with Redemption and Reduction of capital.

With the Purchase of own shares you say that the price offered might be below the current market price. Taking LLPC as an example, why would any offer by Lloyds for LLPC be below the current market price when holders of LLPC could sell in the market for a higher price ? Why would Lloyds ever offer a price below the market price ?

Just because the price is whatever is agreed with the seller at the time. I can think of many situations in which a seller might accept a discount to market: for example, Lloyds announce a tender for LLPC at 120p per share hinting that they intend to exercise a reduction of capital at some unspecified future date. I think many institutional holders would be glad for the opportunity to sell at a decent premium to par, albeit far below the prevailing "market" valuation. Similarly for other "liquidity events".

My statement about prices below and above market was more a comment on the fantasy** of "market price" than about the powers of issuers in a purchase of own shares.

GS
[** based on my observation that market price seems to have attained a god-like status in the minds of some people, maybe partly because of EMH and partly hubris. Some people on this forum have even claimed that preference share contracts must have a particular meaning based on the market price of the shares! Because the market is always right. -EDIT]

[PeterGray]

based on my observation that market price seems to have attained a god-like status in the minds of some people, maybe partly because of EMH and partly hubris. Some people on this forum have even claimed that preference share contracts must have a particular meaning based on the market price of the shares! Because the market is always right

I don't think that's a fair characterisation, GS. What is quite clear, is that if holders, both PIs and IIs who hold prefs believed in the past they could be paid back at par (and that there was a significant likelihood it would happen - a somewhat different question) then their prices would never have got to the levels they have. Also if they believed that now then most pref prices would have fallen much faster and further than they have post Aviva.

Since that hasn't happened either there are a lot of both PIs and IIs out there who remain in ignorance - possible, but unlikely to that extent, and even less so for the II investors, or there are a lot of people who either disagree with you on the legal interpretation or disagree that it's likely that any institution would think it worth their while to attempt to do so - for all sorts of reasons (cost in many cases, reputation plus also I suspect a prevailing view that that is not how prefs were expected to work when issued and a, perhaps misplaced, view that the city doesn't operate like that).

Either way, while clearly the SP won't help anyone in a court, it's telling a lot about how what the chances of repayment at par are in practice are viewed.

Peter

[Alaric]

What is quite clear, is that if holders, both PIs and IIs who hold prefs believed in the past they could be paid back at par (and that there was a significant likelihood it would happen - a somewhat different question) then their prices would never have got to the levels they have.

I would have thought that was the case. Furthermore that even when the price stood below par, that the existence of an option to repay should the price climb above par would have affected the price even then. That might even have wound back to the coupon required at issue. Giving a borrower an option to cancel at below the value of the income is an additional default risk. It remains my view that if such an option exists and can be implemented it was not ever intended, arising only by drafting not explicitly ruling it out or ruling it in. The ambiguity over who votes in those circumstances being a contributory factor.

[ChrisNix]

based on my observation that market price seems to have attained a god-like status in the minds of some people, maybe partly because of EMH and partly hubris. Some people on this forum have even claimed that preference share contracts must have a particular meaning based on the market price of the shares! Because the market is always right

I don't think that's a fair characterisation, GS. What is quite clear, is that if holders, both PIs and IIs who hold prefs believed in the past they could be paid back at par (and that there was a significant likelihood it would happen - a somewhat different question) then their prices would never have got to the levels they have. Also if they believed that now then most pref prices would have fallen much faster and further than they have post Aviva.

Since that hasn't happened either there are a lot of both PIs and IIs out there who remain in ignorance - possible, but unlikely to that extent, and even less so for the II investors, or there are a lot of people who either disagree with you on the legal interpretation or disagree that it's likely that any institution would think it worth their while to attempt to do so - for all sorts of reasons (cost in many cases, reputation plus also I suspect a prevailing view that that is not how prefs were expected to work when issued and a, perhaps misplaced, view that the city doesn't operate like that).

Either way, while clearly the SP won't help anyone in a court, it's telling a lot about how what the chances of repayment at par are in practice are viewed.

Peter

Peter,

Other than the legal interpretation, in respect of which there is no real doubt, I agree with your observations on the pref market. But I do think there are a lot of PIs in denial. They have a hope that, even if the prefs can be cancelled at par, lobbying and campaigning will dig them out of the hole.

For most issuers I don't think a cancellation is worth the candle. It costs money, absorbs significant senior management time and won't be popular, but requires a 75% vote of all members, usually meaning above 80% of ords. So unless the saving is material to the ords unlikely to be much attraction of putting one's head above the parapet.

At the polar extreme is the acquisition of an issuer or its parent. The new owner can deliver the vote and if the saving is material can be expected to bank the saving. As I have mentioned elsewhere, Allianz's reported interest in Aviva ought to have put the holders of its direct and indirect prefs on notice -- the saving there is most definitely worth having for an acquirer.

Chris

[Alaric]

but requires a 75% vote of all members

You don't think that's wrong and it should be 75% of the affected share class. That's what European law seems to say as well. I'm aware there's a "white is black" argument that says otherwise, that's something to do with a curious interpretation of what "equity" means.

[ChrisNix]

but requires a 75% vote of all members

You don't think that's wrong and it should be 75% of the affected share class. That's what European law seems to say as well. I'm aware there's a "white is black" argument that says otherwise, that's something to do with a curious interpretation of what "equity" means.

Alaric,

The law is, and has been for at least 70 years, that it is 75% of ALL members. As I pointed out above the companies act also specifies that this can be overridden by the articles. So all the original subscribers had to do to achieve this was to require a suitable article. NWBD investors had no need as they inherited a pre-existing article.

It's a bit like specifying extras when ordering a car.

Can't see how a second hand buyer can expect to complain to the manufacturer about an extra which he thought was fitted standard to the car he bought, but never got around to checking!

I'd paraphrase the European (and Australian) situation as, in cases not overseen by a court, requiring a 75% vote of the affected class. Not relevant here.

Chris

[Alaric]

I'd paraphrase the European (and Australian) situation as, in cases not overseen by a court, requiring a 75% vote of the affected class. Not relevant here.

From an investor viewpoint I'd want protection against the risk that the issuer of an income paying security terminates it at below market value. That's why loans are sometimes secured on assets. If there isn't the compulsion of a class vote, then investor protection is wanting and thus the calls for the FCA to do something about it.

Perhaps a real point is that in a relatively small market where in a number of cases the issuers of Prefs were also at arms length the holders, that there was a general consensus for managements to behave and that there shouldn't be embedded options to repay Prefs that had arisen above par. Aviva tried to break this until they climbed down. It's still a weakness in the legal and regulatory system that the wordings on return of capital and absence of a compulsory class vote make this possible.

[stockton]

Stockton.

It seems we have an agreed position on what irredeemable means in legal terms.

GS's excellent answer to Tara highlights the separate legal process of capital reduction.

Under the procedures set out in the CA all shares (ords and prefs) in a limited company can have have their capital reduced, and then have that amount paid to the shareholders. If all such capital is returned the shares are cancelled.

However, under 641 (6) this authority is subject to any provision of the company's articles restricting or prohibiting the reduction of the company's share capital.

Thus the default position for UK listed prefs is that they are reducible/cancellable. Some issues, such as NWBD, benefit from the protection of an article which requires a reduction of their capital to be subject to the prior sanction of 75% of the pref holders as a class.

I think much of the confusion in the market comes from participants tendency to use a shorthand where one size is used to fit all.

If one adopts a binomial classification, the vast majority of UK listed prefs (e.g. LLPC/LLPD) are freely cancellable, irredeemable shares.

The are quite a few which are freely cancellable and redeemable.

A small number (e.g. NWBD) are restricted cancellation, irredeemable shares.

The two BP prefs are freely cancellable and irredeemable, but the cancellation has to be made at a premium to the market price.

QED?

Chris

I am not sure that we have an entirely agreed position - what you might call "using legal language", I might call "negligence by lawyers".

We do, however, seem to have a similar understanding of the theory, other than that I see the distinction between redemption and reduction of capital as a counter-argument for the benefit of those who believe that irredeemable means "cannot be redeemed". In reality, who would ever define redemption in such a way as to exclude a reduction of capital ?

Overall the neatness and simplicity of your thesis seems to be a drawback. If everything is so simple, how is it that there has ever been any confusion ?
It seems to me that there are some pieces of the jigsaw missing.

[Alaric]

It seems to me that there are some pieces of the jigsaw missing.

There are various legal and accounting means by which Companies return cash to shareholders. What they all have in common apart from the par return of Preference Shares is that they all have to be "fair" in that what shareholders give up is recompensed by cash or something of equivalent value.

The time to be having this conversation was when Preference Shares first climbed above par. If as asserted, Companies have an option to repay at par, that should have been highlighted as a new risk and shouted from the rooftops. But it wasn't.