SC1356

PAPUA NEW GUINEA
[IN THE SUPREME COURT OF JUSTICE]

SCA 60 OF 2009

HENGANOFI DEVELOPMENT CORPORATION LIMITED
Appellant

AND:
PUBLIC OFFICERS SUPERANNUATION FUND BOARD
Respondent

Waigani: Kandakasi, Gabi, Kariko, JJ.
2012: 	30th April
2014: 	02nd July

COMPANY LAW - Shares - Types of shares - Redeemable preference shares entitling holder to a fixed cumulative preferential dividend net of withholding tax of 13% per annum payable six monthly in arrears - Nature of such shares - When dividends are payable - Dividends payable out of declare profits only - On redemption accrued dividends payable only out of pool of undistributed profits or a profit or loss account or a reserve for redemption - Redemption of accrued dividends out of any other source could amount to reduction on capital and not permissible.

Cases Cited:

Papua New Guinea Cases
Nil

Overseas Cases Cited:

Mosgiel Limited v. Mutual Life and Citizens Assurance Company Limited [1994] NZPC9; [1994] UKPC 43,

Sources materials cited:

Halsburys Laws of England, 3rd Edition, Vol. 6, Company Law, para. 765, p.396.
Purvis on Propriety Companies, Butterworths, Sydney (1973).
Introduction to the Law of Business Associations in Papua New Guinea, Pacific Law Press 1989, by Kimuli, Amankwah and Mugambwa at p.84.
http://en.wikipedia.org/wiki/Preferred_stock.
Encyclopedia Brittanica.
http://wiki.fool.com/Cumulative_&_Noncumulative_Preferred_Dividend_Calculation#sthash.sv7dArhm.dpuf.
http://www.ehow.com/how_10016780_calculate-accumulated-dividends-per-share.html#ixzz2uO0xVurA
www.wiziq.com/tutorial/578211-Redemption-of-Preference-Shares

Counsel:

K. Frank, for the Appellant.
W. Neill, for the Respondent.
 
2nd July, 2014

1.	KANDAKASI J: This case concerns the meaning of shares in a company described as "redeemable preference shares" entitling the holder of such shares to "to a fixed cumulative preferential dividend net of withholding tax of 13% per annum payable six monthly in arrears" in an agreement between the parties.

Issues for determination

2.	Specific issues for determination by this Court then are these:

(a)	What is the meaning and effect of "redeemable preference shares" in a company?

(b)	What did the parties mean when they agreed to the Public Officers Superannuation Fund as holder of "redeemable preference shares" being entitled "to a fixed cumulative preferential dividend net of withholding tax of 13% per annum payable six monthly in arrears"? 

Background and Relevant Facts

3.	Matters giving rise to these issues are simple. Henganofi Development Corporation Limited (the Corporation) and the Public Officers Superannuation Fund Board (the Fund) entered into a loan agreement whereby the Fund was to advance certain funds to the Corporation for it to construct a building on its land in Goroka. In exchange of the loan, the Corporation agreed to issue one million fully paid preference shares valued at K1.00 each, which entitled the Fund "to a fixed cumulative preferential dividend net of withholding tax of 13% per annum payable in six monthly in arrears and in any event the shares were agreed to be redeemable within 10 years. In accordance with the provisions of the Agreement, the Fund advanced K1 million to the Corporation and the Corporation issued the agreed shares. The Corporation performed poorly. Hence, it declared no profits and paid no dividends for 9 years out of the agreed 10 years period. When the shares become redeemable at the end of that period, the Corporation paid K1.1 million to the Fund. Of that payment, K100, 000.00 was paid gratuitously. 

4.	The Fund claimed that, the Corporation was liable to pay an additional K1, 253,164.38. That, the Fund claimed was on account of accumulated fixed preferential dividend due and payable over the 10 years duration of its preferential shares. It arrived at its claim by calculating interest at a rate of 13% per annum, without reference to whether: (1)the Corporation made any profits; and (2) any dividend was declared and was or were to be distributed. In support of its claim, the Fund referred to and relied upon the provisions of clause 3.0 of the Agreement which is in so far as is relevant, in the following terms:

"3.1	Subject to the terms of this Agreement the Board hereby agrees to subscribe for and the company hereby agrees to allot one million (1,000,000) redeemable preference shares of one kina (K1.00) each in the capital of the company to the Board in accordance with this clause.

3.2 	The shares shall be issued as fully paid and shall entitle the holder thereof:
(a) to a fixed cumulative preferential dividend net of withholding tax of 13% per annum payable six monthly in arrears."

5.	In response, the Corporation argued that, since it made no profits and paid no dividends over the 10 years period, the Fund was not entitled to the claim for the additional amount of K1, 253,164.38. It also made a cross claim for K87,000.00 being extra payments made out of the only declared profits of K100,000.00. After having heard evidence and arguments from both the Corporation and the Fund, the National Court found for the Fund. Being aggrieved by that decision the Corporation came to this Court through this appeal.
What is the meaning and effect of "redeemable preference shares" in a company?
6.	Bearing the above background and facts in mind, I now turn to a consideration of the issues presented starting with the first issue first.

7.	The law on shares, class or types of shares in a corporation, dividends and when they become payable and at what rate, is clear. There are various authorities on point which say the same thing. For the purpose of determining the issues before us, it will suffice to allow ourselves to be guided by some of authorities learned counsel of both parties have placed before us. However, in terms of the cases they referred to us, I find most of them not helpful because they are not relevant for our purposes. A case I find more helpful is one which the court on its own research came up with. That is the decision of the Privy Council by their Lordships Jauncey, Griffiths, Mustill, Woolf and Nicholls in Mosgiel Limited v. Mutual Life and Citizens Assurance Company Limited. 

8.	In the above case, Williamson J., at the trial level was faced with two issues to determine following the plaintiff company which had share arrangements similar to the case before us going into receivership. The two issues presented were:

(a)	whether the shareholders that elected for redemption of their shares were entitled to any arrears of dividend for the period up to 31st October 1987 during which no profits were available;

(b)	whether former shareholders of all the preference shares would be entitled to repayment of capital and/or to all arrears of dividend whether earned or not down to 31st October 1987 in priority to the claims of other shareholders participate in assets?

9.	Williamson J., made two declarations which effectively answered the two questions in the negative. On appeal, the Court of Appeal overturned that decision and quashed the orders made by the learned trial judge. Then on further appeal to the Privy Council, their Lordships in a unanimous decision overturned the decision of the Court of Appeal and restored the trial judge's decision. The decision of the Privy Council and before that, the decision of the trial judge was correct as it confirmed with the relevant and prevailing principles of law and more so the nature of the kinds of shares in question before us and those that arose in the Mosgiel Limited case.

10.	Turning then to the case at hand, it is necessary to understand the true meaning and nature of the kinds of shares the Fund subscribed for and the Corporation issued and dividends. Starting first with dividends, I note and as Halsburys Laws of England makes it clear, the ordinary meaning of the term "dividend" means a share of profits in a company. Such shares can either be fixed at a particular rate or otherwise allocated to the holders of shares in trading or other companies. The term "dividend" usually implies a share of profits periodically payable in any year or period in which a company makes a profit. Dividends are therefore based and payable on the declared profits of a company and not otherwise. Clearly therefore, no payment can be made to any share holder at any rate out of a company's capital except when there is a re-issuance of shares. Similarly there can be no other payment to a shareholder except for the value of shares on the sale of shares.  

11.	The learned authors of the book, Purvis on Propriety Companies, puts the same position in the following terms at paragraph 116 at page 190:

"The articles of association of a company usually provide that no dividend is to be paid otherwise than out of profits or bear interest against the company. 'If expenses or payments are obviously charged to capital and are so charged simply to swell the apparent profits and to make it appear that dividends may properly be declared, dividends declared and paid under such circumstances cannot be treated as legitimately paid out of profits, and can no more be justified than if they were paid out of capital. No dividend is payable to the shareholders of any company except out of profits.'"

12.	The phrase "preference dividend," "preferential dividend," and "cumulative preferential dividend" refer to shares having preferential rights. This would be for shareholders who hold shares in a company that are described as "preference" or "preferential shares" or "cumulative preferential shares". Again as Halsburys Laws of England, states, where a preferential dividend of a specified amount is attached to shares, they are usually limited to the fixed dividend and are precluded from participation at a greater extent. Of course, there is an exception to this. This would be cases in which the articles or the constitution of the company clearly provide to the contrary.

13.	If preference shares confer a preferential cumulative right in respect of dividends, the dividend is prima facie cumulative that is to say, if the moneys applicable to dividend in one year are not sufficient to pay the preference dividend, the deficiency, including arrears must be made good out of moneys so applicable in future years, before anything is paid as dividend to the holders of other shares ranking after such preference shares. This dividend belongs to the holders of the shares when it is declared, not to the holders of the shares when the arrears accrued, and no lapse of time will bar the right to payment of arrears in full before payment of any dividends on junior ranking shares. The dividend may, however, be non-cumulative if the articles or terms of issue upon their true construction so provide. In this regard, a preference share only gives a right to a preferential dividend upon either a wind up of the company or otherwise and not a right to a preferential payment out of the share capital. 
 
14.	Purvis (supra) explains the difference, therefore, between cumulative and non-cumulative preference shares at page 67 as follows: 

"Non-cumulative preference shares confer upon the holder a right to receive an annual dividend of a fixed percentage out of the net profits of each year available for distribution before any dividend is paid to any other shareholder holding shares of a class over which the non-cumulative shares have priority. The dividend is dependent upon there being a net profit for the year available for distribution. In the event of the profit available for distribution being insufficient to meet the preference dividend, future profits cannot be resorted to, to make up the deficiency as in the case of cumulative preference shares."

15.	The learned authors of our own text book that deals with company law namely, Introduction to the Law of Business Associations in Papua New Guinea, render the position clearer in these terms:

"As dividends are only paid out of profits, it is possible that the preferential dividend may not be paid in a given year. The articles may provide that if the company does not pay the preferential dividend for the year, arrears shall be made up in subsequent years when profits are available, hence the name cumulative preference shares. Preference shares are presumed to be cumulative."

16.	Making such provision in a company's articles removes any doubt in the cumulative nature of cumulative preferential shares. 

17.	As for redeemable shares, the law is also very clear. A company limited by shares may issue preferential shares that are redeemable, if its articles so authorize. But the fact that they are redeemable does not entitle the holder of such shares to look upon the company's capital for redemption. Instead, the focus must still and can only be on the profits the company makes and the dividends declared out of it. The only exception to that is where there is a fresh issue of shares made for the purposes of redemption of shares. Even in that case however, the shares may not be redeemed unless they are fully paid and the premium, if any, payable on redemption must have been provided for out of the profits of the company or out of the company's share premium account before they are redeemed. 

18.	I note that, the learned trial Judge correctly noted and accepted these principles of law when for instance, at paragraph 7 of his written judgment His Honour said:

"Of course, a person holding shares in a company expects, amongst other things, dividends to be paid to him but he does not receive such dividends unless the company makes a profit. ... In the event of loss, no dividend is declared and no payment of dividend is possible."

19.	Then when it came to the application of the principles to the case at hand, the learned trial Judge also correctly found and said at page 9 of his written judgment:

"It is not disputed that the Defendant, out of 10 years made profit and declared dividend in just one year. The other nine years were years of loss. Accordingly, as argued by the Defendant, the Plaintiff could only receive dividend paid out of the profit."

20.	The learned trial Judge however with the greatest respect erroneously came to the view subsequently that, "preference share or preference dividend is cumulative and shall be paid regardless of loss." The first part of that view is correct as it is consist with the principles discussed above. However the later part as to when preference cumulative dividends are payable, the learned trial Judge again with great respect, fell into a readily identifiable error. The well accepted principle is this. Dividends by whatever description are payable only out of profits. The only other time in which shareholders can expect a return on their investment in the form of their shares in a company is when the company goes into liquidation or there is a sale of their shares. As noted, this principle applies regardless of the class of shares. If a class of shares is cumulative preferential shares, it only means that the holders of such a class of shares can only look forward to an accumulation of their dividends as against the profits in subsequent years if no profits are made in previous years. In other words as the Encyclopedia Brittanica makes it clear: 

"The dividend on preference shares is either 'cumulative' or contingent on the profits of each separate year or half year. When cumulative, if the profits of any one year are insufficient to pay in full, the deficiency has to be made good out of subsequent profits." 

21.	As some write up on the subject demonstrates, usually:

"[e]ach share of preferred stock includes a par value and a dividend rate. The par value represents an arbitrary value that the company assigns to the stock. This value holds no relationship to the selling price of the stock. The dividend rate refers to the amount of dividend to be paid, and can be stated as a dollar amount or as a percent of par. The company calculates the dividend to be paid by multiplying the par value times the dividend percent. This calculates the dividend rate per share. The company multiplies the dividend per share by the total number of preferred shares outstanding to determine the annual dividend amount to pay the preferred stockholders. The company then adds the number of years the dividends are in arrears to the current year. The company multiplies this number by the annual dividend payment."

22.	Duly noting all of the above, it follows therefore that the correct test in this case is this. Is the Corporation liable for any amount in excess of K1, 100,000.00? That question had to and can be determined by reference to:

(a)	Did the Corporation make any profit in any of the years within the 10 year period under consideration?

(b)	If so, did the Corporation allocate any part of any such profit for distribution as dividend? and

(c)	If so, was 13% of the dividend declared for distribution paid to the Fund as holder of the Shares.

(d)	What is the correct way to calculate and allow for the Funds dividends?

23.	If questions (a) and (b) are answered in the affirmative and question (c) is answered in the negative, the Corporation could be found liable to pay more. The exact amount due and owing to the Fund would have been calculated and arrived at using the correct formula. Hence, it is important that I get to that question first.

24.	The correct formula to work out what is payable on redemption of preferred cumulative and redemptive shares is this. There must first be an ascertainment of the guaranteed dividend a company is required to pay per year to an holder of such a shareholder. Then added to that should be the unpaid dividend for the previous years. Let us say for example, a company is obliged to pay K5.00 per share each year but made no payments for the last two years, the preferred accumulated dividends would be K10.00. This would then be added to the current year's to produce a total of K15.00 The actual accrued cumulative shares payable would be arrived at by a multiplication of the accumulated dividend by the number of shares owned by such a share holder. That is to say, if such a shareholder owns 100 shares and the accumulated dividend is K15 per share, the final payout would be K1,500.00. It would be simple and straight forward as that if the company has made profits sufficient to cover the accumulated shares as at the time of the redemption. 

25.	 If however the company has not made any profits, and there is no pool of undistributed profits or, there is a lack of reserve to cover for a redemption exercise, there can be problems. This follows from the conditions upon which there can be a valid redemption of the kinds of shares under consideration. The conditions are:

(a)	there must be provision in the company's articles allowing for redemption;

(b)	the shares have been fully paid;

(c)	the funds for the redemption must come out from a pool of undistributed profits, and if that happens the value of redemption gets entered against the company's redemption reserve account;

(d)	if the redemption is at a premium, the funds for the redemption must come out of securities for premiums or profit or loss account or general reserves;

(e)	proceeds of any new or fresh debentures cannot be used to fund the redemption; and finally

(f)	the funds cannot come out of any capital reserves. 

26.	In the present cases, there was no serious contest between the parties that the Fund is entitled to a redemption of its shares. There was also no serious contest that the Corporation did not make any profits for a period of 9 years out of 10 years under consideration. The one year in which the Corporation made a profit was in 1999. The declared profit for that year was K100, 000. The Corporation decided to have all of that profit paid to the Fund upon redemption of the Fund's shares in the Corporation. None of the other shareholders were paid any dividends. Despite this evidence, the learned trial Judge with great respect, erroneously found that a sum of K2, 153,164.38 was due and payable to the Fund as at 28th July 1999. 

27.	A correct calculation of the Funds dividends, according to its particular class of shares as noted above, would have entitled the Fund to a part or, the whole of declared profit of K100, 000.00 and no more, in the absence of any evidence of a pool of undistributed profits and or, the existence of securities for premiums or, a reserve of profit or, loss account or, general reserves, that could cover the redemption. Given the lack of evidence as highlighted and given that, there was an agreement and a decision based on that to have, the shares redeemed by the Corporation the total payable and due to the Fund on redemption was K1 million being the value or price for the shares that were redeemed and, no more than K100,000.00 on account of declared and accumulated preferential shares. Going beyond that amount, was complicated by two factors. First, there is no evidence of a par value agreed to between the parties for the purposes of calculating any accumulation of any unpaid profit in the non profit years. The par value would usually be specified in the Corporations articles and memorandum of association. We were not assisted with any evidence on that. Secondly, there was no evidence of there being a pool of undistributed profits or a profit or loss account or a reserve for redemption or an agreed par value. In these circumstances, the best that can be done is to, go by the evidence that is available and the nature of preferential cumulative shares. Hence, based on evidence before the Court, if there is to be any allowance to be made in favour of the Fund as a preferential share holder as to its annual accumulation it has to be on the amount of profit the corporation was eventually able to make. If we went by that, and the agreed rate of 13%, purely to try as best as we can to give effect to the parties agreement, and more so, in the absence of any evidence to the contrary, it would produce a sum of K13,000 for each of the 9 non profit years, producing a grand total of K117,000. But since the actual profits was K100,000, all that the Fund could claim and be entitled to receive would have to be not more than K100,000.00

28.	Despite these facts, as noted, the learned trial Judge with the greatest respect, erroneously found for K2, 253,164.38 in favour of the Fund. Following on from that erroneous finding, the learned trial Judge went on to allow for K1.1 million that was paid and found that K1, 053,164.38 was additionally due and owing to the Fund from the Corporation. 

29.	Further, His Honour again with the greatest respect, failed to set out in clear terms, how he arrived at that finding. It is however, evident from the concluding part of His Honour's judgement that, His Honour merely accepted the Fund's calculation as set out in the Fund's "Table of Dividend Calculation". In advancing that argument in the Court below and before us on appeal, the Fund argued that, the terms "to a fixed cumulative preferential dividend net of withholding tax of 13% per annum payable six monthly in arrears" meant that, it was entitled to its dividends being calculated at 13% per annum on the capital paid up that is, 13% of K1 million preference shares per annum for 10 years. For reasons given above, this in itself was also erroneous and the learned trial Judge clearly fell into an identifiable error. The price paid for the shares by the Fund upon incorporation became part of the capital of the Corporation and not part of any available profit for distribution and paid over to any share holder let along the Fund. To do so would have meant a reduction of the capital of the Corporation which would have rendered any such payment improper and not permissible. 

30.	The errors which I have identified above clearly call for correction to confirm with both the law as discussed and accepted by the learned trial Judge and the uncontested evidence that was before the learned trial Judge and now before us. Accordingly, I would uphold the appeal in part.

31.	However, I would not uphold the appeal in respect of the Corporations cross claim against the Fund. The reason for that can easily be stated as this. What I have discussed in the foregoing as regards the calculation of what was due to the Fund on redemption of its shares, makes it clear that, the Corporation's claim for a reimbursement of part of the K100,000 has no foundation. But for the lesser profits declared, the Corporation is indebted to the Fund as noted above. I would thus dismiss this part of the appeal. Again for clarity, this does not somehow enable the Fund to look at funds other than purely the profits of the Corporation. Such is the nature of the kind of transaction it entered into, with the kind of shares it negotiated for and received. That is the risk with investing in this kind of investment.

32.	 In the ultimate consequences of my views in the above terms, I would quash the judgment of the National Court save only for the part that concerns the Appellants cross-claim. I would then substituted the orders the National Court made with an order in the form of a declaration that, the Corporation discharged all of its obligations under the agreement between the parties upon the payment of the K1.1 million and there is nothing more due and owing to the Fund from the Corporation. Finally, I would order the Fund to pay the Corporations costs of the appeal and the National Court proceedings.

33.	GABI J: I have had the benefit of reading the draft opinion of my brother Kandakasi J. and am in respectful concurrence with the conclusion he has reached on this appeal, and the reasons thereof. There is, thus, no need for me to add anything further.

34.	KARIKO J: I have also had the benefit of reading the draft opinion of my brother Kandakasi J. I am also in agreement with his Honours views that this appeal should be allowed in part and the orders his Honour proposes should be made for the reasons he gives. I have nothing further to add.

Decision and orders of the Court

35.	Ultimately, the decision of the Court is that the appeal be allowed in part for the reasons given above. Then based on those reasons, the Court makes the following orders:

(1)	The appeal is allowed in part.
(2)	The Judgment of the National Court save only for that part that concerns the Appellants Cross -Claim is quashed.
(3)	An order in the form of a declaration that the sum of K1.1 million paid by the Appellant to the Respondent is sufficient discharge of all funds due and owing to the Respondent.
(4)	The Respondent shall pay the Appellants costs of the Appeal and the National Court proceedings. 

__________________________________________________________
Ashurst Lawyers: Lawyers for the Appellant
Young & Williams Lawyers: Lawyers for the Respondent