Islamic Preference Shares Section 4(1) of the Companies Act, 1965 (Act) defines preference share as a share by whatever

name called, which does not entitle the holder thereof to the right to vote at a general meeting or to any right to participate beyond a specified amount in any distribution whether by way of dividend, or on redemption, in a winding-up, or otherwise. Under Section 66 (1) of the Act, no company shall allot any preference shares or convert any issued shares into preference shares unless there is set out in its memorandum or articles the rights of the holders of those 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. Preference shares can be classified into various types, as follows: (a) Cumulative or non-cumulative preference shares A cumulative preference shareholder is entitled to receive a fixed cumulative preference dividend right. If in any year dividend is not paid, the cumulative preference shareholder is entitled to have the equal amount of the unpaid dividend added to the dividend to be paid in the following year(s). Non-cumulative preference shares, on the other hand, entitle the holder to a dividend at a fixed rate only in the years where a dividend is declared and paid. A failure to pay the dividend does not carry the obligation to meet the deficiency in the ensuing year(s). (b) Participating or non-participating preference shares Unlike the non-participating preference shares, participating preference shares entitle the holder to a return in excess of the stated fixed preference dividend rate by participating in the distribution of profits available to ordinary shareholders. (c) Redeemable or irredeemable preference shares Section 61(1) of the Act provides that a company may, if so authorised by its articles, issue preference shares which are, at the option of the company are to be liable to be redeemed and the redemption shall be affected only on such terms and in such manner as is provided by its articles. Section 61(3) of the Act provides that the preference shares shall not be redeemed: (a) 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; and (b) unless they are fully paid up. Irredeemable preference shares, on the other hand, are not entitled to be redeemed.

(d)

Convertible or non-convertible preference shares Unlike non-convertible preference shares, convertible preference shares allow or require the preference shares to be converted into ordinary shares at the end of the term or upon the happening of a particular event.

Shariah scholars seem to disapprove preference shares due to the following priorities given to the preference shareholders over the ordinary shareholders: (i) priority of payment of dividend; and (ii) priority of payment of capital upon liquidation. Nevertheless, many seem to approve preference shares with some modification, as discussed below. The Securities Commission (SC) Shariah Advisory Council (SAC) ruled that noncumulative preference shares are permissible based on tanazul where the right to profit of the ordinary shareholder is willingly given to a preference shareholder. Tanazul is agreed upon at an annual general meeting of the company which decides o issue preference shares in an effort to raise new capital. As it agreed at the meeting to issue preference shares, this means that ordinary shareholders have also agreed to give priority to preference shareholders in dividing the profits, in accordance with tanazul. In the context of preference shares, tanazul means surrendering the rights to a share of the profits based on partnership, by giving priority to preference shareholders. It is also known as isqat haq in Islamic jurisprudence. It is to be noted that some Shariah scholars are of the view that the ordinary shareholders can only surrender their rights to a share of the profits, based on partnership, by giving priority to preference shareholders upon the dividend is declared by the company. Contrary to SACs view, such surrender of rights cannot be given upfront and must be given upon each declaration of dividend by the company. Although the SAC generally recognize the concept of preference shares, the SAC however does not recognize the concept of cumulative preference shares. Some Shariah scholars recommend that instead of prescribing the preference shares to be cumulative, the dividend payable to the preference shareholders may be spread over the life span of the investment by the preference shareholders in the company and to be paid proportionately each year. Any unpaid dividend in each year will be carried forward to the next year. To better understand the foregoing, lets look at the following illustration:

Normal Cumulative Preference Shares Term of investment : 7 years

Rate of dividend

8% cumulative

Islamic Modified Preference Shares Term of investment Projected Rate of dividend over term of investment: Proportionate Annual dividend Special features : : : : 7 years 8% x 7 years = 56% 56% 7 years = 8% Any unpaid dividend in a particular year will be carried forward to the next year(s) as the dividend is calculated over the life span of the investment