Highlights: Preferred shares and the changes introduced by law 9.457/9

1. – Before enactment of Law No. 9457 of May 5, 1997, companies usually issued preferred shares without voting rights, offering no compensation whatsoever to make up for this absence of corporate rights. In order to change this scenario, Law 9457/97 changed several provisions of Law No. 6404 of December 15, 1976 (the Corporation Law)–notably its article 17, for which the wording below was approved:

Article 17. – The preferences or privileges inherent to preferred shares:

Paragraph 2. – Unless otherwise stated in the company’s bylaws, priority dividends shall not have a cumulative nature; shares entitled to fixed dividends shall not take part in the remaining profits; and shares entitled to minimum dividends shall participate in the profits paid, on equal footing with common shares, after the last-named have been ensured a participation equal to minimum dividends.

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2. – As can be seen, the company’s bylaws may provide for the existence of preferred shares entitled to (i) fixed or minimum dividends, or (ii) minimum dividends at least ten percent higher than those paid to common shares, if fixed or minimum dividends have not been set forth. When establishing clear-cut dividend mechanisms applying to preferred shares, Law 9457/97 barred the existence of non-voting preferred shares deprived of any actual privileges when compared to common shares.

3. – For a greater understanding of the extent of such legal provision, the legal criterion of fixed and minimum dividends, as well as related concepts (priority and non-priority dividends) must be looked into.

Preferred Shares entitled to Fixed Dividends/ Minimum Dividends

4. – Preferred shares entitled to fixed or minimum dividends break a company’s shareholders into two groups, namely: shareholders entitled to priority in payment of dividends, and shareholders not entitled to such priority rights. This segregation arises from the mechanisms devised for payment of fixed or minimum dividends, as follows:

(i) – the overall profits payable as dividends are earmarked, in the first place, to preferred shares entitled to fixed or minimum dividends until the respective (fixed or minimum) participation is achieved;

(ii) – after payment of the profits as stated above, (x) if there are no remaining profits, then the common shareholders receive nothing further, but (y) if there are remaining profits, then such profits are shared only among the holders of common shares for an amount equal to the minimum dividends paid to preferred shares; and

(iii) – if profits are still available, preferred shares entitled to minimum dividends participate in the allotment of such profits, on equal footing with common shares. This is the key difference between minimum and fixed dividends: the holders of preferred shares entitled to fixed dividends do not take part in the payment of profits at this stage.

5. – Preferred shares entitled to fixed or minimum dividends may be given, as dividends, a sum certain provided for in the company’s bylaws, or a floating value calculated as per the respective formula (rate x calculation base) also dealt with in the bylaws. Should the fixed or minimum dividends be computed on the basis of the aforementioned formula, then the calculation base may be set at the par value of the shares, the ownership capital, profits in the period, and others.

Preferred shares entitled to minimum or fixed dividends, whether cumulative or non-cumulative

6. – Fixed or minimum dividends paid to preferred shares may have a cumulative or non-cumulative nature. In the former case, the fixed or minimum dividends unpaid in a certain year must be disbursed in the subsequent period in which profits are recorded.

7. – If a company’s bylaws are silent on the cumulative nature of fixed or minimum dividends, they will be treated as non-cumulative. In this sense, article 17, paragraph 2 of the Corporation Laws states that “unless otherwise stated in the company’s bylaws, priority dividends shall not have a cumulative nature (…).”

Preferred shares not entitled to fixed and minimum dividends

8. – According to the Corporation Law, if a company’s bylaws make no express reference to the fixed or minimum status of preferred shares, they will be entitled to dividends at least 10% higher than those attributable to common shares.

9. – Now, as the Corporation Law states that shares entitled to fixed or minimum dividends are afforded priority in payment of dividends, the general rule set out above may be construed as follows: if a company’s preferred shares are not entitled to priority dividends, i.e. fixed or minimum dividends, then the preferred shares will be accorded a non-priority entitlement to dividends, being thus paid dividends 10% higher than those attributable to common shares.

10. – Consequently, the preferred shares entitled to fixed or minimum dividends will have no inherent prerogative to receive a larger amount of dividends when compared to common shares. In fact, the preference or privilege afforded to preferred shares entitled to minimum or fixed dividends will refer to the priority in the receipt of dividends.

11. – On the other hand, the preference or privilege inherent to preferred shares not entitled to fixed or minimum dividends (that is to say, not entitled to priority in payment of dividends) will be the right to receive dividends at least ten percent higher than those attributed to common shares. For this reason, preferred shares without priority to dividends are accorded the right to receive dividends always at a level higher than that ascribed to common shares.

Acquisition of the Right to Vote

12. – Preferred shares without voting rights may invest their holders in voting powers if the company fails to pay fixed or minimum dividends to which such shares are entitled. This corporate right is provided for in article 111, paragraph 1 of the Corporation Law, as follows:

Art. 111, para. 1. Preferred shares without voting rights shall invest their holders in voting powers if the company, for a period set out in the bylaws not exceeding three (3) consecutive years, fails to pay fixed or minimum dividends to which such shares are entitled, whereupon such voting right shall be effective until actual payment of dividends, if such dividends are not cumulative, or until cumulative dividends in delay have been paid.

13. – It should be noted that, according to the Corporation Law, this voting right only applies to preferred shares entitled to fixed or minimum dividends, that is, with priority rights concerning the distribution of dividends. Therefore, preferred shares not entitled to priority in the distribution of dividends (other than those entitled to fixed or minimum dividends) will not be granted the voting right set forth in article 111, paragraph 1 of the Corporation Law.

14. – According to the aforementioned legal provision, the right to vote is no longer in effect when dividends are paid to the holders of preferred shares.