Introduction
Listed companies globally have two main types of shares:
Common shares and Preference shares.
A share represents a fractional ownership in a listed company. They usually come with a right to receive dividends i.e. they are entitled to a share of profits in the company. If the company makes a profit then then a part of it is distributed to the Shareholders. But if the company does not make a profit or decides not to issue any dividends, then shareholders do not get paid out.
Such equity share investors also usually have a right to one vote per share which enables them to participate in the affairs of the company on such matters which the company puts up for vote. Such as elect the board members, appoint auditors, approve large investments and any other major decisions of the management.
Preferred shares have some special rights, such as they are usually guaranteed a dividend or have a preference in getting dividends over other class of shareholders i.e. preferred shareholders may have a right to get dividends before the common/ordinary shareholders. They also typically have a right to receive back their capital invested before other classes of shareholders, in case the company goes bust and liquidates.
In this article we will help you understand if Preferred Shares are Shariah compliant to invest.
Pros and cons of Common or Ordinary Shares.
Most of the stocks traded on the stock market are usually common or ordinary shares. Some companies only issue common stocks and no other class of stocks (e.g. Preference stocks).
Pros::
Entitled to receive a share of profit in the company through dividends -Allowed to vote in the affairs of the company
Cons::
Entitled to dividends only if the company makes a profit and declares a dividend. If the company does not make a profit or does not declare a dividend, the common stock holders of the company do not get anything.
If the company goes bust, the common shareholders are not guaranteed a return of the capital they invested. They are also the last to be given back their capital (or a portion of it) only if funds are left with the company after paying off all other liabilities and other class of shareholders such as preference shareholders.
Pros and Cons of Preference Shares
Preference shares can also be traded on the stock market just like common shares.
Pros::
Unlike common shares, preference shares do not have voting rights, but they have ownership rights like common shares.
Preference shareholders are usually guaranteed a specific dividend rate, maturity, and dividend payment date for their preference shares.
Preference stockholders have a higher claim on the company than common shareholders during liquidation and at the time of dividend distribution.
The company has to prioritize preference stockholders over common stockholders when dividends are paid out. Cons: Unlike common shareholders, preference shareholders do not usually enjoy a right to vote in the affairs of the company.
Cons::
Unlike common shareholders, preference shareholders do not usually enjoy a right to vote in the affairs of the company. They are also usually not entitled to higher dividends than has been guaranteed by the company.
Types of Preference Shares
Cumulative Preference Share
Cumulative preference shareholders are also entitled to be paid dividends in arrears. If the company’s financial status prevents it from paying dividends in a particular period, the unpaid dividend, as guaranteed to them, gets accumulated and the company is bound to pay the same in the next period along with the dividends for that new period.
Non-cumulative preference shares
Here if the company does not pay dividend for a particular year or period, they do not get accumulated and hence are not paid in arrears. Hence the non-cumulative preference shareholder loses the right to receive dividend for that unpaid/undeclared period.
Why are Preference Shares not Shariah Compliant?
Preference shares typically guarantee shareholders’ capital and promise a fixed income on the investment.
Hence, it contradicts the principles of Islamic investment.
Most GCC Shariah scholars disapprove of preference shares practice as it violates the regulations of musharakah as applied in shareholdings of listed companies. Preferred shares resemble debt properties such as fixed dividend distribution and privileged treatment of preference shareholders during the company’s liquidation.
In contrast to principles of Musharakah, preference shareholders are not typically exposed to the profit and loss in the company.
Further, participants in preferred stocks have no voting rights, unlike Musharakah’s participants, even though they are also partners in the musharakah contract but are disqualified from the right to speak up and vote at the company’s Annual General Meeting.
Shariah Resolutions on Preference Shares
Various fatwas have been issued by organizations such as the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), Islamic Fiqh Conference (Majma ‘Fiqh Islami), Arab Conglomerate, Dallah Al-Barakah, and Securities Commission of Malaysia, on the status of preferred shares in Shari’ah.
Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI)
AAOIFI has ruled that preference shares are prohibited as mentioned in Shari’ah Standard No. (12) Sharika (Musharakah) and Modern Corporations, items 4/1/2/14:
“It is not permissible to issue priority shares, which are stocks that have special financial features that give them priority at the date of company liquidation or on the date of distribution of profits. However, it is permissible to give certain shares in respect of rights related to ordinary shares, matters relating to procedures and administration such as the right to vote”.
Islamic Fiqh Academy
The Islamic Fiqh Academy (Majma ‘Fiqh Islami) prohibits investment in preference shares through their resolution.
“It is not permitted for companies to issue enjoyed shares or preference shares or debentures. In a situation where the company is suffering, each shareholder must carry its share of losses according to their particular capital contribution within the company” (Resolution and Recommendation of the Islamic Fiqh Conference Council 1985-2000 at the 7th Conference, 2000, Resolution No. 6/94, pp. 140).
The Arab Conglomerate, Dallah Al-Barakah
The Arab Conglomerate, Dallah Al-Barakah, approved the ban on preference shares by issuing a resolution.
In the 6th Islamic Economic Symposium in Algeria, the Arab conglomerate, Dallah Al-Barakah, believes that particular services are not permitted in some instances as it may dissolve the shariah contract (Dallah Al-Barakah Group, 2003, Resolution No. 6/28).
Dallah Al-Barakah‘s Shariah Resolution presented some impressions and views on the issuance of preferred shares by joint-stock companies involving Islamic fund investments in the 17th Islamic Economic Symposium Algeria (Dallah Al-Barakah Group, Resolution No. 17/4). As preference shares give a fixed rate of profit (dividend) and guarantee capital preservation, it is considered to resemble interest based borrowing by the company. Therefore, through this resolution, preference shares were prohibited.
Redeemable preference shares were also banned by the Shariah Resolution in the 10th Islamic Al-Barakah Islamic Symposium based on Resolution No. (65- / 1/7 Article 6) by the International Islamic Fiqh Academy.
To issue shares with financial privileges or capital guarantees or specific profit values and the preference of paying capital through liquidation of the company or profit distribution is illegal (Dallah Al-Barakah Group, Resolution No. 10/9).
The Securities Commission of Malaysia
The Securities Commission of Malaysia at its 20th Meeting held on 14th July 1999, has ruled on the non-cumulative preference share based on the idea of tanazul:
“The Shariah Advisory Council ruled that non-cumulative preference shares are required based on the principle of tanazul whereby the common shareholder’s profitability is freely granted to the preference shareholders. tanazul is agreed at the Company’s Annual General Meeting, which decided to issue priority shares to acquire new capital. When this Meeting agrees to issue a preference share, it means that common shareholders have agreed to prioritize preference shareholders in the distribution of profits according to tanazul.”
In its Shariah Resolutions, the Securities Commission Malaysia states that non-cumulative preference shares are those where shareholders’ or investors’ period to hold the shares are permanently unrestricted.
These shares are similar to ordinary shares, except they are fixed and draw non-cumulative dividends.
Both, preference shares and common shares, have the same characteristics in that they have no maturity period and do not have rights to non-accumulated dividends.
Hence, Non-cumulative preferred shares are only allowed by the Shariah Resolution of the Securities Commission of Malaysia while preference shares were deemed non-permissble by all global fatwa organizations such as Islamic Fiqh Conference (Majma ‘Fiqh Islami), AAOIFI, and Arab Conglomerate, Dallah Al-Barakah.
Summary
Eventually, it is clear based on the rulings and resolutions that most Islamic jurists have made preference shares impermissible.
However, the Securities Commission of Malaysia issued a Shariah Resolution making it permissible, conditionally which states that the non-cumulative shares must be based upon the concept of wa’d bi al-tanazul.
The idea of tanazul is used at three different times; when common shareholders grant tanazul to preference shareholders, when common shareholders agree to let go their right to profit only until the preferred shareholders gained their benefit at a specific rate, and when the tanazul is at the beginning of the musharakah contract for ensuring the occurrence of such matter in the future. In other situations, common shareholders grant tanazul to the preferred shareholders by limiting their profits to specific rates.
Apart from this, when a company is under liquidation, then also the common shareholders’ tanazul is granted to preference shareholders, leading to preference shareholders being given priority over the common shareholders to recover their capital contribution.
Conclusion
Today, contemporary scholars recognize and adopt the concept of shares in listed companies as it is in sync with the idea of musharakah.
With time and continuous advancements, the Islamic stock market is coming up with new products to meet the market demand and fit into the current economic role.
For this purpose, preference shares being a stock product can prove to be advantageous. However, preference shares in its current form are contrary to Shariah’s guidelines in a musharakah contract as capital guarantees, guaranteed returns, no voting rights, and preferential or special treatment than other common shareholders do not fall in line with Shariah.
Hence, the wider opinion of Shariah scholars seems to be that investment in Preference Shares of listed companies is deemed not permissible.
