SMEs must be clear on how they treat different classes of shares

We work with many small and medium-sized companies that are owner managed, and often see various owners spending differing amounts of time in the day-to-day running of the business.

We also often see senior employees at SMEs incentivised with shares so that they can receive dividends that are linked to their contribution to the company’s success.

These arrangements mean that the shares held by an SME’s various shareholders are split into what are described as ‘alphabet’ shares. This means you have A shares, B shares, C shares, and so on, where dividend amounts are varied between these shares to reflect varying contributions made by the shareholders.

An example

For example, the A shareholder may be an investor shareholder and not work in the company, and so would receive a basic dividend each year. In contrast, the B Shareholder may be a major shareholder who also works full-time, and so would receive a larger dividend per share. And then the C shareholder may be a minority employee shareholder who will receive varying dividends based on their performance each year.

In each case the dividends are proposed by the SME’s board of directors using their discretion and the shares are treated as different classes of shares. However, this treatment of the A, B and C shares as different classes may not be correct and, if that is the case, it leaves the dividend payments open to challenge.

Quite often, we have seen that the only description of the rights attaching to the varying shares are those detailed in the statements of capital lodged at Companies House. In many cases, these make no mention of differing shares in the Articles of Association. What this means is that even though each of the A, B and C shares are described as though they are separate classes, the rights each has will be stated as identical in each case.

Therefore, each of the A, B and C shareholders will be described as having a right to attend and vote at company meetings, a right to participate in dividends and a right to participate on a winding up or return of capital.

In such cases, if the Articles of Association of the company fails to state more explicitly that each of the A, B and C shares constitute separate classes which differ for the purposes of dividends, companies could be challenged over their dividend payments.

This is because the much overlooked section 629(1) of the Companies Act 2006 provides that shares are of one class if the rights attached to them are in all respects uniform. This means that the A, B and C shares are not different classes of shares but merely differing name designations within the same class of shares.

Crucially, this would technically mean that A, B and C shares should have identical dividends paid on them, which took place in the recent Routledge v Skerritt (2019) case. This potential banana skin could have serious and costly consequences for any SME.

But fear not: such disasters can be easily avoided by ensuring appropriate provisions are included within the Articles of Association of the company and by having a properly adopted dividend policy.

For advice contact Fiona Boxwell, Associate Director in the Corporate Law team at Thursfields on 0345 20 73 72 8 or email fboxwell@thursfields.co.uk