Understanding Preference Shareholders in Liquidation: How They Relate to Ordinary Shareholders

In the United States, when a company undergoes liquidation, the treatment of preferred shareholders and ordinary shareholders is determined by the company's articles of incorporation and the specific conditions set out in the preferred stock issuance agreement. This article provides an overview of the rights and treatment of preference shareholders vis-à-vis ordinary shareholders during liquidation events.

Secured Creditors and Unsecured Creditors

Before delving into the specifics of preferred versus ordinary shareholders, it is crucial to understand the hierarchy of claims. In liquidation, secured creditors (those with collateral) are usually the most senior, followed by unsecured creditors, which can include bondholders, the government, and employees owed wages. Any remaining funds are then distributed to preferred stockholders, and finally, to the owners of common stock.

Preference Shareholders: Defined and Protected

Preference shareholders, also known as preferred shareholders or preferred stockholders, have a leg up in the distribution of assets during liquidation. These shares typically provide rights to priority dividends and a higher claim on assets than common stockholders. While the specifics can vary, certain rights are almost universally granted to preference shareholders, including:

Prior claim on assets and dividends Dividend preferences over common stockholders Seniority in the event of bankruptcy liquidation

Dividend Preferences of Preference Shareholders

Preference shareholders can have different levels of dividend preferences. Some may receive regular dividends, while others may receive cumulative dividends, which means any unpaid dividends must be paid before any dividends can be distributed to common stockholders. In some cases, preference shareholders can even have a 'participating' status, where they are entitled to receive both fixed dividends and a percentage of any remaining profits after all other shareholders have been paid.

Ordinary Shareholders: Less Privilege in Liquidation

In comparison, ordinary shareholders, or common stockholders, have fewer protections and rights during liquidation. Their dividends are typically only paid if the company has profits available, and they have no priority over secured or unsecured creditors. In the context of a liquidation event, common shareholders are generally last in line for any remaining assets after all other claims have been settled.

The Role of the Articles of Incorporation and Liquidation Preferences

The treatment of both preference and ordinary shareholders during a liquidation event is heavily dependent on the articles of incorporation and the specific terms outlined for the preferred stock. These documents determine various aspects, such as the liquidation preferences, conversion rights, and dividend policies. Therefore, the rights of both types of shareholders can vary widely from one company to another.

Conclusion

When considering the treatment of preference shareholders in liquidation compared to ordinary shareholders, it is clear that preference shareholders are afforded more protections and rights. However, it is important to note that the specifics of these rights are not universal and are highly dependent on the particular terms set forth in the company's articles of incorporation and preferred stock agreements. Always consult with a licensed attorney for professional advice regarding the unique situation and legal requirements of a specific company.

Disclaimer: This information is for general informational purposes only and does not constitute legal advice. If you have specific questions or concerns about your rights as a shareholder, consult with a licensed attorney in your jurisdiction.