Risks when the company issues preference shares and preventive measures
In the capital structure of a joint-stock company, preference shares are an important tool that allows businesses to flexibly mobilize financial resources, while serving the goals of governance and power distribution among groups of shareholders. However, these benefits are only be achieved when the preference mechanism is designed appropriately and strictly controlled through the company’s Charter. In fact, the inadequate regulation or ineffective operation of these types of preference shares creates financial pressure, increases conflicts of interest between groups of shareholders and poses many potential legal risks in the process of corporate governance. In the following article, TNTP will analyze common legal and financial risks when issuing preference shares, and at the same time provide recommendations for mitigating such risks to ensure stability, transparency and efficiency in the operation of joint-stock companies.
1. Potential legal and financial risks from preference shares
1.1 Risk of financial instability and liquidity risk
The issuance of preference shares, especially dividend preference shares and redeemable preference shares, may give rise to significant financial obligations for the enterprise in the course of operation.
For dividend preference shares, the enterprise is responsible for fulfilling dividend rights according to the commitments, in which the fixed dividend portion does not depend on the company’s business results. This shows that even in the event that the enterprise encounters financial difficulties or declining profits, the company still has to ensure the fulfillment of payment obligations to preferred shareholders. Maintaining the above financial obligations may affect the ability to accumulate profits, reinvestment capital and development plans of the business in the long term.
Similarly, for redeemable preference shares, the company must repay the invested capital to shareholders according to the committed term or conditions in the certificates of the redeemable preference shares and the company’s Charter. In case the enterprise does not have an appropriate cash flow management plan or does not establish a reasonable financial reserve fund, the simultaneous occurrence of many capital redemption requests may lead to the risk of financial imbalance, directly affecting the solvency and stability of business activities.
1.2 Risk of conflict of interest between groups of shareholders
By their nature, preference shares establish a mechanism for the distribution of unequal rights and interests among groups of shareholders. It is this characteristic that has become the cause of conflicts of interest in the process of corporate governance.
In fact, shareholders who own dividend preference shares or redeemable preference shares are usually guaranteed a higher level of financial security than shareholders who own ordinary shares through the right to enjoy preferential dividends or the capital redemption mechanism. Meanwhile, ordinary shareholders, although they are the group that directly bears the greatest risks from the business activities of the enterprise, are only allowed to receive dividends and remaining assets after the company has fulfilled its obligations to preferred shareholders.
This difference in priority levels of rights can lead to inconsistent views on profit distribution, financial strategy planning, or decisions on important corporate governance issues. In particular, in case of declining business results or limited profit sources, the conflict between the group of financial investment shareholders and the group of executive shareholders tends to intensify, negatively affecting the stability of corporate governance
1.3 Limited flexibility in governance structure
Although voting preference shares are considered a tool to protect the control of the founding shareholders, the corporate law sets certain limits to ensure the principle of balance of power in a joint-stock company.
According to Article 116 of the Law on Enterprises 2020 amended and supplemented in 2025 (“Law on Enterprises”), voting preference shares can only be owned by founding shareholders and organizations authorized by the Government. At the same time, the preferential voting rights of founding shareholders are only valid for a period of 03 years from the date the company is granted the Enterprise Registration Certificate. As for voting preference shares held by organizations authorized by the Government, the voting rights and the preferential duration are prescribed according to the company’s Charter. After this time limit, the voting preference shares shall automatically be converted into ordinary shares in accordance with the provisions of law.
In addition, Clause 3, Article 116 of the Law on Enterprises stipulates that shareholders who own voting preference shares are not free to transfer those shares to others, except for the case of transfer under a legally effective judgment or decision of the Court or according to regulations on inheritance. This restriction reduces the transferability of this type of shares, and at the same time limits the flexibility in the process of restructuring capital or transferring ownership of founding shareholders in the business.
1.4 Legal risks arising from a loosely drafted company’s Charter
Clause 2, Article 114 of the Law on Enterprises allows joint-stock companies to be entitled to stipulate other types of preference shares in the company’s Charter. This open regulation creates conditions for businesses to flexibly design a mechanism for the distribution of rights and interests among groups of shareholders. However, if it is not built in a strict and transparent way, this can also become the cause of many complex legal risks.
In practice, many enterprises formulate their company charters in general terms or use the standard charter form without clearly stipulating the issuance conditions, scope of preferences, order of exercise of rights or mechanism for handling disputes related to preference shares. This lack of clarity may lead to the situation that preferential rights in practice cannot be exercised and applied inconsistently among the relevant stakeholders.
As a result, disputes between shareholders over voting rights, dividend rights or the right to request capital redemption may arise during the operation of the enterprise. In particular, if the preference terms are contrary to the provisions of the Law on Enterprises or violate the legitimate rights and interests of other shareholders, these terms are at risk of being declared invalid, leading to adverse consequences for the governance structure and legal stability of the enterprise.
2. Preventive measures and notes when formulating the company’s Charter related to preference shares
Most of the risks arising from preference shares do not stem from the preferential mechanism itself but from the lack of strict design of relevant provisions in the company’s Charter, especially for regulations related to preference shares. Because, the Enterprise Law only establishes a basic legal framework, while the specific operating mechanism of each type of preference share largely depends on the content, scope and method of exercising the preferential rights recorded in the company’s Charter. Therefore, when an enterprise chooses to issue preference shares, the development of the Charter should be carried out in a careful, transparent and risk-aware manner to ensure the feasibility in practice. Key considerations when drafting Charter provisions relating to preference shares include:
2.1 Clearly stipulating the financial mechanism for dividend preference shares
For dividend preference shares according to Article 117 of the Law on Enterprises, the company’s Charter needs to specify the basis for calculation, method of determination, dividend payment mechanism and conditions for entitlement to dividends in order to limit the risk of disputes between the company and preference shareholders.
Accordingly, enterprises need to clearly determine whether the preferential dividend is a fixed dividend or a bonus dividend. In case there is an additional bonus mechanism, the Charter should also clearly stipulate the basis for determination, application conditions and calculation methods to ensure transparency in the implementation process.
In addition, the company needs to specify the financial sources used to pay preferential dividends, especially in case the business activities are unprofitable or incur losses. At the same time, the priority order of profit distribution between preferred shareholders and ordinary shareholders should also be clearly recorded in the Charter to avoid conflicts in the process of distributing annual profits.
2.2 Strict design of redemption conditions for redeemable preference shares
For redeemable preference shares according to Article 118 of the Law on Enterprises, enterprises need to develop a reasonable redemption mechanism to ensure a balance between the interests of shareholders and the company’s financial capacity. Giving shareholders the right to request an absolute or unconditional redemption of capital can put great pressure on cash flow and increase the risk of insolvency for the business.
Therefore, the company’s Charter should specify the time, conditions and order of exercising the right to redemption; At the same time, it clearly stipulates financial limits to ensure that the return of capital does not affect the company’s ability to pay due debts and asset obligations.
2.3 Building a mechanism to harmonize interests and resolve conflicts between groups of shareholders
Due to the difference in rights and interests between types of shares, the company’s Charter needs to establish appropriate protection mechanisms to limit the risk of disputes arising within the enterprise. One of the important contents that needs to be clearly stipulated is the order of priority of asset payment for preference shareholders in case of dissolution or bankruptcy of the enterprise. In addition, the specific determination of the mechanism for dividing the remaining assets will help ensure transparency of the legitimate rights and interests of groups of shareholders and limit conflicts in the process of handling the company’s financial obligations.
In addition, instead of giving shareholders preferential economic privileges or overly broad veto power, the company’s Charter should establish a transparent consultation and dialogue mechanism within the scope of decisions that directly affect their interests, such as changing dividend policies, capital redemption conditions, or issuance of additional preference shares with a higher priority. This approach not only ensures the legitimate interests of preferred shareholders, but also maintains a balance of interests with ordinary shareholders and limits the risk of conflicts in corporate governance.
2.4 Defining the Scope of Voting Preferences
For voting preference shares according to Article 116 of the Law on Enterprises, shareholders owning these types of shares have the right to vote on all matters under the jurisdiction of the General Meeting of Shareholders, so the company’s Charter needs to stipulate a reasonable percentage of preferential votes, commensurate with the role and level of contribution of the founding shareholders, in order to limit the risk of concentration of power and ensure the balance with ordinary shareholders.
In addition, although the voting preference shares of the founding shareholders are automatically converted into ordinary shares after 03 years according to the law, the Charter should still specify the procedures for updating the Register of Shareholders, revoking and renewing share certificates, as well as related information disclosure procedures. The standardization of these processes contributes to ensuring continuity, transparency and stability in the corporate governance structure, while limiting disputes arising related to the validity of preferential voting rights after the statutory time limit.
From a legal and corporate governance perspective, preference shares are important legal tools in capital mobilization, power allocation, and shareholder structure design. However, the effectiveness of this tool depends greatly on the quality of the company’s Charter and the ability to predict legal risks of the enterprise. If the preference shares are properly designed, they will become an effective support mechanism for the development of the enterprise; On the contrary, the lack of strict regulation or inconsistency with the law can become the cause of internal disputes, financial instability and long-term governance risks.
Above is an article about “Risks when companies issue preference shares and preventive measures”. In case businesses need advice or support related to the issuance, management and use of preference shares, please contact TNTP for further assistance.
