Preference shares in a Thai Co., Ltd.
If the Thai shareholder owns preference shares, this results in a sophisticated foreign direct investment structure. However, the reverse preference share structure with a foreigner holding preference shares is a dangerous misconception and malpractice.
Equal share rights and preference share structures
Under Thailand‘s company laws, the shares in a limited company generally have the same characteristics. Each share represents the corresponding portion of the corporate property, in the corporates profits and the same voting rights of the shareholders meeting. The equal rights principal is a typical characteristic of a limited company. The share does not change its character by a share transfer to a new owner. Therefore, concerning the shares, the memorandum of association just has to indicate the amount of share capital and the divisions thereof into shares of a fixed amount with no further details required (Section 1098 no. 5 CCC).
In the case of a traditional foreign direct investment under a (cheap) non-preferred shareholding structure (that means all shareholders have equal rights) with foreign investors, the Thai shareholder has no business interest in the company and does not invest with his own funds, but has majority voting and dividend rights. This is deemed to be a nominee structure under the Foreign Business Act because voting power without voting interest and profit rights which are not adequately carried out result in an illegal imbalance. Such investment structure is strictly forbidden and even a severe criminal act. However, that law is till today poorly enforced in Thailand.
Deviating from the general principle as stated above, the limited company can issue two types of shares, common shares (aka ordinary shares) and preference shares. In this case, the number of preference shares to be issued, and the nature and extent of the preferential rights accruing to them has to be agreed in detail in the statutory meeting of the company (Section 1108 no. 4 CCC). Under Section 1111 CCC these details have to be officially registered in conformity with the resolution of the statutory meeting. After this has been accomplished, the preferential rights attributed to preferred shares cannot be altered at any later point in time (Section 1142 CCC).
However, the design of the preference clause depends on the agreements made in the corporate documents, not automatically by law. Under Thailand’s company legislation, a preferred shareholder may have less, more or different company rights than an ordinary shareholder. There is no legally defined preference share structure. However, in any case, it is a misconception to qualify preference shares as “half share and half debt”. It is preferred equity, but definitely equity, no senior debt, no mezzanine financing.
The straight preference share structure with Thai preference shares – a beneficial foreign investment structure
The law does neither describe or define the type or scope of preference nor does it allocate the preferred shares to the Thai or non-Thai shareholders. A typical preference share structure could be:
- The foreign shareholders hold in total 49% of common shares and the Thai shareholders own 51% preference shares.
- Preference shareholders have one vote for ten shares held, while ordinary shareholders have one vote for one share held,
- Preference shareholders are entitled to receive dividends before ordinary shareholders at the fixed rate of 5%.
Also, preference shareholders are typically entitled to receive capital returns upon liquidation of the company not more than the proportion of capital investment. However, a liquidation scenario is a rather unusual event and has, therefore, no relevance for the structuring and the legal judgment.
This preference share structure results in a perfect combination of foreign domination of the Thai company and compliance with Thailand’s foreigner legislation (Foreign Business Act). Because the Thai partner has no voting majority and no dividend rights, there is no need for an illegal restriction of the rights of the Thai partner. This can be seen as a win-win situation. As a result, it is required, or at least highly advisable to use a preference share structure in which the Thai shareholder owns the preference shares.
Reverse preference share structure with foreign preference shares – an ill-advised misconception
Purely for marketing purposes, it might be easier to explain to a foreign investor that he owns preference shares while the Thai partner has ordinary shares only. The reverse preference shares might be advertised as “golden shares”. However, nothing could have been further from the truth.
This preference share structure has to be clearly defined during the formation process. In the reverse preference share structure, 49% of the shares are preference shares. They might have ten voting rights per share so that the Thai partner is easily outvoted. And it might have the clause, which in a liquidation procedure the reverse preference shareholder gets his investment back in priority to the common shareholder. But how should the profit participation clause be drafted?
The 51% Thai shareholder obtains under his common shares 51% of the dividends. Is it allowed under Thailands company laws that the 49% foreign shareholder receives more than 49% of the dividends? The technique would be to provide the preference shares with ten times dividend rights or even 100 times profit participation. In that case, the common shares would generate for the Thai shareholder just 9.4% respectively 1% of the company’s dividends. Would Thailand’s courts accept such a corporate design in litigation?
Anyway, to incorporate such reverse structure, this requires a specific wording in the corporate documents and statutory meeting. Experience shows that this is not the case. Such documents typically just have a vague clause that the share of the foreign shareholder “have priority”, without a precise definition what that means. Such provision does not limit the 51% profit participation rights of the Thai shareholder. In so far the reverse preference share structure is just a fake to confuse the foreign investor.
Under such simple foreign preference priority clause, the Thai shareholder is still entitled to receive 51% of the yearly dividends, to receive 51% of the extraordinary dividends if the company sells its assets (for example real estate) and obtains a high capital gain from an “asset deal”. And the Thai shareholder is even entitled to receive 51% of the profits if all the shares are later sold to a buyer of the company in a “share deal”.
If the foreign investor can manage to receive all the dividends based on his “priority rights” because the Thai partner is not aware of the legal situation or is compensated in another way, then the whole structure would have to fear the Foreign Business Act as an apparent nominee structure. A preference share structure is lawful under the Foreign Business Act if the preference shareholder reasonably combines advantages with disadvantages. Because in a foreign preferred share structure, the benefits are all for the foreigner and the obstacles are all for the Thai shareholder, this is the straw that breaks the camel’s back.
In the famous Shincorp case, the Ministry of Commerce (DBD) took the view that it does not make any sense from a commercial perspective for the Thai investors who actually owned the majority shares to agree to accept less voting rights than foreign shareholders without preferential (guaranteed) dividends. As a result, it is highly advisable to repair the birth defect of the corporate structure to protect the foreigner’s interest in his Thailand property – even if this is not a multi-billion-baht investment.
The reverse preference shares have a lethal birth defect. Ask PUGNATORIUS how to repair ill-advised corporate structures before it is too late.