The legal challenges of “Scrip Dividend” transactions and their implications for beneficial owners of shares in Spain
In recent years, the “Scrip Dividend” mechanism has gained popularity in Spain among large, listed companies, such as Banco Santander, BBVA, Iberdrola and Telefónica. This practice, presented as a form of alternative remuneration, has been promoted under different names, such as “flexible dividend”, “dividend election”, or simply “Scrip Dividend”.
At first glance, it appears to be a capital increase paid out of reserves, but the choice between receiving a dividend in cash or in the form of new shares can have significant consequences for the beneficial owners of shares in these companies.
The basic mechanics of the “Scrip Dividend”
The “Scrip Dividend” is a strategy that seeks to reconcile the interests of the company and shareholders by offering a solution to the traditional conflict between the company’s retention of profits and the shareholders’ desire to receive dividends. In essence, it involves a capital increase against reserves, which is generally approved together with the previous year’s annual accounts.
Shareholders have the option to sell their free allotment rights to the company or in the market, allowing them to receive the traditional cash dividend. The rights acquired by the company from the shareholders are usually waived by the company once acquired. There is also the possibility for shareholders to receive new bonus shares in proportion to their shareholding in lieu of the cash dividend.
However, the complexity arises where the scrip dividend transaction may be a pure capital increase out of reserves or a mixed transaction combining dividend payments and capital increase. This may have significant legal implications as to who is entitled to receive the new shares or the consideration for the free allotment rights disposed of.
The regulatory provisions for usufructuary shares
Spanish regulation raises two fundamental questions in relation to scrip dividend transactions involving usufructuary shares: the first question is who decides the form of the “dividend” and the second is who benefits from the dividend. The Capital Companies Act (hereinafter “LSC”) addresses these questions in several articles.
Article 129.2 of the LSC provides that the choice and negotiation of the form of the “dividend” may be left to the usufructuary, but the profits remain the property of the bare owner, although they are subject to the usufructuary’s lien. On the other hand, if the transaction is considered a dividend, Article 127.1 of the LSC provides that the resulting assets belong to the usufructuary.
However, in “Scrip Dividend” transactions which often mix elements of capital increase against reserves and distribution of company profits, the answer to who is entitled to receive the shares or the consideration for the disposed free-of-charge allocation rights is not clear under the LSC. Since most of the rules are dispositive, it is highly advisable to establish corresponding covenants in the constitutive title of the usufruct to avoid possible legal disputes.
Opinions on the rights of the usufructuary in the “Scrip Dividend”
Different experts and authors have expressed varying opinions on who should have the right to elect in Scrip Dividend transactions and who should benefit from such elections. Some argue that it is more consistent with the institution of the beneficial interest and the nature of the transaction to allow the beneficial owner to make choices about the options offered. This would prevent the usufruct from being emptied of content.
In a judgment of the Provincial Court of Navarra in 2014, it was concluded that the new shares received as a result of a “Scrip Dividend” belong to the usufructuary instead of the bare owner. However, this interpretation may be questionable from a strictly legal perspective, as Spanish law establishes that the new shares belong to the bare owner in the case of a capital increase charged to reserves.
Iberdrola case: a detailed perspective
A prominent case illustrating the legal challenges of the “Scrip Dividend” is that of Iberdrola in 2013. In this case, Iberdrola’s General Shareholders’ Meeting approved a proposal for the appropriation of profits and distribution of dividends, as well as two capital increases released against reserves.
Although the operation was presented as a “flexible dividend”, it was financed from a reserve called “RDL 7/1996” and was clearly differentiated from the distributable profits earmarked for the dividend. This raises the question whether this operation can be considered a distribution of profits, or a capital increase charged to reserves.
According to the strict application of the LSC, the new shares should belong to the bare owner, even if the usufructuary chooses to sell his free-of-charge allocation rights.
The regulation of the usufructuary’s rights in scrip dividend transactions in Spain does not provide an unequivocal solution to the problems raised. The interpretation may depend on the specific circumstances of each transaction. Therefore, it is essential that clear covenants are established in the constitutive title of the usufruct to address this issue and avoid possible legal disputes in the future.
In addition, it is important to consider the nature of the reserve used in the transaction to determine who is entitled to the new shares in each case. The naming of the transaction as a “flexible dividend” should not be the sole determining factor, as the source of the funds used may be crucial in determining who should benefit from the transaction.
Ultimately, the legal challenges and the implications for beneficial owners in scrip dividend transactions highlight the importance of careful planning and legal advice to ensure that the rights of all parties involved are fairly and adequately protected in this increasingly complex context of corporate profit distribution in Spain.
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