Sunday, October 16, 2011

Moving swiftly on

So yer Djanogly and his legal aid bill and his insurance companies. Something I'd love to know more about is his rather odd statement that his kids had "non-interest bearing non-voting shares" in these companies and that they were "of no value". This is of course another case of the principle that lawyering a statement is much like doctoring it.

So, I presume that Djanogly (whose name is remarkably hard to type if you're a pythonista and therefore have the word "django" wired into touchtyping muscle memory) didn't really intend to leave his kids something of "no value". Had he wanted to do that, he could just leave them nothing, and save the lawyers' fees.

Now, the financially interesting thing here is that the securities involved are shares. Most shares are ordinary shares - they convey a share of ownership of the company, which is expressed by the fact they carry votes in the annual general meeting, and they carry the potential right to a share of profits if the directors (who the shareholders elected) so decide. However, they come dead last in terms of the company's credit and they pay no interest. All your capital is at risk if the company can't pay its bills, as everyone else gets paid out first. This is the nature of ownership - you have control over whatever it is you own, you can draw on its profits if you want to, but if it goes bust, it's your funeral.

Non-voting shares are usually preference shares. The difference is that you give up the vote, in exchange for a regular, guaranteed payout of income rather than just a chance of a dividend. Further, the preferred shareholders have to be paid their money before any dividends or anything else are paid to the ordinary shareholders, so there is an additional measure of security. This is why they are "preferred".

But Djanogly's statement excludes both preferred and ordinary shares. Note that there is neither a vote, nor any interest. Who would want such a security?

There are reasons. If a company is wound up, its creditors get paid first, with the government at the front of the queue. At the back of the queue are the shareholders, of all kinds. But this is only of interest if the company has creditors - i.e. if it is in debt. If there were no creditors, then its assets would be divvied up by the shareholders in return of their capital. Even if the company, like most companies, has some debt, such a residual claim would be worth having if the company's assets are worth much more than the debts.

Or the company might buy out the funny shares, or swap them for ordinary or preference shares. Also, you'll note that the shares are not "interest bearing", but then shares usually aren't and this is very important. If the shares aren't preference shares - i.e. they are not "interest bearing" - it's entirely up to the directors to decide what to pay out to them and when. They could hold a board meeting tomorrow and pay a huge special dividend in cash, on the special class of shares alone. Or they could wind up the company and divvy-up the pool. In a public company with thousands of shareholders, they might struggle to get away with this, but the Djanogly family controls 100% of the company.

So. The shares are worthless now, but the directors of Djanogly's firm are in a position to make them very valuable at a time of their choosing. Why would you want this set-up? The short answer is "inheritance tax".

As is fairly well known, inheritance tax has a time component. If you give away your money, and then die, it counts as an inheritance for tax purposes if you died seven years or less after giving away the money. If you give it all to the kids, you then have to live seven years without your money, and with the risk that you might survive much longer. And even if you commit suicide, you've to stick the seven years first. Of course, it is extremely annoying to tax-evaders that you can only control the moment of your death in a negative and unpleasantly dramatic fashion.

So the value of a device that permits you to bequeath something that is worthless until activated by a third party ought to be obvious. Ideally, you'd want something that permitted activation from beyond the grave, like the Soviet nuclear missile command system in Charlie Stross's The Jennifer Morgue. But that is impossible, and I think that a contract that required your executor to convene the board and pay out the money the day afterwards would break the rules on related-party transactions, although who knows?

Thanks are extended to Jones the tax.

1 comment:

Tim Worstall said...

You're probably right in what is going on but just a technical detail:

"Non-voting shares are usually preference shares. The difference is that you give up the vote, in exchange for a regular, guaranteed payout of income rather than just a chance of a dividend."

No, preferred shares do not have to pay interest. They might just have priority over a dividend pay out for example. They don't even have to have that: it could just be a preference, a step up the claims chain in case of liquidation.

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