Each shareholder in a corporation is entitled to a share in the dividend pro rata with his shareholding in the company’s capital. Unless otherwise is agreed in the articles of association, a dividend shall be calculated pro rata with the payments made by the shareholder to the company for his capital share. In other words, as a rule. the “proportionality” principle is of essence in dividends

As the wording in the law reads “unless otherwise is agreed in the articles of association”, it may be agreed that certain shares may be entitled to such dividend that is more than the amount that it would be otherwise entitled under the applicable law. In this respect, by means of a provision to be incorporated in the articles of association during the incorporation or a subsequent amendment to the articles, it is possible to elevate the status of certain shares to a position that is more favourable (advantageous/ paramount) compared to other shares.

It should be noted that here this preferred status is not vested in the shareholder but the share itself. It is not possible to grant a preferred status to dividend by specifying the name of a natural or legal person.

As a preferred dividend may be defined in a shareholders’ agreement only to be incorporated into the articles of association later,  an investor is recommended to see that applicable provisions should be strictly agreed in the shareholders’ agreement if that investor is willing to collect a dividend more than the share entitled by him under the law, given the fact that this investor’s first and foremost goal in his investment is to collect dividends.

There is a gap in the law as to how the preferred status in dividend shall be secured, and the most common models in practice are as follows:

a. Supreme right to profits

Under this model, a dividend is first paid to the preferential shareholder and any balance may be distributed to non-preferential shareholders. As preferential shares are eligible to dividends prior to other ordinary shares, this model is rather called “supreme entitlement to dividends”.

b. Higher share in dividend

As the name suggests, a preferential shareholder is paid a higher dividend compared to other shareholders. This type of preferential right, also called a higher entitlement to dividend, has the chance to be entitled to company dividends at shares that are larger than the other shareholders.

c. Entitlement to dividend cumulatively

Pursuant to this model, if a preference is granted, a preferential shareholder is not deprived of his dividend rights for periods in which the company pays no dividend although the company makes a profit. When the company decides to distribute dividend, that shareholder will now have the chance to collect such dividends that he has been denied in no-distribution times. It is possible to limit this model in time or to grant it without any restriction whatsoever.

Usually a newco uses this model because it is not likely that investors will be attracted to a company, which will evidently not be able to distribute dividend for a long time, this model may boost the demand to company shares thanks to cumulative dividends (Karahan,  Preferential Shares, p. 70)

d. Entitlement to profit on a re-cumulative basis

Pursuant to this model, a preferential shareholder first makes use of his preferential status and collects the dividend. Later he may be once more eligible to a a distribution to be made to other shareholders.

These four models are the most common ones used in preferential dividends, and it is possible that shareholders may agree on other models.

If a preferential dividend is prescribed in both articles of association and a shareholders’ agreement signed to serve as basis for that articles, then it is important to define the scope; limits and terms of the preference without any margin of doubt in order to avoid problems in practice.

We would like to also note that these preferential shares may be created by means of provisions in the articles of association or it is possible to secure exclusive interests in the company’s earnings for specific individuals. By means of a provision in the articles, it may be prescribed that a share shall be granted from the company earnings to founders, board members and others. As one can see, an opportunity may be given to any non-shareholder to participate in the company profits. This opportunity relies on the wording of paragraph of Article 339 of Turkish Code of Commerce (TCC) which describes the provisions to be incorporated into articles of association: “Interests to be granted to founders, board members and other individuals out of the company profit.” is based on clause (f)

It should be finally noted that under Turkish Code of Commerce system, an incorporation is not obliged to distribute dividends at the end of every financial year. Dividend distribution in publicly traded companies are subject to special regulations. A company is statutorily obliged to distribute dividend to shareholders as a rule unless it is publicly traded. Publicly traded company shall act in line with their dividend distribution policies and may not distribute dividends to shareholders.

We would like to state additionally that in practice, there are circumstances where certain rights are vested in third parties for dividend distribution by means of various contracts. For instance, contracts such as the ones made between the company and/ or the shareholder and company employees for the transfer of financial rights may give to employees certain rights to collect dividends in part or in full. Thanks to these regulations which are documented in writing and operate as an assignment, the company shall not pay a dividend to a shareholder but to an assignee.

* The work authored by Assoc. Prof. Dr. Hakan Bilgeç and titled “Preferences in Dividends in Incorporations in Turkish law” was used as a reference.