‘Preferred’ Can Be a Relative Term With Stock Issues

In recent years, many income-hungry investors have been attracted to so-called preferred shares of major companies. The appeal is the often high dividends the stocks pay and the fact that investors in these shares usually have a greater claim on company assets, in the event of a bankruptcy filing, than common shareholders.

But as owners of about 6 million UAL Corp. preferred shares have found, “preferred” can be a relative term.

The airline giant’s two preferred issues have plunged in price in recent months, as investors have anticipated the company’s Chapter 11 filing. Both of the stocks were trading near $1 on Monday, down from about $20 in June, according to Bloomberg News data.

Here are answers to some questions preferred shareholders may have:

Question: Where do preferred holders stand on the bankruptcy priority list? Who gets paid before and after them?

Answer: There are three categories of debtors in a corporate bankruptcy.

Secured creditors -- in this case, mainly banks that hold liens on UAL assets such as airplanes and terminal slips -- would be paid first.

Unsecured creditors, such as suppliers of fuel, food and other services to the company, are in the second slot. Holders of some types of preferred stock also fall into this category.

The final group is made up of equity security holders -- the holders of UAL’s common stock, and sometimes preferred stock. They are at the bottom of the heap, though preferred holders rank above common holders.

Equity owners, if they’re not wiped out completely in the bankruptcy proceedings, are likely to have their interests drastically diluted, said Jack Williams, professor of bankruptcy law at Georgia State University College of Law.

Q: How are UAL’s preferred stocks structured?

A: UAL has two distinct types of preferred shares outstanding. It has about 3 million Series B preferred shares and an additional 3 million in Trust Originated Preferred Securities.

The Series B preferred is structured more like equity, according to company representatives. The so-called TOPS shares are structured more like debt.

Q: Does that mean that the TOPS holders will get paid and the Series B holders won’t?

A: Not necessarily. The final determination about whether a preferred share is considered debt or equity will be up to the presiding Bankruptcy Court judge, Williams said.

The judge will look at myriad factors to decide how to classify UAL preferred. Generally, preferred shares are classified as equity if the preferred holder is able to vote on directors and other issues relating to the company’s governance or is able to somehow participate in the company’s profits.

Preferred stock usually is classified as debt if it pays a set rate of return, the holders are not given a vote in company matters and do not have a representative on the board, Williams said.

Q: What happens to the dividends owed to UAL preferred shareholders?

A: UAL suspended dividend payments on its Series B preferred, which had paid $3.06 a share annually, in September and “extended” payment of the Dec. 31 dividend on its TOPS preferred, paying $3.31 annually, until March 31.

UAL representatives on Monday could not say whether the TOPS quarterly payment would be made in March or if it would be postponed again. Under the terms of the initial offering of the securities, the company can postpone TOPS dividend payments up to 20 consecutive quarters -- five years total.

Q: Is there any downside to owning TOPS shares compared with UAL’s Series B preferred?

A: Just one: TOPS owners are likely to get tax statements showing that UAL “accrued” the Dec. 31 quarterly dividend payment on shareholders’ behalf, even though it wasn’t paid in cash. That makes the unpaid but accrued amount taxable on 2002 tax returns.

If UAL ultimately fails to make the payment owed, shareholders would be able on future tax returns to claim a loss for the unpaid dividend income.

In the case of the Series B dividends, the payments don’t accrue; they are paid at the discretion of UAL’s board.

Q: What arrangement could United make to repay preferred shareholders?

A: In many bankruptcy cases, bondholders are offered a combination of cash and stock in the reorganized entity in exchange for their debt.

But it isn’t known whether holders of either of UAL’s preferred issues would eventually be offered an equity stake in the reorganized company.