What creates an obligation to pay dividends on preference shares?

Preference shares often come with specific rights and obligations regarding dividend payments. When preference shares are labeled as cumulative, this means that if the company does not declare a dividend in a given year, the unpaid dividends accumulate and the obligation to pay these amounts carries over to future years. This creates a legal obligation for the company to eventually pay the owed dividends to preference shareholders before any dividends can be distributed to ordinary shareholders.

In contrast, options like standard market practice or company bylaws may outline general practices or rules; however, they do not inherently create an obligation. While bylaws might govern how and when dividends are declared, they do not specifically guarantee the accumulation of unpaid dividends, which is a hallmark of cumulative preference shares.

Shareholder agreements might delineate terms between shareholders, but they typically do not establish obligations at the level of preference share dividends. Thus, the presence of cumulative dividends distinctly indicates an obligation to pay that goes beyond mere practice or terms laid out in bylaws or agreements. This accumulation feature is essential in understanding why cumulative dividends create a clear obligation to pay dividends on preference shares.