Financial Liability

Hello tutor,

Could you please assist me on this?

Question : (June 2014; Kaplan revision kit question 60)
Lidan has in issue two classes of shares: A shares and B shares. A shares are correctly classified as equity. Two million B shares of nominal value of $1 each are in issue. The B shares are redeemable in two years’ time at the option of Lidan. Lidan has a choice as to the method of redemption of the B shares. It may either redeem the B shares for cash at their nominal value or it may issue one million A shares in settlement. A shares are currently valued at $10 per share. The lowest price for Lidan’s A shares since its formation has been $5 per share.

Answer:
In this case, the value of the own share settlement alternative substantially exceeds that of the cash settlement option, meaning that the entity is implicitly obliged to redeem the option for a cash amount of $1 per share. The B shares of Lidan will
therefore be classified as a liability.

Could it be argued that since Lidan has the option to redeem B shares, no contractual obligations exist and thus this instrument should be classified as equity?

I just don’t understand how a contractual obligation can exist when Lidan can simply choose not to redeem the shares. Or have I misunderstood what the question meant by “…B shares are redeemable in two years; time at the option of Lidan?”