While clarifying that holders of Cumulative Redeemable Preference Shares (CRPS) cannot be treated as financial creditors under the Insolvency and Bankruptcy Code, 2016 (IBC), the Supreme Court held that preference shareholders are investors and not lenders, and their claims for redemption shall not constitute a ‘financial debt’ which is capable of triggering insolvency proceedings under Section 7 of the IBC.
The Court emphasized that there is a statutory distinction between share capital and debt, and hence, the provisions of the IBC cannot be invoked as a recovery mechanism for equity investments, even if the redemption period for preference shares has expired. Essentially, the Court asserted that the preference share capital remains part of the company’s equity structure until duly redeemed in accordance with Section 55 of the Companies Act and cannot, by default, metamorphose into a debt obligation.
A Two-Judge Bench of Justice J.B. Pardiwala and Justice K.V. Viswanathan explained that a debt would be a financial debt if it is raised under any other transaction, including any forward sale or purchase agreement having the commercial effect of borrowing, and therefore, the paid-up amounts towards shares do not have the character of debt. Reference was made to Section 55 of the Companies Act, 2013, as per which the shares could be redeemed only out of the profits or with any amount kept apart for dividends.
The Bench observed that Accounting Standards (AS 32) prescribe that a preference share that provides for mandatory redemption by the issuer for a fixed or determinable amount at a fixed or determinable future date, or gives the holder the right to require the issuer to redeem the instrument at or after a particular date for a fixed or determinable amount, is a financial liability.
However, the treatment in the accounts due to the prescription of accounting standards will not be determinative of the nature of the relationship between the parties as reflected in the documents executed by them. Further, the IBC has its own prerequisites that a party needs to fulfil, and unless those parameters are met, an application under Section 7 will not pass the initial threshold, added the Bench.
Briefly, the dispute between the appellant (EPC Constructions) and the respondent (Matix Fertilizers) arose out of a commercial relationship between the two companies, when in 2009, the appellant (also formerly known as Essar Projects) was engaged by the respondent to construct a large fertilizer plant in West Bengal. In the course of the project, the respondent faced liquidity issues, resulting in delayed payments to the appellant for its engineering and construction services.
The respondent proposed that the outstanding dues be converted into equity-linked instruments to improve its debt-equity ratio, which was accepted, and the appellant agreed to convert a portion of its receivables amounting to Rs. 250 crore into 25 crore 8% Cumulative Redeemable Preference Shares (CRPS) of Rs. 10 each. When insolvency proceedings were initiated against the appellant, the liquidator raised a claim representing the redemption value of the CRPS along with accrued dividends. The respondent refused to redeem the shares on the ground that it lacked sufficient profits as required under Section 55 of the Companies Act, 201. The matter reached the NCLT, which held that the preference shareholders are not financial creditors under the IBC. This decision was affirmed by the NCLAT.
Appearances:
Senior Advocate Niranjan Reddy, AOR Sanya Sud, along with Advocates Abhishek Swaroop, Aditya Vikram Singh, Akhila Reddy, Palak Arora, and Shreya Chandhok, for the Appellant
Senior Advocates Mukul Rohatgi and Nitin Rai, AOR E.C. Agrawala, along with Advocates Mahesh Agarwal, Rishi Agrawala, Geetika Sharma, and Madhavi Agarwal, for the Respondent
