- within Corporate/Commercial Law topic(s)
- with Senior Company Executives, HR and Finance and Tax Executives
- in United States
- with readers working within the Business & Consumer Services, Technology and Media & Information industries
Facts of the Case
The cause of the dispute lies in a series of commercial transactions between EPC Constructions India Limited (EPCC), formerly known as Essar Projects India Limited, and Matix Fertilizers and Chemicals Limited (Matix).
EPCC had entered into an Engineering, Procurement, and Construction (EPC) contract with Matix on 11 December 2009 for setting up a large-scale fertilizer complex, involving the design, procurement, construction, and commissioning of facilities for ammonia and urea production.
Pursuant to these contracts, EPCC claimed that a total sum of ₹572.72 crores became due and payable by Matix. During this period, Matix faced delays and cost escalations and was unable to repay its dues or secure further disbursements from its lenders. Consequently, it proposed converting a part of the outstanding dues owed to EPCC into preference shares to show equity infusion and maintain a debt-equity ratio that would enable it to raise further credit. On 27 July 2015, Matix wrote to EPCC proposing that up to ₹400 crores of its dues be converted into Non-Cumulative Redeemable Preference Shares (NCRPS). EPCC's Board, in its meeting on 30 July 2015, approved the proposal but directed that the preference shares be cumulative in nature and carry an 8% annual dividend. The Board resolution recorded that accepting the proposal would involve no outflow of funds and that converting receivables into shares would facilitate project completion, which was in the company's interest. It also explicitly noted that Matix's lenders had conditioned further credit facilities upon additional equity infusion, and thus, this conversion would allow Matix to access the funds necessary to complete the project.
Following the resolution, Matix issued a letter confirming the allotment of 25 crore 8% Cumulative Redeemable Preference Shares (CRPS), redeemable at par at the end of three years. EPCC accepted the allotment, and the CRPS were duly issued. However, EPCC itself underwent corporate insolvency resolution proceedings under the IBC. Thereafter, Matix claimed to have unilaterally adjusted the CRPS liability against its alleged claims and later filed a revised claim before the RP, which was rejected. In 2018, EPCC's Liquidator issued a demand notice to Matix claiming ₹632.71 crores, of which ₹310 crores pertained to the redemption amount of the matured CRPS. Upon Matix's refusal to pay, EPCC, through its Liquidator, filed a petition under Section 7 of the Insolvency and Bankruptcy Code, 2016, alleging default in payment of financial debt.
|
Findings of NCLT |
Findings of NCLAT |
|
The Tribunal held that under Section 55 of the Companies Act, 2013, preference shares can only be redeemed out of profits available for dividend or from the proceeds of a fresh issue of shares. Since Matix had not declared any profits and its financial statements for the relevant period revealed continuing losses, the condition precedent for redemption had not been fulfilled. Consequently, the question of any payment becoming due did not arise. The NCLT further held that the non-redemption of preference shares does not convert a preference shareholder into a creditor. The Tribunal also referred to Section 123 of the Companies Act, which prohibits declaration of dividends out of losses, and observed that unless the preference shares had become lawfully redeemable, they could not constitute "debt" or "financial debt." Hence, the application under Section 7 of the IBC was held to be not maintainable. |
The NCLAT emphasized thatpreference shares can only be redeemed from profits available for dividend or proceeds of fresh issues. Since Matix had never declared any dividend nor made profits sufficient for redemption, no debt had become due. The Appellate Tribunal observed that the correspondence between the parties and the resolution of EPCC's Board dated 30 July 2015 demonstrated that both parties intended to treat the outstanding dues as share capital rather than debt. Once the preference shares were allotted, the earlier receivables stood extinguished, and the relationship between the parties changed from that of debtor and creditor to that of shareholder and company. The NCLAT, therefore, affirmed that EPCC, being a preference shareholder, was not a "financial creditor" within the meaning of Section 5(7) of the IBC and consequently could not maintain a petition under Section 7. |
Findings and Observations of the Supreme Court
The Supreme Court affirmed the concurrent findings of the NCLT and NCLAT and held that Cumulative Redeemable Preference Shares (CRPS) do not constitute debt under the IBC. The Court began its analysis by stating that it is well-settled in company law that preference shares are part of the company's share capital, not borrowed funds. Dividends on such shares are payable only out of profits; if paid without profits, they would amount to an unlawful return of capital. Therefore, the amount paid on preference shares cannot be equated with a loan and cannot be characterized as debt.
The Court examined Section 43 of the Companies Act, 2013, which classifies share capital into equity and preference share capital, and Section 55, which regulates the issue and redemption of preference shares. It observed that the second proviso to Section 55(2) makes it explicit that preference shares may be redeemed only from profits available for dividend or from the proceeds of fresh issues made for that purpose. If a company has not made profits or undertaken a fresh issue, redemption is not legally possible, and no enforceable liability arises. Thus, the existence of a debt or default, the core requirement for a Section 7 IBC proceeding could not be established.
The Court placed reliance on authoritative company law texts and judicial precedents. Quoting from A. Ramaiya's Guide to the Companies Act (18th Edition, Volume I, page 879), the Court reiterated that preference shareholders are shareholders, not creditors, they cannot claim repayment of their share money except upon winding up. Similarly, Lalchand Surana v. Hyderabad Vanaspathy Ltd. [(1988 SCC OnLine AP 290)] was cited, where Justice B.P. Jeevan Reddy had held that unredeemed preference shareholders do not become creditors since redemption depends upon profits or fresh issue proceeds, limitations not applicable to ordinary creditors. The Court also referred to Gower's Principles of Modern Company Law (10th Edition, page 1071), which draws a conceptual distinction between debt and equity, explaining that while preference shareholders receive fixed dividends, their entitlement arises only when profits exist, unlike debt holders whose rights to interest are independent of profits.
The Supreme Court then turned to the statutory framework of the IBC. Under Section 3(11), "debt" means a liability in respect of a claim which is due from any person, and Section 3(12) defines "default" as non-payment of a debt that has become due and payable. Section 5(8) defines "financial debt" as one disbursed against the consideration for time value of money. The Court observed that since the CRPS had not become payable, given Matix's financial condition and the absence of profits or fresh share proceeds, there was no default in law or in fact. Relying on Innoventive Industries Ltd. v. ICICI Bank [(2018) 1 SCC 407], the Court reiterated that a default must be of a debt that is payable in law or in fact; since no lawful obligation to redeem existed, the foundational requirement for triggering Section 7 was absent.
In addition, the Court referred to Radha Exports (India) Pvt. Ltd. v. K.P. Jayaram [(2020) 10 SCC 538], which had held that payment for shares cannot be construed as a financial debt; to Anuj Jain, IRP for Jaypee Infratech Ltd. v. Axis Bank Ltd. [(2020) 8 SCC 401], for the principle that disbursal against consideration for the time value of money is essential to qualify as financial debt; and to Global Credit Capital Ltd. v. Sach Marketing Pvt. Ltd. [2024 SCC OnLine SC 649], where the Court reaffirmed that all clauses of Section 5(8) must satisfy the test of "disbursal against consideration for time value of money." The Court thus concluded that preference share capital, being part of the company's equity and not disbursed capital, fails to meet this test.
Analytical Note: Reconsidering the Legal Character of CRPS under the IBC Framework
The Court, in holding that Cumulative Redeemable Preference Shares (CRPS) do not constitute "debt" or "financial debt" under the Insolvency and Bankruptcy Code, 2016 (IBC), has reaffirmed the classical position that preference share capital is part of a company's equity base and not its borrowing. The ruling emphasizes statutory fidelity to the Companies Act, 2013, particularly Sections 43 and 55, and underscores the principle that preference shareholders remain members of the company until winding up and cannot claim parity with creditors.
While the Court's interpretation is doctrinally sound and consistent with traditional understanding of Company law, it may be argued that it adopts a somewhat formalistic approach, overlooking the economic substance of hybrid financial instruments. In commercial reality, redeemable preference shares, especially those carrying fixed redemption terms and dividend rates, often mimic debt in their risk structure and repayment expectation. They are frequently used as quasi-debt instruments to infuse capital while preserving lender-like rights without dilution of control. The appellant's argument that the conversion of dues into CRPS was merely a functional restructuring of debt had some commercial plausibility. However, the Court preferred to treat the legal form as determinative, reasoning that once conversion occurred, the creditor's claim was extinguished and replaced by a membership interest.
A more nuanced interpretation could have been possible within the broad and purposive definition of "financial debt" under Section 5(8)(f) of the IBC, which includes any amount having the commercial effect of a borrowing. The Supreme Court itself in Pioneer Urban Land & Infrastructure Ltd. v. Union of India (2019) 8 SCC 416 recognized that expansive interpretation of the phrase "Commercial effect of borrowing" must be undertaken and in the case of Anuj Jain v. Axis Bank Ltd. (2020) 8 SCC 401 recognized that the IBC law should interpret "financial debt" expansively even if the transaction is not necessarily stated therein in section 5(8) , focusing on the real nature of the transaction rather than its nomenclature. The redemption feature and fixed return attached to CRPS arguably produce a "commercial effect of borrowing," especially where the shares were issued in lieu of an existing receivable, as in this case. A pragmatic interpretation could have treated such CRPS as contingent debt, the enforceability of which depends on statutory preconditions like profits or fresh issue proceeds, without completely denying its debt-like substance.
This is more evident from the legislative transformations around the world, In UK, The Govt tax authority in the HMRC's Corporate Finance Manual explains that "certain types of share can be accounted for as a financial liability rather than equity"
The approach adopted by U.S. bankruptcy courts, particularly in Pepper v. Litton and subsequent jurisprudence such as In re AutoStyle Plastics and In re Live Primary, LLC, offers a compelling interpretive framework that can serve as a guiding light for Indian insolvency jurisprudence. These decisions affirm the principle that the economic substance of an instrument should prevail over its formal classification, empowering courts to recharacterise an ostensible debt or equity instrument based on its true commercial nature.
At the same time, the Indian Court's reasoning reflects legitimate concern over destabilizing corporate finance by equating equity instruments with debt. Recognizing preference shareholders as financial creditors could create a floodgate of insolvency petitions from investors whose dividends remain unpaid due to accounting losses, thereby distorting the IBC's objective of resolving genuine debt defaults. Thus, while the strict interpretation preserves doctrinal clarity and corporate stability, it may inadvertently discourage the use of CRPS as a flexible capital-structuring tool.
The way forward lies in legislative or regulatory clarification. The Companies Act could expressly distinguish between redeemable preference shares issued against new capital and those issued in lieu of existing debt, recognizing the latter's hybrid character for limited insolvency purposes. Alternatively, the IBC framework could evolve to accommodate instruments that, though structured as equity, serve the commercial effect of borrowing. Such calibrated recognition subject to objective conditions like fixed maturity and assured return would better reflect the economic realities of modern finance without eroding the fundamental debt–equity divide.
In conclusion, the Supreme Court's ruling in EPC Constructions upholds doctrinal purity but leaves limited room for the commercial elasticity that contemporary financing demands. The interpretation is legally correct but perhaps economically conservative. The challenge now is to ensure that insolvency jurisprudence develops in a manner that respects both legal form and financial substance, harmonizing corporate law formalism with the IBC's remedial purpose.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
