2023 (6) TMI 1492 - AT - IBC

NCLAT Rules Fully Convertible Debentures Are Equity, Not Financial Debt Under Section 5(8) IBC

M/s IFCI Limited Versus Sutanu Sinha, Asset Care Reconstruction Enterprise Ltd (ACRE)

The NCLAT upheld the Resolution Professional's rejection of the claim, ruling that the fully convertible debentures (CCDs) constitute equity instruments, ... Rejection of claim by the 1st Respondent/ the Resolution Professional (RP)fully Convertible Debentures should be treated as an Equity Instrument or as a Debt -amount stated to be due and payable, falls within the definition of Financial Debt or not - HELD THAT:- The perusal of the record also shows that the Concession Agreement dated 25/03/2010, the DSA Agreement dated 14/10/2011, the Share Pledge Agreement dated 21/10/2011 and the Share Buy Back Agreement dated 14/10/2011 executed between the Parties clearly treated the CCDs as ‘Equity’. There is no condition in any of the Agreements which changes the nature of the CCDs in the ‘happening of any event’. Merely because of the fact that interest is payable on the CCDs, by the Sponsor, in the case of a default, it cannot be construed that the CCDs fall with the definition of Section 5(8) of the Code. It is relevant to read Section 71(8) of the Companies Act, 2013 which states that ‘debt’ means a ‘liability’ or ‘obligation’ in respect of a `Claim’ which is due from any person and includes a `Financial Debt’ and `Operational Debt’. Hence, this Tribunal is of the considered view that ICTL is bound by the terms of the CCDs provided for under the Agreements. It is significant to mention that the exit option for IFCI is only buy-back of CCDs by the IVRCL or conversion of CCDs into equity. It is evidenced from the material on record that as per terms of the CLA between the Lenders Consortium, assigned to ACRE and the Corporate Debtor, the Corporate Debtor was prohibited from taking any further debt without the consent of the assignee. The Record does not show anywhere that any such approval was sought by the Corporate Debtor from the Lenders Consortium. At the time of disbursal of the amount, it was to be treated as Equity alone and not as ‘Debt’. Even if these amounts were reflected in the financial statements of the Corporate Debtor as ‘Other Financial Liability’, it would depend on the facts of each case as to whether such an entry in the balance sheet construes a ‘Financial Debt’ as defined under the Code. In the instant case, the terms of the DSA, CLA and the ‘Share Agreement’ have to be read together with the fact that it was the Sponsor Company which was liable to pay the interest component and not the Corporate Debtor. The Hon’ble Supreme Court in a catena of Judgments has categorically held that ‘IBC Code, 2016’ is a time bound process and any delay in challenging the rejection of the claims cannot be condoned as a matter of routine. In the instant case, the claim of the Appellant was rejected on 09/08/2022 where as the challenge to the Rejection was filed only on 30/11/2022 after a period of four months after the rejection of the claim. Today, the Resolution Plan has already been approved by the CoC by 100% majority voting share. This Tribunal is of the earnest view that in the facts of the attendant case, the CCDs are in the nature of ‘Equity Instruments’ and do not fall within the definition of ‘Financial Debt’ as defined under Section 5(8) of the Code - appeal dismissed. ISSUES: Whether Compulsorily Convertible Debentures (CCDs) subscribed by a financial creditor constitute 'financial debt' under Section 5(8) of the Insolvency and Bankruptcy Code, 2016 (the Code) or are to be treated as 'equity instruments'.Whether the occurrence of default or any other event can change the nature of CCDs from equity to debt absent contractual provisions to that effect.Whether a CCD holder whose CCDs have matured for conversion prior to initiation of Corporate Insolvency Resolution Process (CIRP) is entitled to be treated as a financial creditor and included in the Committee of Creditors (CoC).Whether reliance on RBI Master Directions on Foreign Direct Investment (FDI) is appropriate for determining the nature of CCDs in domestic transactions.Whether the delay in challenging the rejection of claim by the Resolution Professional (RP) can be condoned under the Code. RULINGS / HOLDINGS: CCDs which are fully, compulsorily and mandatorily convertible are to be treated as 'equity instruments' and not as 'financial debt' under the Code, as they do not postulate any repayment of principal. The Court held that 'a compulsory Convertible 'Debenture does not postulate any repayment of the principle' and thus 'does not constitute a 'debenture' in its classic sense'.The occurrence of default or any other event, unless expressly provided in the contract or subsequently agreed upon, cannot change the nature of CCDs from equity to debt. The Court stated: 'occurrence of default or any other happening, unless it is a part of the conditions of the contract/ agreement or later on agreed between the parties... cannot change its very nature from equity to debt'.A CCD holder whose CCDs have matured before admission into CIRP is not entitled to be treated as a financial creditor or included in the CoC if the CCDs are equity instruments as per the contractual terms and applicable law. The Court observed that 'the CCDs had already matured on 09.11.2017 and therefore stood automatically converted to equity'.RBI Master Directions on FDI, though issued in a different context, provide relevant guiding principles for classifying CCDs as equity instruments, and reliance on these directions was held appropriate. The Court noted that 'Debentures which are fully, compulsorily and mandatorily convertible shall be treated as 'Equity Instruments'' as per RBI guidelines.The delay of more than three months in challenging the rejection of the claim by the RP is not condoned under the Code, given the time-bound nature of insolvency proceedings. The Court held that 'any delay in challenging the rejection of the claims cannot be condoned as a matter of routine'. RATIONALE: The Court applied the definition of 'financial debt' under Section 5(8) of the Code, which requires the debt to be disbursed against consideration for the time value of money, and noted that CCDs do not satisfy this criterion as the principal repayment is not contemplated and interest payment obligations lie with the sponsor company, not the corporate debtor.The Court relied on the Supreme Court precedent in Narendra Kumar Maheshwari v. Union of India, which clarified that compulsorily convertible debentures are equity instruments because they do not involve repayment of principal and only convert into shares, distinguishing them from classic debentures.The contractual documents including the Concession Agreement, Debenture Subscription Agreement (DSA), Share Pledge Agreement, and Share Buy Back Agreement consistently treated the CCDs as equity instruments with no provision for conversion to debt upon default or other events, and the Court emphasized that no such term was brought to its notice.The Court considered the RBI Master Directions on FDI as providing authoritative guidance on the classification of CCDs, despite their issuance in the context of foreign investments, and found their principles applicable to the present domestic dispute.The Court rejected the contention that financial statements recording CCDs as 'Other Financial Liabilities' automatically classify them as financial debt, recognizing that accounting treatment alone does not determine legal classification under the Code.The Court noted that the sponsor company's obligation to pay interest on CCDs and the absence of any obligation on the corporate debtor to pay interest negate the presence of 'time value of money' consideration, a key element of financial debt.The Court underscored the importance of adhering to the time-bound framework of the Code and refused to condone the appellant's delay in challenging the rejection of its claim, especially since the Resolution Plan had already been approved with 100% voting share of the CoC.