NCLAT dismisses appeal on convertible debentures classification as equity instruments not debt under IBC

The NCLAT Chennai dismissed an appeal regarding treatment of compulsorily convertible debentures (CCDs) under IBC. Following SC precedent in IFCI Limited case, the tribunal held that CCDs without repayment obligation constitute equity instruments, not debt. The debentures automatically converted to equity shares after 10 years with no liability for principal repayment. Under waterfall mechanism, equity holders rank after creditors, meaning appellant would receive nothing. The tribunal applied the test that convertible debentures are debt only if they provide for principal repayment; otherwise they are equity instruments.

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Issues Involved:
1. Whether the Compulsorily Convertible Debentures (CCDs) held by the Appellant should be treated as financial debt or equity.
2. Whether the principles of natural justice were violated by not providing the Appellant an opportunity of hearing.
3. Whether the inclusion of the Appellant in the Committee of Creditors (CoC) was permissible under law.

Issue-wise Detailed Analysis:

1. Whether the Compulsorily Convertible Debentures (CCDs) held by the Appellant should be treated as financial debt or equity.

The Appellant advanced unsecured loans to the Corporate Debtor, which were later converted into CCDs carrying 0% interest under a Debenture Subscription Agreement (DSA) dated 02.03.2020. The CCDs were to automatically convert into equity shares at the end of 10 years if not converted earlier by the Appellant. The Appellant argued that CCDs should be treated as financial debt, emphasizing that the CCDs were reflected under 'long term borrowings' and not as share subscription money. The Appellant also cited several judgments, including "Commissioner of Wealth Tax, Madras v. Spencer & Co. Ltd." and "R D Goyal v. Reliance Industries Ltd.," to support its claim.

The Respondents countered that the Appellant, as a CCD holder, had no right to repayment, only to conversion into equity shares, and cited judgments under the IBC, including "M/s IFCI Limited vs Sutanu Sinha" and its affirmation by the Supreme Court, to argue that CCDs should be treated as equity.

The Tribunal, guided by the Supreme Court's decision in "M/s IFCI Limited vs Sutanu Sinha," held that CCDs, which do not carry any obligation to repay and are compulsorily convertible into equity, should be treated as equity rather than debt. The Tribunal emphasized that commercial contracts should be read as they are without adding implied terms, and since the DSA had no clause regarding repayment, the CCDs are equity instruments.

2. Whether the principles of natural justice were violated by not providing the Appellant an opportunity of hearing.

The Appellant argued that the NCLT's order was made without giving it an opportunity of hearing, violating the principles of natural justice. However, the Tribunal did not find any substantial discussion or decision on this issue in the judgment. The focus remained on whether the CCDs should be treated as financial debt or equity.

3. Whether the inclusion of the Appellant in the Committee of Creditors (CoC) was permissible under law.

The Appellant was initially included in the CoC by the Interim Resolution Professional (IRP) after verifying its claim as financial debt. However, the Operational Creditor objected, and the NCLT held that the inclusion of the Appellant as a Financial Creditor was impermissible under law, rejecting the prayer to receive the revised list of members of the CoC.

The Tribunal upheld the NCLT's decision, stating that since the CCDs are equity instruments, the Appellant cannot be treated as a Financial Creditor. Consequently, the reconstitution of the CoC to include the Appellant was not permissible.

Conclusion:

The Tribunal dismissed the appeal, holding that the compulsorily convertible debentures held by the Appellant are equity instruments and not financial debt. Therefore, the Appellant cannot be included in the list of Financial Creditors, and the reconstitution of the CoC to include the Appellant was not permissible. The principles of natural justice were not substantially addressed in the judgment, and the focus remained on the classification of CCDs under the IBC.

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