TaxTMI 
TaxTMI 
TaxTMI 
2025 (10) TMI 1163
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....LAT had dismissed the application of the appellant filed under Section 7 of the Insolvency and Bankruptcy Code, 2016 (for short the 'IBC'). 2. Both the NCLT and the NCLAT held that the Cumulative Redeemable Preference Shares (for short 'CRPS') held by the appellant is in the nature of an investment and not a debt. It further held that since payment against the CRPS is not due, no liability can be said to arise. 3. To appreciate the controversy in question, a brief reference to the facts of the case, needs to be made. BRIEF FACTS :- OFFER AND ACCEPTANCE OF CRPS:- 4. The appellant-EPC Constructions India Limited (for short 'EPCC') was formerly known as Essar Projects India Limited. It entered into an engineering and construction contract with the respondent-M/s Matix Fertilizers and Chemicals Limited (for short 'Matix') on 11.12.2009. The contract was for the establishment of a fertilizer complex for Ammonia and Urea production at Panagarh Industrial Park, District Burdwan, West Bengal. The project involved designing, engineering, procurement, construction, erection and installation. An On-shore Supply Contract was executed on 29.07.2010 (for supply of Indian origin pl....
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....complete the project. If Matix does not get additional funding from its lenders, the project will not be completed which will hamper the possibilities to recover Company's outstanding amount from Matix. Therefore it is in the best interest of the Company to extend support to Matix by making investment in the RPS that will help Matix drawdown additional debt for completion of the project and also commence its operations. This in turn will help Matix to raise fresh equity which will be used to redeem the RPS as assured by Matix vide their letter dated July 27, 2015. The Directors then discussed about the terms and conditions of the proposal given by Matix. The Company Secretary explained in detail the terms and conditions of the RPS. She also informed the Board that if the proposal is accepted by the Board of Directors, there will be no outflow of funds from the Company and only the outstanding receivables will be converted into RPS. The Directors after further deliberation desired that RPS should be cumulative and carry a dividend rate of 8%. Taking into account the representation made by the Company Secretary and the clarification given by Mr. Sawa th....
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....e at par at the end of 3 years. However, Company at its sole discretion, may redeem CRPS at any time within 3 years from the date of issue. 6 Annual Dividend rate (Cumulative) 8% in first year 8% in second year 8% in third year 7 Transferability Can be transferred subject to the approval of Board of the Company 8 Listing Not to be listed 9 Rights These CRPS carry a preferential rights with respect to- a) Payment of dividend, and b) Repayment in the case of a winding up or repayment of capital, of the amount of the share capital paid-up or deemed to have been paid-up. 10 Modification of terms Can be modified before redemption with mutual discussions and written consent of both the parties. We request your confirmation by signing as EPILs acceptance to proceed with documentation and other necessary compliances." There is no dispute that the appellant accepted this letter and in fact the CRPS came to be issued as proposed hereinabove. APPELLANT BROUGHT UNDER CIRP :- 8. When matters stood thus, Corporate Insolvency Resolution Process (CIRP) under the IBC was initiated against the appellant on 20.0....
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....lue of preference shares and dividends becoming a debt. c) The Balance Sheet of 2018-19 to 2020-21 manifests losses incurred and the 4th proviso to Section 123 of the Companies Act 2013 manifestly indicates that no dividend is payable out of losses and unless the CRPS becomes redeemable it cannot be termed as a "debt", much less a financial debt. PROCEEDINGS BEFORE NCLAT:- 12. The appellant filed an appeal before the NCLAT. The NCLAT, by its judgment of 09.04.2025, dismissed the appeal and held as under: - a) Preference shares shall be redeemed only out of the profits of the company which would otherwise be available for dividend or out of the proceeds of a fresh issue of shares made for the purposes of such redemption. b) Matix never declared dividend or earned profit to redeem the preferential shares. If the preferential shares allotted to the Appellant could not have been redeemed, no debt became due. c) The correspondence between the parties which ultimately resulted in approval of resolution by the Board of Directors of the Appellant on 30.07.2015 and allotment. of shares by letter dated 26.08.2015 are evidence of a contract between th....
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....nior Counsel also relied on the judgments of this Court in Global Credit Capital Ltd and Anr. v. Sach Marketing Pvt Ltd and Anr. 2024 SCC OnLine SC 649, and Pioneer Urban Land and Infrastructure Ltd. and Another v. Union of India and Others (2019) 8 SCC 416 to contend that an expansive interpretation of the phrase "commercial effect of borrowing" ought to have been placed by the NCLAT. CONTENTIONS OF THE RESPONDENT:- 16. Mr. Mukul Rohtagi and Mr. Ritin Rai, learned Senior Advocates, vehemently countered the submissions of the learned Senior Counsel for the appellant. They contended that under Section 3(37) of the IBC words and expressions used in the IBC but not defined in the Code but defined in the Companies Act, 2013 shall have the meaning assigned to them under the Companies Act. 17. They contended by referring to Section 3(37) of the IBC read with Sections 2(64), 2(55), 2(84), 43, 47 and 55 of the Companies Act, 2013 that preference shares do not constitute debt and preference shareholders are not creditors of the Company. In their submission, preference shares being part of the share capital (and not debt capital), preference shareholders do not have a right to initi....
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....rential rights as to dividend, voting or otherwise in accordance with such rules as may be prescribed; and (b) preference share capital: Provided that nothing contained in this Act shall affect the rights of the preference shareholders who are entitled to participate in the proceeds of winding up before the commencement of this Act. Explanation.-For the purposes of this section,- (i) "equity share capital", with reference to any company limited by shares, means all share capital which is not preference share capital; (ii) "preference share capital", with reference to any company limited by shares, means that part of the issued share capital of the company which carries or would carry a preferential right with respect to- (a) payment of dividend, either as a fixed amount or an amount calculated at a fixed rate, which may either be free of or subject to income-tax; and (b) repayment, in the case of a winding up or repayment of capital, of the amount of the share capital paid-up or deemed to have been paid-up, whether or not, there is a preferential right to the payment of any fixed premium or premium on any fixed scale, s....
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.... (c) where such shares are proposed to be redeemed out of the profits of the company, there shall, out of such profits, be transferred, a sum equal to the nominal amount of the shares to be redeemed, to a reserve, to be called the Capital Redemption Reserve Account, and the provisions of this Act relating to reduction of share capital of a company shall, except as provided in this section, apply as if the Capital Redemption Reserve Account were paid-up share capital of the company; and (d) (i) in case of such class of companies, as may be prescribed and whose financial statement comply with the accounting standards prescribed for such class of companies under section 133, the premium, if any, payable on redemption shall be provided for out of the profits of the company, before the shares are redeemed: Provided also that premium, if any, payable on redemption of any preference shares issued on or before the commencement of this Act by any such company shall be provided for out of the profits of the company or out of the company's securities premium account, before such shares are redeemed. (ii) in a case not falling under sub-clause (i) above, the....
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....nce shareholder is only a shareholder and cannot as a matter of course claim to exercise the rights of a creditor. Preference shareholders are only shareholders and not in the position of creditors. They cannot sue for the money due on the shares undertaken to be redeemed, and cannot, as of right, claim a return of their share money except in a winding-up. In Lalchand Surana v. Hyderabad Vanaspathy Ltd., (1990) 68 Com Cases 415 at 419 (AP), where a preference shareholder was denied redemption in spite of maturity, he was not allowed to file a creditor's petition for a winding-up order under s. 433(e) of the 1956 Act. An unredeemed preference shareholder does not become a creditor." (Emphasis supplied) 27. B.P. Jeevan Reddy, J. (as His Lordship then was) in Lalchand Surana vs. M/s Hyderabad Vanaspathy Ltd. [1988 SCC OnLine AP 290] held as under:- "... .... ... The only question is whether, in case of failure of the company to repay the amount due thereunder, such shareholders become "creditors". It is in this context that proviso (a) to sub-section (1) of section 80 becomes relevant. Sub-section (1) of section 80 says that subject to the provisions of the sa....
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....st entitlement is not subject to this constraint; and that the debt holder will rank before the preference holder in a winding-up. Thus, the legal rules operate with a binary divide between debt and equity, but the accounting rules and general practice leads to the creation of securities whose classification in accordance with this divide is problematic." (Emphasis supplied) RELEVANT PROVISIONS OF THE IBC :- 29. This being the legal position, it is also time now to examine the statutory provisions of the IBC to understand the pre-requisites to maintain a petition under Section 7 of the IBC. Section 7 speaks of initiation of Corporate Insolvency Resolution Process by the financial creditor. Section 5(7) of the IBC defines a financial creditor. It reads as under:- "5(7) "financial creditor" means any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred to;" 30. Section 5(8) defines financial debt and it is extracted hereunder: - "5(8) "financial debt" means a debt along with interest, if any, which is disbursed against the consideration for the time value of money and includes- ....
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....y be;" 33. Section 7(1) and 7(5) of the IBC read thus:- "7. Initiation of corporate insolvency resolution process by financial creditor. (1) A financial creditor either by itself or jointly with other financial creditors, or any other person on behalf of the financial creditor, as may be notified by the Central Government, may file an application for initiating corporate insolvency resolution process against a corporate debtor before the Adjudicating Authority when a default has occurred: xxx xxx Explanation.-For the purposes of this sub-section, a default includes a default in respect of a financial debt owed not only to the applicant financial creditor but to any other financial creditor of the corporate debtor. (5) Where the Adjudicating Authority is satisfied that- (a) a default has occurred and the application under sub-section (2) is complete, and there is no disciplinary proceedings pending against the proposed resolution professional, it may, by order, admit such application; or (b) default has not occurred or the application under sub-section (2) is incomplete or any disciplinary proceeding is pending agains....
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....rofessional in Part III, particulars of the financial debt in Part IV and documents, records and evidence of default in Part V. Under Rule 4(3), the applicant is to dispatch a copy of the application filed with the adjudicating authority by registered post or speed post to the registered office of the corporate debtor. The speed, within which the adjudicating authority is to ascertain the existence of a default from the records of the information utility or on the basis of evidence furnished by the financial creditor, is important. This it must do within 14 days of the receipt of the application. It is at the stage of Section 7(5), where the adjudicating authority is to be satisfied that a default has occurred, that the corporate debtor is entitled to point out that a default has not occurred in the sense that the "debt", which may also include a disputed claim, is not due. A debt may not be due if it is not payable in law or in fact. The moment the adjudicating authority is satisfied that a default has occurred, the application must be admitted unless it is incomplete, in which case it may give notice to the applicant to rectify the defect within 7 days of receipt of a notice from....
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....ked the borrowing arrangements is absolutely without merit. As the board resolution dated 30.07.2015 clearly indicates, the appellant who before the issuance of CRPS had some receivables due on account of the construction contracts took a conscious call to accept the CRPS. The Board resolution further indicates the following:- "The company secretary explained in detail the terms and conditions of the RPS". She also informed the board that if the proposal is accepted by the board of directors, there will be no outflow of funds from the company and only the outstanding receivables will be converted into RPS. The Board resolution also noticed that the lenders of Matix, the respondent, have agreed to extend additional credit facilities to Matix provided Matix brings in additional equity to such extent as to achieve the debt equity ratio of 2:1 and therefore, by conversion of dues of the company into RPS, Matix will be able to show equity infusion and draw additional credit facilities from the lenders. It is further mentioned in the board resolution that if CRPS is not accepted the prospects of recovery of the dues looked dim. On this basis CRPS came to be issued for a total value of IN....
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....nd Pioneer Urban Land and Infrastructure Ltd. (supra) by Mr. Niranjan Reddy, learned Senior Advocate, is not apposite. Applying the real nature of the transaction, the sole irresistible conclusion that is possible is that the appellant being a preference shareholder, is not a creditor and an application by it under Section 7 was not maintainable, as has been rightly held by the authorities below. ENTRIES IN BOOKS OF ACCOUNTS - NOT DETERMINATIVE: 43. Mr. Niranjan Reddy, learned Senior Counsel, contended that financial debt is an admitted liability in the books of accounts of Matix. This was countered by the learned Senior Counsels for Matix by contending that entries in account books are not determinative of the true nature of the transaction. 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 stan....
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....is only for uniformity that the account has to be maintained as per accounting standards AS-9 which are prescribed from time to time. Once the licensee provides the details to the Government in format Annexure II along with accounts certified by the auditor, the reconciliation has to take place. The accounting standard AS-9 is relevant only for whether the figure given by the licensee as to gross revenue is maintained in proper manner once gross revenue is ascertained, then after certain deductions, adjusted gross revenue has to be worked out. The accounting standard provided in AS-9 cannot override the definition of gross revenue, which is the total revenue for licence and the finding in Union of India v. Assn. of Unified Telecom Service Providers of India, (2011) 10 SCC 543 in this regard is final, binding and operative. The accounting standard AS-9 makes it clear that same is in the form of guidelines, it is not comprehensive and does not supersede the practice of accounting. It only lays down a system in which accounts have to be maintained. Accounting standards make it clear that it does not provide for a straitjacket formula for accounting but merely provides for guidelines t....
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....debt if it is raised under any other transaction including any forward sale or purchase agreement having the commercial effect of borrowing. As already explained the paid up amounts towards shares do not have the character of debt. The further argument that redemption was due, is also not meritorious. As required under Section 55 of the Companies Act, 2013, the shares could be redeemed only out of the profits or with any amount kept apart for dividends which is not the situation in the present case. 48. This Court in Anuj Jain, Interim Resolution Professional for Jaypee Infratech Limited vs. Axis Bank Limited and Others (2020) 8 SCC 401, held as under:- "46. Applying the aforementioned fundamental principles to the definition occurring in Section 5(8) of the Code, we have not an iota of doubt that for a debt to become 'financial debt' for the purpose of Part II of the Code, the basic elements are that it ought to be a disbursal against the consideration for time value of money. It may include any of the methods for raising money or incurring liability by the modes prescribed in sub-clauses (a) to (f) of Section 5(8); it may also include any derivative transaction or cou....
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....n an extended meaning to include a 'financial debt' and an 'operational debt'." (Emphasis supplied) 49. Further, in Global Credit Capital Limited (supra), elucidating on the meaning of "financial debt" as defined in Section 5(8), this Court held as under:- "14. ... ... The definition incorporates the expression "means and includes". The first part of the definition, which starts with the word "means", provides that there has to be a debt along with interest, if any, which is disbursed against the consideration for the time value of money. The word "and" appears after the word "money". Before the words "and includes", the legislature has not incorporated a comma. After the word "includes", the legislature has incorporated Categories (a) to (i) of financial debts. Hence, the cases covered by Categories (a) to (i) must satisfy the test laid down by the earlier part of clause (8). The test laid down therein is that there has to be a debt along with interest, if any, and it must be disbursed against the consideration for the time value of money. 23. Now, coming back to the definition of a financial debt under clause (8) of Section 5 IBC, in the facts of the....