Supreme Court Rules on Preferences Hares of A Company Vis-a Vis Section 7 of The Insolvency And Bankruptcy Code, 2016: No Financial Debt
by Shikha Goenka Ginodia (Partner) and Gaurav Suryavanshi (Principal Associate)
The Supreme Court of India, in a recent judgment, in the case of EPC Constructions India Limited vs M/s Matix Fertilizers and Chemicals Limited1, clarified the critical distinction between a preference shareholder and a financial creditor under the Insolvency and Bankruptcy Code (IBC), 2016.
Brief facts of the case
- EPC Constructions India Limited (“EPCC”), the Appellant, had outstanding receivables of Rs. 572.72 crores from M/s Matix Fertilizers and Chemicals Limited (“Matix”) under an engineering and construction contract.
- In 2015, EPCC agreed to convert a portion of these receivables (up to Rs. 400 crores) into 8% Cumulative Redeemable Preference Shares (“CRPS”) of Matix, to help Matix achieve the required Debt-to-Equity Ratio (2:1) to secure additional credit facilities.
- Matix allotted 25,00,00,000 CRPS aggregating to Rs. 250 Crores and the shares were redeemable at par at the end of 3 years.
- When the three-year redemption period expired, Matix failed to redeem the shares and EPCC, through its Liquidator, filed an application under Section 7 of the IBC against Matix for failure to pay the redemption amount of Rs. 310 Crores
Arguments of the parties
EPCC contended that the CRPS was a “financial debt” and had the “commercial effect of borrowing” under Section 5(8) (f) of the IBC, as the conversion of receivables to CRPS was for commercial purpose (to maintain Debt-to-Equity ratio) and was a commitment to repay the “subordinate debt” within three years. EPCC also contended that the financial statements of the respondent showed the liability towards CRPS as “unsecured loan” and “other financial liability.
Matix, on the other hand objected to EPCC’s case on the ground that preference shares are part of a company’s share capital, and not debt capital. Preference shareholders are not creditors, and thus, they cannot initiate insolvency proceedings under Section 7 of the IBC, which is a right reserved for financial creditors. It was clarified that redemption of CRPS was conditional on the company having profits or issuing fresh shares for that purpose (Section 55 of Companies Act, 2013), and since Matix made losses, no debt was due and payable to EPCC.
Proceedings before NCLT and NCLAT
Both the NCLT and the NCLAT dismissed EPCC’s application and held that the CRPS were an investment and not a debt. The key reasoning provided by the Tribunals was that payment against CRPS by Matix was not due, because redemption is conditional upon the company having profits available for dividend or proceeds of a fresh issue of shares, as set out under Section 55(2)(a) of the Companies Act, 2013. Since Matix did not declare a dividend or earn profit for redemption, no liability or debt arose in favour of EPCC.
Supreme Court’s Key Observations
The Supreme Court upheld the dismissal of the Section 7 application, making the following key observations:
a) Preference Shareholder is Not a Creditor: It is a well-settled Company Law principle that preference shares are part of the company’s share capital and not loans. Amounts paid on preference shares, not being loans do not qualify as a debt. By the definition of “Share”, Section 2(84) of the Companies Act defines share as:- “Share” means a share in the share capital of a company and includes stock. A preference shareholder does not automatically assume the character of a “creditor” even if the redemption is not honoured at the appropriate time.
b) Extinguishment of Debt: Upon issuance of the CRPS, the earlier outstanding amount stood extinguished, and the relationship became that of a preference shareholder. The attempt to “unscramble the egg” (i.e., treating the share as a debt) must fail.
c) Condition of ‘Default’: For a Section 7 application to be maintainable, a ‘default’ must have occurred, and the debt must have become due and payable. Since redemption was conditional on profits/fresh issue (as per Section 55 of the Companies Act, 2013), and those conditions were not fulfilled, the CRPS were not yet due and payable, and thus, no default occurred under Section 3(12) of the IBC.
d) Commercial Effect of Borrowing: The CRPS were at a stage when the redemption period had expired and would not lend greater weight to the case of the appellant. They continue to be preference shareholders and by being preference shareholders they do not enjoy the status of the creditors of the company. The transaction does not satisfy the essential element of “financial debt” under Section 5(8) of the IBC, which requires a disbursal against the consideration for the time value of money. Thus, the money paid for shares is share capital and not debt under the IBC.
e) Books of Accounts are Not Determinative: The fact that Matix’s financial statements showed the liability as “unsecured loan” or “other financial liability” was not determinative of the true nature of the transaction, as entries in account books cannot override statutory definitions or the actual relationship established by the documents.
Finding:
The Supreme Court held that an unredeemed Cumulative Redeemable Preference Shareholder (“CRPS holder”), whose shares could not be redeemed due to the Company not having sufficient profits or proceeds from a fresh issue as mandated by Section 55 of the Companies Act, 2013, is not a financial creditor under Section 5(7) of the IBC and cannot maintain an application under Section 7 of the IBC.
Footnotes
1 CIVIL APPEAL NO. 11077 OF 2025
