[Chirayu Singh is a third year student at Gujarat National Law University]
The Insolvency and Bankruptcy Code 2016 (IBC), under section 71(1), classifies debentures as financial debt. According to Section 71(1) of the Companies Act 2013, there are various types of convertible debentures, one of which is "Compulsory Convertible Debentures" (CCD). CCDs are mandatorily converted into equity at the time of redemption.
Compulsory Convertible Debentures
A debenture is a loan taken by a company based on its goodwill without any collateral. Debentures are issued at a discount and redeemed at par. CCD is a hybrid security as it is neither a pure debt nor equity. This is done to offer an advantage to the investors as their investment will be converted into equity only if they are willing to accept less amount for interest on debentures. This also helps the company to repay the debt without actually paying in cash.
But there has always been a question will such debentures be recorded in the liabilities of the company or the asset column and will the investors have a voting right as debenture holders in the company or will such right arise after the conversion of such debentures into equity? Now the question is whether Compulsory Convertible Debentures as financial debt in IBC or not since the security has the traits of debt and equity.
What is Financial Debt?
Section 5(8) of IBC defines financial debt as, “a debt along with interest, if any, which is disbursed against the consideration for the time value of money and includes”, and sub-clauses (a) to (i) stating some credit situations. The time value of money means the amount of time an investor needs to wait until he earns from his investment.
The term “Time value for money”, was first interpreted in the case of Nikhil Mehta and Sons (HUF) v. AMR Infrastructure Ltd. where NCLAT focused on the factors such as assured return in the stipulated time period, and declared this as the Time value of money.
Compulsory convertible debenture – Equity or Financial Debt?
CCD as a Financial Debt : Compulsory convertible debentures have always been in controversy, whether such convertible instruments will be considered as financial debt under IBC or not. First, the position of considering CCD as a Financial Debt was questioned in 2019 in the case of “SGM Webtech Pvt. Ltd. vs. Boulevard Projects Pvt. Ltd”, where NCALT Principal Bench, New Delhi clarified, whether a CCD can be treated as equity during the resolution of the company or will it remain a financial debt. NCLAT held that during the resolution if the CCD has not attained its maturity then it will be considered as a financial debt and not equity.
CCD as Equity : This position was enacted in the case of IFCI Limited vs. Sutanu Sinha where NCLAT Chennai interpreted the nature of CCD as equity. While making this interpretation reliance was put on the 2013 judgment of the Supreme Court of India in the case of Narendra Kumar Maheshwari vs. UOI, in which Hon’ble Supreme Court observed and defined the nature of convertible debentures at the option of the investor, as a financial debt by using the ‘repayment of the principal’ test, as the reasoning for the same. Further in its decision The Hon’ble Supreme Court drew a distinction between the Convertible debenture at the option and the CCDs and predicted the nature of CCDs as Equity and not as financial debt. NCLAT Chennai based its decision on the same reasoning and declared the nature of the CCDs as Equity and not as Debt for the purpose of Section 5(8) of IBC. The case was appealed before the Supreme Court, wherein the court upheld the decision rendered by the NCLAT. The Supreme Court held that the investment was obviously in the nature of debentures that were compulsorily convertible into equity, and that there was no condition saying that these CCDs would take on the character of financial debt if a specified occurrence occurred.
When CCD is contingent in nature : The NCLT Bench, Mumbai, through the Agritrade Power Holding Mauritius Limited vs. Ashish Arjunkumar Rathi case in 2023, established that contingent CCDs, those converting upon resolution, fall under the definition of financial debt within the Insolvency and Bankruptcy Code. The tribunal held that such conversion arises only at the initiation of CIRP, so the accrued interest on the CCDs till the date of CIRP will be considered as financial debt but the CCDs won’t be considered as financial debt and will be recorded as equity only once the CIRP is initiated.
Analysis
The position of Compulsory convertible debentures in IBC has been interpreted by different courts and tribunals in the passage of time. The main point of focus while reaching the conclusion was put on the maturity date of the instrument. The court established that if a CCD has not achieved its maturity or the date of conversion into equity and the company has initiated CIRP then such CCDs will be considered as financial debt under Section 5(8) of IBC but if the CCD has achieved its maturity before the CIRP then it will be considered as equity and not as financial debt because now there is no principal to pay back to the investor and the investor will be a shareholder and not a debenture holder. In the case when conversion only arises when the company initiates CIRP then such CCD will be considered as equity only because there exist no requirement to repay the principal amount. In 2023, the rules around CCDs became clearer. Still, one thing remains the same: interest earned on CCDs is always considered financial debt under the IBC, no matter what happens to the CCD itself. In 2023 the position of CCD was further refined But the one thing which continues to have the same status is the accrued interest on the CCDs, this accrued interest on CCD with no regard to the status of CCD will be considered as financial debt under Section 5(8) of IBC.
If a company particularly wants to treat CCD as financial debt or debenture during CIRP they have to mention it prior to the sale of such CCD. Now considering CCD as financial debt can benefit the investor during insolvency as they will be repaid the amount but generally, the investors are worried regarding their investment as this whole issue creates a sense of confusion among them regarding the status of their investment whether as equity or as debt and this generally doesn’t leave any remedy for the investors whereas for a company all the convertible instruments constitute a part of equity only so considering such instruments debt and repaying their principal amount during insolvency is not viable for a company, now the investor has to be more cautious with his investment as this is not just a basic debenture it is a hybrid instrument which has benefits like making the investor an equity participant and giving him the voting rights and a share from income, but at the same time the investor is losing his chance to be repaid during insolvency and being treated as a debenture holder.
CCD lacks the basic element of debt making it a big mistake to consider it as Financial Debt if the court had ruled in the favour of investors for considering CCD as debt during the insolvency then such an error would have affected many companies going through CIRP their actual creditors towards whom the company has an actual liability and such ruling would have also created an overriding effect on other laws.
Conclusion
The question regarding whether CCD will be considered as financial debt or equity during CIRP has been answered by the Supreme Court in the case of IFCI Limited vs. Sutanu Sinha in 2023 and has finally reached a position where it can be established that if the CIRP is initiated prior to the conversion event of the CCDs, the CCDs are likely to be construed as financial debt under the IBC; however, if the conversion event of the CCDs has expired on the date of the CIRP’s inception and the CCDs have not been converted into equity shares, the CCDs are unlikely to be construed as financial debt under the IBC. The interest accrued on such debentures will be cons