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Riddhi Gandhi and Ashrita Tyagi are students of Gujarat National Law University.
Introduction
The Insolvency and Bankruptcy Code of 2016 (IBC) is a significant law that aims to simplify resolving insolvent entities across various industries. Since its creation, the IBC has undergone several amendments to address the complexities inherent in insolvency proceedings involving various stakeholders. One of the complexities revolves around the classification of financial instruments, particularly hybrid securities like Optionally Fully Convertible Debentures (OFCDs). These instruments, which have both debt and equity characteristics, have posed interpretational challenges within the framework of the IBC.
Recently, the National Company Law Appellate Tribunal (NCLAT) rendered a significant decision in the case of Santosh Kumar Vs. ASK Trusteeship Services Private Limited. [AE1] [1]distinguishing Compulsory Convertible Debentures (CCDs) from OFCDs, reclassifying the latter as financial debt within the purview of the IBC. This decision has sparked discussions among legal experts, financial analysts, and corporate entities, prompting an exploration of the reasoning behind the NCLAT’s decision.
In this blog, we will explore the intricacies of the NCLAT’s ruling, dissecting its implications and underlying reasoning. We aim to shed light on the implications of classifying OFCDs as financial debt under the IBC by analysing the legal framework and precedents. Furthermore[AE2] , we seek to understand the broader implications of this judgment on corporate financing structures, creditor rights, and the resolution landscape within the Indian insolvency framework.
Facts
A Debenture Subscription Agreement was established, in which a Financial Creditor, i.e. , ASK Trusteeship Services Private Limited., subscribed to Unlisted Optionally Convertible Cumulatively Secured Debentures (OCD) worth Rs. 125,00,00,000/- issued by the Corporate Debtor. In 2020, the Financial Creditor corresponded with the Corporate Debtor via multiple emails regarding breaches in the Debenture Subscription Agreement and associated Transaction Document. Initially expected to be redeemed on 6.10.2020, the redemption date was later extended to 31.07.2021 due to ongoing communication and subsequent modifications to the agreements. However, on 05.02.2022, the Financial Creditor issued a notice demanding redemption of the aforementioned amount, inclusive of additional coupons and redemption premiums accruing until the payment date, within a seven-day period. Due to the failure of the Corporate Debtor to meet the redemption demand, the Financial Creditor initiated legal action by filing a Section 7 application against the Corporate Debtor.
Arguments by the Appellants[AE3] :
The learned counsel for the appellant stated that the Section 7 petition is not admissible as optionally convertible debentures were in the nature of equity and didn’t constitute the nature of Financial Debt under Section 5 (8). The appellant’s counsel relied on the Supreme Court’s Judgement in the case of IFCI Limited vs. Sutanu Sinha & Ors.
Arguments by the Respondent:
The learned counsel for respondent stated that the facts of the case relied on by the appellant are different from the facts of the current case. In that case, the securities issued were debenture, which were compulsory to be converted into equity shares, whereas in the current situation, the debentures are optionally convertible, and hence, they are to be considered as Financial Debt.
NCLAT Findings
The NCLAT while analysing the case considered the Santosh Kumar’s argument that they do not owe any debt to the Financial Creditor since the OCDs should be classified as equity rather than financial debt. While making this claim, they refer to the case of IFCI Limited to state that CCDs are regarded as equity in project financing arrangements. In order to determine the validity of this claim, NCLAT decided to examine the facts and observations of the cited case.
The cited case concerns a highway project in which the appellant invested through CCDs. The project was awarded to IVRCL Chengapalli Tollways Ltd (ICTL) by the National Highways Authority of India (NHAI). The question of the validity of securities was also raised in this case.
The Supreme Court, in this case, made reference to the case of Narendra Kumar Maheshwari v. Union of India. It held that “A Compulsory Convertible Debenture does not postulate any repayment of the principle. The question of security becomes relevant for the purpose of payment of interest on these debentures and the payment of principle only in the unlikely event of winding up. Therefore, it does not constitute a ‘debenture’ in its classic sense. Even a debenture, which is only convertible at option, has been regarded as a ‘hybrid’ debenture. Any instrument which is compulsorily convertible into shares is regarded as an “equity” and not a loan or debt.”
In contrast, the Tribunal examined the Debenture Subscription Agreement and concluded that OCDs should be classified as financial debt under Section 5(8)(c) of the I&B Code and held ASK Trusteeship Services Private Limited to be the Financial Creditors.
Analysis of the term Financial debt under 5 (8).
According to Section 5(8) of the Code, Financial Debt refers to a debt that includes interest, if applicable, disbursed against the consideration for time value of money. In the case of Anuj Jain (RP) v. Axis Bank Limited & Ors, it was determined that in order for a debt to be considered financial, it must meet the essential element of disbursement of an amount against the consideration for the time value of money.
In this particular case, the NCLAT noted that Rs 102 crores had been disbursed in favour of the Corporate Debtor through OCDs. The Adjudicating Authority also held that these Debentures were issued against the time value of money, including an element of interest.
Furthermore, Section 5(8)(c) of the Code includes any amount raised through a note purchase facility or the issuance of bonds, notes, debentures, loan stock, or similar instruments within the definition of Financial Debt.
Based on a careful reading of the Code and the facts of the case, it appears that Optionally Fully Convertible Debentures may constitute Financial Debt under the Code. As a result, the Creditor would be considered a financial creditor and eligible to initiate Corporate Insolvency Resolution proceedings under Section 7 of the Code.
Conclusion
After careful consideration of the arguments presented by both parties, as well as an analysis of relevant legal precedents and provisions under the IBC, it is clear that the OCDs [AE4] subscribed to by the Financial Creditor, in this case, constitute financial debt as defined under Section 5(8)(c) of the IBC. The tribunal properly assessed the nature of debentures in question and determined that they meet the criteria of financial debt under IBC. The disbursement of funds against the time value of money, coupled with the involvement of interest, aligns with the essential elements outlined in Anuj Jain (RP) v. Axis Bank Limited & Ors. Furthermore, Section 5(8)(c) of the IBC includes instruments such as debentures, loan stock, and similar financial instruments within the definition of financial debt. Since the Optionally Convertible Debentures fall within this classification, the Financial Creditor rightfully qualifies as a financial creditor under the IBC. The argument raised by the Santosh Kumar, citing the case of IFCI Limited vs. Sutanu Sinha & Ors, pertaining to the nature of compulsorily convertible debentures (CCDs), is distinguishable from the circumstances of the present case. The distinction lies in the optional convertibility of the debentures in question, which does not alter their classification as financial debt. Therefore, it is evident that the Financial Creditor is entitled to initiate Corporate Insolvency Resolution proceedings under Section 7 of the IBC against the Corporate Debtor. The NCLAT’s decision to uphold the Financial Creditor’s petition for initiating insolvency proceedings is therefore deemed appropriate and in accordance with the provisions of the IBC and relevant legal principles.
