Supreme Court rules that converting unpaid bills into redeemable preference shares transforms creditors into shareholders - they cannot file for corporate insolvency
IF A COMPANY CONVERTS ITS UNPAID BILLS INTO "REDEEMABLE PREFERENCE SHARES" OF ITS DEBTOR COMPANY, DOES IT BECOME A SHAREHOLDER OR REMAIN A CREDITOR? CAN IT LATER FILE FOR THE DEBTOR'S INSOLVENCY IF THE SHARES ARE NOT REDEEMED ON TIME?
NO, IT BECOMES A SHAREHOLDER AND LOSES THE RIGHT TO FILE FOR INSOLVENCY AS A CREDITOR. The Supreme Court has ruled that money paid for shares, including preference shares, becomes part of the company's capital, not a loan. A preference shareholder is an investor, not a lender. Therefore, they do not qualify as a "financial creditor" under the Insolvency and Bankruptcy Code (IBC) and cannot initiate the corporate insolvency process.
Engineering Contract: EPC Constructions entered into engineering and construction contract with Matix Fertilizers
Debt Conversion Proposal: Matix requested conversion of outstanding dues up to ₹400 crores into Preference Shares
Share Allotment: Matix allotted 25 crore 8% Cumulative Redeemable Preference Shares of ₹10 each to EPC
CIRP Against EPC: Corporate Insolvency Resolution Process initiated against EPC Constructions
Demand Notice: EPC's Resolution Professional issued demand notice for ₹310 crores for matured CRPS
Supreme Court Ruling: "Preference shareholders are not creditors" - dismissed EPC's insolvency application
Be aware that by accepting shares, you are moving from the relatively safer position of a creditor (with a right to sue for repayment) to the riskier position of an investor. Your repayment is now contingent on the company's future profits and legal restrictions on redemption.
Ensure proper corporate approvals through valid Board and Shareholder resolutions, clearly stating that outstanding dues are being extinguished and converted into share capital. Execute a formal agreement documenting terms of preference shares.
Before claiming redemption, ascertain if the company has sufficient distributable profits. If it is incurring losses, it is legally barred from redeeming your shares. Do not threaten insolvency as this remedy is not available to shareholders.
Your remedies lie under the Companies Act, not IBC. You may file a suit for specific performance of the terms of issue. In extreme cases, if the company is unable to pay its debts, you may have grounds to support a winding-up petition.
| Legal Provision | What It Means | Application in This Case |
|---|---|---|
| Section 55 Companies Act, 2013 |
Governs issue and redemption of preference shares | Redemption only from profits or fresh issue proceeds, not automatic |
| Section 5(8) IBC - Financial Debt |
Defines what constitutes a financial debt under IBC | Preference shares do not qualify as financial debt |
| Section 7 IBC |
Allows financial creditors to initiate corporate insolvency | Preference shareholders cannot file Section 7 application |
| Section 43 Companies Act |
Defines kinds of share capital including preference shares | Preference share capital is share capital, not debt |
A class of shares that carries a preferential right to receive dividends and to the repayment of capital in the event of a winding-up, before any payment is made to equity shareholders.
A debt disbursed against the consideration for the time value of money. It includes money borrowed, debentures, bonds, and other transactions having the "commercial effect of borrowing."
A person to whom a financial debt is owed. Only a financial creditor (or operational creditor) can initiate the Corporate Insolvency Resolution Process (CIRP) under Section 7 of the IBC.
The non-payment of a debt when it has become due and payable. A default is the trigger for an insolvency application under IBC.
"The architecture of corporate finance rests on the bedrock distinction between equity and debt. Converting a debt into a share is a deliberate crossing of a legal chasm—from the realm of creditors to that of investors. This choice, once made, carries profound consequences. The Insolvency Code is a shield for creditors, not a sword for shareholders who find their investment locked in a non-performing enterprise."
This judgment provides crucial clarity for corporate restructuring and financing. It affirms that the IBC is not a recovery forum for investors and reinforces the separate legal domains of company law and insolvency law.
This content is for informational purposes only and does not constitute legal advice. Consult a qualified legal professional for specific legal guidance. The information provided is based on judicial interpretation and may be subject to changes in law.
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