Supreme Court Clarifies Status of Compulsorily Convertible Debentures Under IBC: IFCI Limited vs. Sutanu Sinha & Ors. (2023)

Introduction

Date of the Judgment: November 9, 2023
Citation: 2023 INSC 1023
Judges: Sanjay Kishan Kaul, J., Sudhanshu Dhulia, J., and Ahsanuddin Amanullah, J.

When a company faces financial difficulties, how are different types of investments treated? The Supreme Court of India recently addressed this question in a case involving Compulsorily Convertible Debentures (CCDs). The core issue was whether these CCDs should be considered as debt or equity under the Insolvency and Bankruptcy Code, 2016 (IBC). This distinction is crucial because it determines the priority of claims during insolvency proceedings. The bench comprised Justices Sanjay Kishan Kaul, Sudhanshu Dhulia, and Ahsanuddin Amanullah, with the judgment authored by Justice Sanjay Kishan Kaul.

Case Background

The case revolves around a highway project awarded to IVRCL Chengapalli Tollways Ltd (ICTL), a subsidiary of IVRCL, by the National Highways Authority of India (NHAI) on March 25, 2010. A consortium of lenders provided a term loan to ICTL, while IVRCL was to finance the remaining project costs through equity infusion. As part of this equity component, the appellant, IFCI Limited, subscribed to Compulsorily Convertible Debentures (CCDs) worth ₹125,00,00,000 on October 14, 2011. These CCDs were to convert into equity in December 2017.

The Debenture Subscription Agreement included a “put option,” allowing IFCI to sell the CCDs to a third party if ICTL defaulted, with IVRCL remaining primarily obligated. However, this option was never exercised. The project faced financial difficulties, and ICTL proposed a one-time settlement, which was not honored. Consequently, IFCI invoked corporate guarantees from IVRCL and initiated Corporate Insolvency Resolution Process (CIRP) under the IBC.

IFCI claimed its dues as a debt, but the Resolution Professional rejected this claim on August 9, 2022, stating that the CCDs were to be treated as equity, as per the Debenture Subscription Agreement and the financial package approved by NHAI. This rejection was upheld by the National Company Law Tribunal (NCLT) and the National Company Law Appellate Tribunal (NCLAT).

Timeline

Course of Proceedings

The Resolution Professional rejected IFCI’s claim, stating that the CCDs were to be treated as equity. IFCI challenged this decision before the National Company Law Tribunal (NCLT), which upheld the Resolution Professional’s decision, relying on the Supreme Court’s judgment in Narendra Kumar Maheshwari v. Union of India & Ors. [(1990) Suppl. SCC 440]. This judgment stated that instruments compulsorily convertible into shares are regarded as “equity” and not debt. The NCLT order was then appealed before the National Company Law Appellate Tribunal (NCLAT), which also dismissed the appeal on June 5, 2023.

Legal Framework

The primary legal framework in this case is the Insolvency and Bankruptcy Code, 2016 (IBC). Section 3(11) of the IBC defines “debt” as a liability or obligation in respect of a claim due from any person, including financial and operational debt.

The court also considered the definition of “equity” as per the Concessionaire Agreement with the NHAI, which includes convertible instruments like CCDs.

The Debenture Subscription Agreement between IFCI, ICTL, and IVRCL also played a crucial role. Clause 2.9 of the agreement provided for the automatic conversion of CCDs into equity shares of ICTL on the specified date (December 2017). Clause 3.1 provided security for the debentures through a corporate guarantee from IVRCL and a pledge of shares in ICTL.

Arguments

Appellant (IFCI Limited)’s Arguments:

• The appellant argued that despite the wording of the CCDs, the transaction should be treated as a debt, considering the financial difficulties of ICTL.
• The appellant contended that the CCDs were intended to be a debt instrument and the conversion to equity became impossible due to ICTL’s insolvency.
• The appellant argued that it was neither treated as a shareholder nor a financial creditor, leaving it remediless.
• The appellant sought to distinguish the judgment in Narendra Kumar Maheshwari’s case, arguing that it was in the context of a public interest litigation and the present case was a commercial matter.
• The appellant also argued that the real objective was that the amount advanced was to be treated as a debt.

Respondent (Sutanu Sinha & Ors.)’s Arguments:

• The respondent argued that the Concessionaire Agreement with NHAI defined equity to include convertible instruments like CCDs.
• The respondent submitted that the common loan agreement required lenders’ approval before issuing debentures or raising loans.
• The respondent argued that the CCDs were part of the equity portion of the funding plan, and the lenders had put restrictions to ensure their debt pool was not expanded.
• The respondent contended that ICTL did not have a liability towards the appellant, as the appellant was an equity participant and not a creditor.

Issues Framed by the Supreme Court

The Supreme Court framed the following issue for consideration:

1. Whether the CCDs along with the other documents can be said to be really a debt and not an equity despite the wording of the CCDs?

Treatment of the Issue by the Court

Authorities

Cases:

Legal Provisions:

Judgment

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the contractual agreements and the definition of equity under the Concession Agreement. The court emphasized that the CCDs were explicitly intended to be converted into equity and that the liability for payments was on the sponsor company, not the SPV.

The court also noted that the commercial nature of the agreements meant that the parties were aware of their obligations and the risks involved. The court was disinclined to interfere with the terms of the contract or to add to them.

The court also considered the fact that the appellant had not exercised the put option available to them, and that the obligations were of the sponsoring company and IVRCL in terms of Clause 2.4.

The Supreme Court’s reasoning was based on the following points:

• The court emphasized that the agreements were commercial documents vetted by experts, and the parties were aware of their obligations.
• The court noted that the definition of equity in the Concession Agreement included convertible instruments like CCDs.
• The court observed that the Debenture Subscription Agreement provided for the automatic conversion of CCDs into equity on a specific date.
• The court pointed out that the liability for payments was on the sponsor company (IVRCL), not the SPV (ICTL).
• The court held that treating CCDs as debt would be a breach of the Concession Agreement and the common loan agreement.
• The court relied on the principle that contracts should be read as they are, without adding or supplementing terms, as established in Nabha Private Limited Vs. Punjab State Power Corporation Limited [(2018) 11 SCC 508].
• The court reiterated that compulsorily convertible debentures are treated as equity and not debt, as held in Narendra Kumar Maheshwari v. Union of India & Ors. [(1990) Suppl. SCC 440].

The court considered the appellant’s argument that they were left remediless but stated that it could not interfere with the commercial decisions of the parties. The court also noted that the appellant had not exercised the put option available to them.

The majority opinion was delivered by Justice Sanjay Kishan Kaul, with Justices Sudhanshu Dhulia and Ahsanuddin Amanullah concurring. There were no dissenting opinions.

The court explicitly stated: “Thus, normally a contract should be read as it reads, as per its express terms.”

The court further noted: “It is an unfortunate scenario where the appellant is being left high and dry as there is nothing which it can recover from the sponsor company, there being no assets and funds.”

The court also stated: “We thus find it difficult to read into or add to what the document says about a CCD.”

Key Takeaways

• Compulsorily Convertible Debentures (CCDs) are generally treated as equity, not debt, under the Insolvency and Bankruptcy Code (IBC).
• The specific terms of the agreements, including the Concession Agreement and Debenture Subscription Agreement, are crucial in determining the nature of the instrument.
• Courts are generally reluctant to interfere with the commercial decisions of parties and will interpret contracts as they are written.
• Investors in CCDs may not be treated as creditors in insolvency proceedings, which could affect their recovery prospects.
• This judgment reinforces the principle that the substance of a transaction is determined by the contractual terms and the nature of the instrument, not just the parties’ intentions.

Directions

No specific directions were given by the Supreme Court in this case.

Specific Amendments Analysis

There was no discussion on any specific amendments in the judgment.

Development of Law

The ratio decidendi of this case is that Compulsorily Convertible Debentures (CCDs) are to be treated as equity and not debt under the Insolvency and Bankruptcy Code, 2016 (IBC), based on the contractual agreements and the definition of equity in the Concession Agreement. This reaffirms the position of law established in Narendra Kumar Maheshwari v. Union of India & Ors. [(1990) Suppl. SCC 440], and there is no change in the previous position of law.

Conclusion

The Supreme Court dismissed the appeal, holding that Compulsorily Convertible Debentures (CCDs) should be treated as equity, not debt, under the Insolvency and Bankruptcy Code (IBC). The court emphasized the importance of the contractual agreements and the definition of equity in the Concession Agreement. This decision clarifies the treatment of CCDs in insolvency proceedings and reinforces the principle that courts will interpret contracts as they are written, without adding or supplementing terms.