Insolvency Code : Preference shareholders are not financial creditors

Supreme Court Upholds NCLAT Decision: Preference Shareholders Not Financial Creditors Under IBC. Apex Court affirms that preference shares are part of share capital, not debt, dismissing EPC Constructions' appeal for insolvency proceedings against Matix Fertilizers.

In a significant ruling, the Supreme Court of India dismissed the appeal by EPC Constructions India Limited against the judgment of the National Company Law Appellate Tribunal (NCLAT), which upheld the order of the National Company Law Tribunal (NCLT), Kolkata. The apex court confirmed that preference shareholders do not qualify as financial creditors under the Insolvency and Bankruptcy Code, 2016 (IBC), thus preventing them from initiating insolvency proceedings.

The case revolved around EPC Constructions’ attempt to file a corporate insolvency resolution process (CIRP) against M/s Matix Fertilizers and Chemicals Limited under Section 7 of the IBC. EPC Constructions argued that the cumulative redeemable preference shares (CRPS) they held constituted financial debt. However, both the NCLT and NCLAT held that these shares were investment instruments and part of the company's share capital, not debt.

The Supreme Court, bench comprising Justices J.B. Pardiwala and K.V. Viswanathan, emphasized the statutory provisions of the Companies Act, 2013, and the IBC, stating that preference shares are part of the share capital and do not create a debtor-creditor relationship. The court highlighted that preference shareholders are entitled to dividends only out of profits and have preferential rights only during winding up or capital repayment.

The judgment clarified that under Section 55 of the Companies Act, preference shares can only be redeemed out of profits or fresh capital infusion, and non-redemption does not transform preference shareholders into creditors. The court also dismissed the argument that the classification of CRPS as liabilities in financial statements indicated a financial debt, reiterating that accounting entries do not alter the fundamental nature of such instruments.

This ruling has far-reaching implications for companies and investors, reinforcing the distinction between equity and debt, and limiting the rights of preference shareholders under insolvency proceedings.

Bottom Line:

Preference shareholders are not financial creditors under the Insolvency and Bankruptcy Code, 2016 (IBC), as preference shares are part of the company's share capital and do not constitute debt.

Statutory provision(s): Insolvency and Bankruptcy Code, 2016 Sections 3(11), 3(12), 5(7), 5(8), 7; Companies Act, 2013 Sections 43, 55

EPC Constructions India Limited v. M/s Matix Fertilizers and Chemicals Limited, (SC) : Law Finder Doc id # 2800065