Supreme Court Rules Preference Shareholders Are Not Financial Creditors; Non-Redemption of CRPS Doesn’t Trigger Insolvency Under IBC

Supreme Court Rules Preference Shareholders Are Not Financial Creditors; Non-Redemption of CRPS Doesn’t Trigger Insolvency Under IBC

Introduction

The Supreme Court has clarified a significant aspect of insolvency jurisprudence by holding that holders of Cumulative Redeemable Preference Shares (CRPS) are investors and not financial creditors, and therefore cannot initiate insolvency proceedings under Section 7 of the Insolvency and Bankruptcy Code, 2016 IBC. The Court observed that non-redemption of such shares does not amount to a “default” under the Code. The judgment, authored by Justice K.V. Viswanathan and concurred by Justice J.B. Pardiwala, reinforces the principle that preference share capital forms part of a company’s equity base, not debt.

Factual Background

EPC Constructions India Limited (“EPCC”) had entered into an engineering and construction contract with Matix Fertilizers and Chemicals Limited (“Matix”). Against dues worth ₹250 crores owed by Matix under this contract, EPCC agreed to convert the amount into 8% Cumulative Redeemable Preference Shares (CRPS), redeemable after three years. When Matix failed to redeem the shares upon maturity, EPCC’s liquidator treated the failure as a “default” and filed an application under Section 7 of the IBC before the NCLT, claiming the status of a financial creditor.

Procedural Background

The National Company Law Tribunal (NCLT) dismissed the Section 7 application, holding that CRPS holders are not financial creditors under the IBC. This decision was affirmed by the National Company Law Appellate Tribunal (NCLAT), which reiterated that the nature of CRPS is that of an investment, not a loan or financial debt. Aggrieved, EPCC approached the Supreme Court, challenging these concurrent findings.

Issues for Determination

1. Whether holders of Cumulative Redeemable Preference Shares (CRPS) qualify as “financial creditors” under Section 5(7) of the IBC?

2. Whether non-redemption of CRPS constitutes a “default” within the meaning of Section 3(12) of the IBC?

Contentions of the Parties

Appellant (EPCC): The appellant contended that since the CRPS were redeemable with a fixed return, the transaction carried the essential characteristics of a financial debt, i.e., disbursal against the time value of money. Hence, failure to redeem should be treated as a default, entitling CRPS holders to file for insolvency.

Respondent (Matix): The respondent argued that preference share capital forms part of the company’s share capital and cannot be equated to a loan or borrowing. The obligation to redeem preference shares arises under the Companies Act, 2013 and not under any financial contract, thus excluding such claims from the ambit of “financial debt” under Section 5(8) of the IBC.

Reasoning and Analysis

The Supreme Court examined the definition of financial debt under Section 5(8) of the IBC, emphasizing that the provision requires a disbursal against consideration for the time value of money. The Court noted that Section 5(8)(c) mentions instruments such as “notes, bonds, debentures, loan stock, or any other similar instrument,” but significantly omits preference shares from this list.

Citing A. Ramaiya’s Guide to the Companies Act (18th Edition, Vol. 1, p. 879), the Bench reaffirmed that preference shares, even when cumulative and redeemable, remain part of share capital, and the sums paid towards them cannot be treated as loans. The Court observed that dividends on preference shares are payable only out of profits, and payment of dividends without profits would amount to an illegal return of capital.

Thus, the Bench held that preference shareholders, even when unpaid or unredeemed, remain investors rather than creditors. Since there was no disbursal of funds against time value of money, the transaction did not qualify as a financial debt, and the consequent non-redemption could not constitute a default under the IBC.

Implications

This decision has clarified a crucial distinction between equity and debt instruments in insolvency law. It affirms that preference shareholders cannot invoke IBC proceedings merely because their shares remain unredeemed. The judgment preserves the integrity of corporate capital structure and ensures that insolvency proceedings remain confined to genuine debt-based defaults. It further safeguards companies from misuse of IBC by investors seeking recovery of capital under the guise of financial claims.

Order

The Supreme Court upheld the concurrent findings of the NCLT and NCLAT, holding that the appellant, as a preference shareholder, could not maintain an application under Section 7 of the IBC. Consequently, the appeal was dismissed.

In this case the appellant was represented by Mr. Niranjan Reddy, Sr. Adv. Mr. Abhishek Swaroop, Mr. Aditya Vikram Singh, Ms. Sanya Sud, AOR, Ms. Akhila Reddy, Ms. Palak Arora, Ms. Shreya Chandhok, Advocates.

Meanwhile the respondent was represented by Mr. Mukul Rohatgi, Sr. Adv. Mr. Nitin Rai, Sr. Adv. Mr. Mahesh Agarwal, Mr. Rishi Agrawala, Ms. Geetika Sharma, Ms. Madhavi Agarwal and Mr. E. C. Agrawala, Advocates.