Mahesh Sharma vs Onspon Services Pvt Ltd.

This Application has been filed by the Applicant, Mr. Mahesh Sharma under Section 7 of the Insolvency & Bankruptcy Code, 2016 (hereinafter referred as I&B Code, 2016) read with Rule 4 of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules 2016 in Form 1 containing all the information as required in Part I, II, III, IV and V of the Form, against the Respondent, M/s Onspon Services Pvt. Ltd., which is a company engaged in the business of event management and sponsorship. Applicant, Mr. Mahesh Sharma is treated as Financial Creditor and the Respondents, M/s Onspon Services Pvt. Ltd. is treated as Corporate Debtor in terms of the provisions of Section 7 of the I&B Code, 2016. This application has been filed by the Financial Creditor for initiating corporate insolvency resolution process (hereinafter referred as CIRP) against the Corporate Debtor providing details of default occurred due to non-payment of a financial debt amounting to Rs. 17,70,000/- as computed in Part IV of the Application in Form 1.

The facts leading to filing of this Application as discussed in the Form 1 are as below:

The Corporate Debtor, namely, Onspon Services Private Limited allotted 1486 Optionally Convertible Preference Share (hereinafter referred as OCPS) of Rs. 1000/- each bearing certificate number 01 to Mr Mahesh Sharma on 15th June 2016.The Share Subscription Cum Shareholders Agreement (hereinafter referred to as the Shareholders Agreement) in its Article 8.2(b) stated that if the OCPS is not converted within the first two years, that shall be redeemed by the company to investors along with the simple interest of 6% per annum. Also, Article 8.5 (d) mentioned that if the investors choose not to exercise the option to convert, it shall be deemed that they have waived off their option to convert and the OCPS would automatically be redeemed at the end of 3 years from the date of issue and allotment. In the present case, the Financial Creditor did not exercise his option of converting the OCPS within the first two years of allotment, thus, the period of 3 years expired on 14 June 2019. Therefore, as per article 8.5 (d), the Applicant became eligible to exercise his PUT option of redeeming his shares. As per the Applicant, the OCPS automatically got converted into debt of the Corporate Debtor when the Corporate Debtor failed to redeem the OCPS.

The Financial Creditor sent reminder letters dated 9^thand 29^thJuly, 2019 to the Corporate Debtor to exercise PUT option of redemption as the period of 3 years had already expired and also instructed the Corporate Debtor to redeem and remit the redemption amount in the Bank Account for which details were provided by the Applicant. Since the Corporate Debtor failed to redeem OCPS along with interest @ 6% per annum, the Applicant is of the view that the OCPS automatically got converted into debt after the expiry of 3 years i.e., 14^thJune 2019. The Applicant demanded the principal amount of Rs. 14,86,000/- along with 6% interest of Rs.2,70,000/-. Thus, the total default amount was Rs. 17,70,000/- due as on 31^stJuly 2019.

The Applicant sent a notice dated 01.08.2019 to the Corporate Debtor giving it an opportunity to pay the default amount within 7 days of the receipt of this notice. The Corporate Debtor neither replied nor repaid the money to the Applicant. Since the Corporate Debtor did not pay the amount within the prescribed period of 7 days, the Applicant filed an application for initiation of CIRP against the Respondent/Corporate Debtor before this Adjudicating Authority.

Countering the above details and disputing the claim of the Financial Creditor as discussed in the Application concluding that the Corporate Debtor defaulted on repayment of the Financial Debt, a detailed reply has been filed by the Respondent/Corporate Debtor submitting as below,

The Respondent averred that this Application is liable to be dismissed since the Applicant herein is not a Financial Creditor of the Corporate Debtor, he is rather a shareholder of the Company. Hence, he does not have the required locus to file an application for initiation of CIRP against the Corporate Debtor under section 7 of I & B Code, 2016.

The Respondent further submitted that a conjoint reading of Article 2.1 with Schedule D to the Shareholders Agreement makes it clear that the Applicant was allotted a total of 1486 OCPS of Rs.1000/- each and one equity share of Rs.14000/- in the Respondent Company/Corporate Debtor. Therefore, it is contended by the Respondent Company/Corporate Debtor that this amount received from Applicant was an investment in the share capital of the Corporate Debtor and it wasn't done with the intention of earning interest over a period of time. It is also stated that the Hon’ble NCLAT in various cases, has made it clear that shareholders of a company cannot be deemed to be its creditors.

The Respondent further stated that an OCPS with the rights attached to it under the Shareholders Agreement cannot be considered to fall under the definition of “financial debt” since it is neither money borrowed against payment of interest nor it is an amount raised pursuant to any note purchase facility, issue of bonds, notes, debentures, loan stock etc., and it does not have the effect of a borrowing.

While the Applicant relied on Article 8.5 (d) of the Shareholders Agreement, which stipulated that at the end of three years, the OCPS would become redeemable, however, as pointed out by the Respondent, the Applicant has intentionally failed to mention Article 8.6 of the Shareholders Agreement, which states that no individual investor will be entitled to exercise any of its rights in the Company arising from his shareholding in the company individually and contrary to the collective decision taken by all the investors in terms of the Shareholders Agreement entered into and executed by them.

It is further submitted by the Respondent that under Article 11.8 which states that all investors agreed that they shall exercise their right to seek redemption or conversion of the OCPS held by them collectively and not individually. Thus, the right of the Applicant under the Shareholders Agreement to claim redemption of the OCPS can only be materialized when all other investors under the Shareholders Agreement agree to seek redemption of their OCPS. The redemption in this case by the Applicant is not made collectively and hence, the Respondent pointed out that this individual right of redemption does not vest in the Applicant.

It is further mentioned by the Respondent that under Article 6 of the Shareholders Agreement, an authorized representative of the Investors, (Mr. Abhishek Sanghvi) represents their interests as well as liaises with the Corporate Debtor as and when required via a facilitator (Swan Investments Management Service LLP.) This arrangement was done to ensure a seamless communication channel between the investors and the Corporate Debtor. The Respondent also argued that the Applicant herein, has attempted to completely circumvent the terms of the Shareholders Agreement and not to adhere to the aforementioned mechanism. The Respondent is of the view that the liability of the Corporate Debtor would only arise, if there was a collective request made by all the investors, but in this case, no debt has arisen in favour of the applicant as no such collective request has been made for redemption.

The Respondent further pointed out that the Applicant very conveniently hasn't mentioned the response of the Corporate Debtor in reply to the letters sent by the Applicant. The Respondent/Corporate Debtor had sent letters dated3^rdand 7^thAugust 2019 to the Applicant. But the Applicant did not respond to the same and proceeded with the filing of this Application.

The Respondent further goes on to state that even if it is assumed that the Applicant is a Financial Creditor and the debt is owed by the Corporate Debtor to the Applicant, this Application is still not maintainable because no event of default has been established. In the present case, no amount has become payable by the Corporate Debtor given the provisions of the contract and the legal constraints as provided in the Shareholder Agreement.

The Respondent also pointed out that though Article 8.5(d) of the Shareholders Agreement provides for automatic redemption of OCPS at the end of three years but the Applicant has failed to undertake the provisions of Section 55 of the Companies Act, 2013, which deal with the redemption of preference shares. It is stated that in terms of Section 55 of the Companies Act, preference shares can be redeemed only out of the profits of the company. In the instant case, the Corporate Debtor is not a profit-making enterprise hence, the Corporate Debtor cannot redeem the OCPS held by the Applicant in violation of the applicable laws. The Shareholders Agreement cannot override the express provisions of law and hence, there is no default on the part of the Corporate Debtor.

It is also mentioned by the Respondent that the Applicant has taken the articles of the Shareholders Agreement in isolation for his own convenience. A holistic reading of the entire Shareholders Agreement shall make it clear that it is incumbent upon the Corporate Debtor to redeem the OCPS in three years in terms of the provisions of the contract where the option of conversion has been adopted by all the shareholders collectively. Here, the Applicant is the only one investor trying to exercise this right and hence, the liability of the Corporate Debtor does not arise.

The Respondent in its reply also drew the attention of this Adjudicating Authority on the terms of the Shareholders Agreement, which state that the remedy for non-redemption available to the Applicant who is an investor under the Shareholders Agreement, is not against the Respondent Company/Corporate Debtor but against the promoter shareholders and the facilitator (Both defined under the shareholders agreement).

It is further submitted by the Respondent Company/Corporate Debtor that as per Article 8.3 of the Shareholders Agreement, where the Corporate Debtor is not capable of redeeming the OCPS, the promoter shareholders shall make suitable arrangement to buy the OCPS along with the accumulated interest thereon to enable the exit of the investors from the company, failing which, the facilitator shall identify a third party to buy the OCPS at a price not less than that offered by the promoter shareholders.

In this reply, the Respondent emphasised that in the instant case, if the Corporate Debtor is incapable of redeeming the OCPS given the express provision of the Companies Act, the investors are entitled to call upon promoter shareholders first and then the facilitator as defined under the Shareholders Agreement. Here also the Applicant is trying to circumvent the terms of the Shareholders Agreement.

The Respondent also emphasised that there is no particular provision of the Shareholders Agreement under which the Corporate Debtor is liable to redeem the OCPS on the demand of an individual investor, despite the constraints of the Companies Act. Hence, there exists no event of default. The Respondent in the end has prayed to this Adjudicating Authority for dismissing the instant application as the Applicant is not a Financial Creditor and there is no debt or event of default.

The Applicant by filing a rejoinder countered the above reply submitted by the Corporate Debtor and put forth further arguments to disprove the contention raised by the Corporate Debtor and strengthening his claim of the amount due on redemption of OCPS as being financial debt and occurrence of default due to non-payment. It is discussed as below,

In response to the Respondent’s claim that the Applicant is not a Financial Creditor, the Applicant has stated that the Shareholders Agreement clearly mentioned about the term “Simple Interest”. This term is self-explanatory as the word interest implies a financial debt. Applicant is of the view that OCPS is nothing but another word for debt which is owed in this case by the Corporate Debtor to the Applicant.

The Applicant also rebutted the objection of the Respondent when he says that the investment of the investor was in the share capital of the Corporate Debtor and not with the intention of earning interest over a period of time, stating that this statement made by the Corporate Debtor is false as investment made by the Applicant was solely with the intention of investment in the company for a limited period of time i.e., 2 years failing which it is converted into that of the Corporate Debtor. At the end of 3 years, i.e. 14.06.2019 due amount of debt on conversion from OCPS became payable by the Corporate Debtor along with simple interest of 6% per annum.

Article 8.4 of the Shareholder Agreement states that all investors would be entitled to receive individual notices along with the Agenda for all the General Body Meeting of the company and shall be further entitled to attend and vote at the general body meeting of the company either in person or through proxy as the case may be. The Applicant pointed out that Corporate Debtor failed to send individual AGM notices to the OCPS holders. He therefore, violated the Companies Act and rules there under along with Article 8.4 of the Shareholders Agreement, thus, suppressing the rights of the Applicant as Financial Creditor of the Company.

The Applicant pointed out that the reference made by the Respondent about the ruling of the NCLAT in certain cases is also erroneous as those cases talk about preference shares not OCPS and OCPS is debt becoming payable by the Corporate Debtor if PUT option available to Financial Creditor is not exercised for conversion.

As per the Applicant, the OCPS are converted into equity shares only during the first 2 years from date of issue, if PUT option is exercised by OCPS holder. If not exercised, the OCPS shall convert into debt after 3 years. Thus, this clearly illustrates that the OCPS is in the nature of a borrowing and hence, it is a “financial debt” having existence of “time value of money”. The Applicant relies on the case of Bombay Cotton Mfrg. Co. Re, (1909) 11 BOM LR 1302 to illustrate the fact that a creditor remains a creditor irrespective of him claiming the debt immediately or deferring it to a future time.

The Applicant further submitted that though the Shareholder Agreement talks about a facilitator/ authorized representative to coordinate between investors and company and that the investors would exercise their rights collectively, it cannot bar the Applicant from exercising his rights as an individual investor.

The Applicant also stated that the reply letters dated 03.08.2019 and 07.08.2019 sent by the Corporate Debtor are merely business communication and no response from the Corporate Debtor regarding repayment of debt has been received, that led to the filing of this application.

The Applicant further emphasised that the Shareholders Agreement in its Article 8.2(b) stated that if the OCPS is not converted within first two years, that shall be redeemed by the company to investors along with the simple interest of 6% per annum. Also, Article 8.5 (d) mentioned that if the investors choose not to exercise the option to convert, it shall be deemed that they have waived off their option to convert and the OCPS would automatically be redeemed at the end of 3 years from the date of issue and allotment. Thus, the “event of default” arose on 14.06.2019 when the 3 years elapsed and the debt became payable and thus, as per the Applicant, the view of the Respondent that “event of default” did not arise, is unfounded.

The Applicant further stated that though the Respondent mentions Sec 55 of Companies Act, 2013, he very conveniently ignored Rule 9 (6) of the Companies (Share Capital and Debentures) Rules, 2014which states:

As per the Applicant, the terms for redemption in this case will depend upon the Shareholder Agreement and this agreement provides for automatic redemption after 3 years. Thus, in view of the Applicant, the debt is liable to be paid.

We have considered all the pleadings put before us by the Applicant and Respondent and also heard the arguments of their Ld. Counsels. Before deciding the admission of petition u/s 7 of Code, we have first deliberated upon the provisions under the company law relating to issuance, conversion and redemption of OCPS and other provisions connected with admission of petition u/s 7 of I & B Code, 2016.

OCPS is nothing but a preference share that carries an option of to be converted into equity shares. The option of conversion may be given either with the company or with the shareholders or it may be a combination. Generally, terms and conditions for exercising such option are governed by a Shareholder Agreement. Issuance and redemption of preference shares is governed by the provisions of section 55 of the Companies Act, 2013 read with Rule 9 of the Companies (Share Capital and Debentures) Rule, 2014. These provisions as under:-

Issue and redemption of preference shares.

Section 55. (1) No company limited by shares shall, after the commencement of this Act, issue any preference shares which are irredeemable.

A company limited by shares may, if so authorized by its articles, issue preference shares which are liable to be redeemed within a period not exceeding twenty years from the date of their issue subject to such conditions as may be prescribed.

Provided that a company may issue preference shares for a period exceeding twenty years for infrastructure projects, subject to the redemption of such percentage of shares may be prescribed on an annual basis at the option of such preferential shareholders:

Provided further that--

Provided also that premium, if any, payable on redemption of any preference shares issued on or before the commencement of this Act by any such company shall be provided for out of the profits of the company or out of the company’s securities premium account, before such shares are redeemed.

Where a company is not in a position to redeem any preference shares or to pay dividend, if any, on such shares in accordance with the terms of issue (such shares hereinafter referred to as unredeemed preference shares), it may, with the consent of the holders of three-fourths in value of such preference shares and with the approval of the Tribunal on a petition made by it in this behalf, issue further redeemable preference shares equal to the amount due, including the dividend thereon, in respect of the unredeemed preference shares, and on the issue of such further redeemable preference shares, the unredeemed preference shares shall be deemed to have been redeemed:

Provided that the Tribunal shall, while giving approval under this sub-section, order the redemption forthwith of preference shares held by such persons who have not consented to the issue of further redeemable preference shares.

Explanation.-- For the removal of doubts, it is hereby declared that the issue of further redeemable preference shares or the redemption of preference shares under this section shall not be deemed to be an increase or, as the case may be, a reduction, in the share capital of the company.

The capital redemption reserve account may, notwithstanding anything in this section, be applied by the company, in paying up unissued shares of the company to be issued to members of the company as fully paid bonus shares.

Explanation.-- For the purposes of sub-section (2), the term infrastructure projects means the infrastructure projects specified in Schedule VI.

Rule 9. Issue and redemption of preference shares.

A company having a share capital may, if so authorized by its articles, issue preference shares subject to the following conditions, namely:-

A company issuing preference shares shall set out in the resolution, particulars in respect of the following matters relating to such shares, namely:-

Now, the question before us is whether “the OCPS due for redemption” can be taken as a “debt”. As defined in Section 3(11), of the I & B Code, 2016, “Debt” means a liability or obligation in respect of a claim which is due from any person and includes a financial debt and operational debt as dealt with under Section 7 and 9 of I&B Code, 2016 respectively. In the I & B Code, 2016, “Creditor” has also been defined in Section 3(10) as “any person to whom a debt is owed and includes a Financial Creditor, an Operational Creditor, a secured creditor, an unsecured creditor and a decree holder.

In the case under consideration, we are dealing with an Applicant who is claiming to be a Financial Creditor to whom a debt has become due on OCPS becoming due for redemption. The Applicant has claimed that the Respondent Corporate Debtor has not made the payment of amount that has become due on redemption, hence, in his view, the Respondent Corporate Debtor has defaulted in terms of Section 7 of the I & B Code, 2016. Therefore, an application u/s 7 read with Rule 4(1) of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016 in prescribed Form 1 has been filed providing relevant information about the Corporate Debtor and the debt claimed to be due from it in Part I, II, III, IV and V of the said Form 1.

The terms “Financial Creditor” and “Financial Debt” are also defined in the I & B Code 2016 and the same is reproduced as under:-5(7) “Financial Creditor” means any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred to;

5(8) “Financial debt” means a debt alongwith interest, if any, which is disbursed against the consideration for the time value of money and includes-

[Explanation.- For the purposes of this sub-clause –

The term “default” as defined in I & B Code 2016 u/s 3(12) is as under:

9(12) “default” means non-payment of debt when whole or any part or instalment of the amount of debt has become due and payable and is not paid by the debtor or the corporate debtor, as the case may be;

In order to determine whether amount paid by a person to a company is in the nature of “share capital” or “debt”, we are of the opinion that this issue in present case can be decided only after examination of the Shareholders Agreement in the light of relevant provisions of the Companies Act, 2013 as discussed in previous para no.6 of this order. Under the Companies Act, 2013, there is a fundamental difference between the Capital made available to a company by issue of a share and money obtained by a company under a loan or debenture. The nature of money available with a company in its Capital Account through convertible preference share shall depend upon respective incidences and consequences connected with the issuing of a convertible preference share by a Company as per an agreement underlying the relevant terms and condition for its conversion to equity share or redeeming its value at subsequent date. Therefore, first we examined the Shareholders Agreement and our findings are discussed in succeeding paras.

On 12^th May, 2016, the Respondent Company/Corporate Debtor, M/S Onspon Services Private Ltd. and its four promoter shareholders i.e. Mr. Bharat Bhushan Gossain, Ms. Teena Gossain, Mr. Hitesh Gossain and Mr. Sharad Seth entered into Share Subscription Cum Share Holders Agreement (Shareholders Agreement) with 14 persons collectively referred to as the “Investors” and a “Facilitator” named M/S Swan Investments Management Serves LLP for making of investment of a sum of Rs.1,05,00,000/- (Rupees One Crore and Five Lacs only) in the Company by these Investors collectively in the Equity Shares and in the Optionally Convertible Preference Shares (OCPS) of the Company. Applicant, Mr. Mahesh Sharma is one of these 14 Investors. As per the facts brought before us by the Applicant who is one of 14 investors in the above Shareholders Agreement, he subscribed to 1486 OCPS valuing Rs. 1000/- each and 1 Equity Share of Rs. 14000/- of the Respondent Company as per the details given in Para 1 of the Schedule D of the said Shareholders Agreement. For making this investment, the Applicant, Mr. Mahesh Sharma paid a consideration of Rs.15,00,000/- (Rupees Fifteen Lacs) on 13.06.2016 and in lieu of this payment, he was allotted 1486 OCPS of Rs.1000/- each and 1 Equity Share of Rs. 14000/- on 15.06.2016 for a total amount of Rs. 15,00,000/- paid by him.

Terms and conditions relating to allotment, conversion, redemption, dispute resolution etc. are provided in this Shareholders Agreement under various articles totalling to XVII Articles. We have considered the relevant Articles of this Shareholders Agreement in order to decide about the dispute that has arisen between Applicant and the Respondent Company/Corporate Debtor on the amount claimed by the Applicant to have become due for payment by the Corporate Debtor on redemption of the OCPS allotted to him, but so far not redeemed by the Corporate Debtor and also, to decide whether failure of the Corporate Debtor to redeem OCPS and pay the requisite amount to the Applicant, would amount to “default” in payment of a “financial debt” in terms of provisions of section 7 for which, whether CIRP can be initiated against the Respondent Corporate Debtor or not as per the application filed u/s 7 of the Code before us by the Applicant.

The relevant articles of this share agreement are reproduced as under:

ARTICLE-VI

The Investors hereby state that they have entered into the Investors Agreement incorporating therein their terms of investment to be made in the Company. They further state that they have authorised Mr. Abhishek Sanghvi S/o Mr. Mahendra Sanghvi aged about 38 years and residing at AG-158, Scheme No. 54, Vijay Nagar, Indore and is the Managing Partner at Swan Investments Management Services LLP (hereinafter referred to as “the Authorised Representative”) to act on their behalf including to be nominated as a Director/Nominee Director on the Board of the Company. All acts, deeds and actions taken by the Authorised Representative shall be binding on all the Investors and no Investor shall be entitled to question the Company, the Promoter Shareholders or the Facilitator for any action taken based on the Authorised Representative’s acts/deeds. However, in case where the OCPS are not converted into Equity Shares and the Investors have opted for redemption and have received the same along with the interest applicable, then the Nominee Director shall cease to hold his position from the date the Investors cease to hold the OCPS in the Company.

The Authorised Representative is duly authorized by all the Investors to represent their interests on the Board of the Company vis a vis their Committed Investment and also liaison between the Company and the Investors through the Facilitator as and whenever required.

Subject to the terms of Clause 10.3 of this Agreement, obligations of the Company towards the Investors shall be deemed to be complied with if the Company complies with the obligations with reference to the Authorised Representative and not with reference to each of the Investors.

The Investors should inform and shall keep the Promoter Shareholders and the Company informed at all times of any amendment, modifications or representations carried out to the Investor Agreement.

The Investors Facilitator and Shareholders agree and accept that the Company maintains and works on proprietary algorithms and processes proprietary databases. Such intellectual properties and proprietary information are property of the Company protected either as intellectual property and/or as trade secrets. The Investors, Promoter Shareholders and the Facilitator undertake and agree not to share such property information without consent of the Company.

The OCPS issued and allotted to the Investors shall carry voting rights on an as if converted basis on par with Equity Shares of the Company and the Charter Documents especially the Articles of Association of the Company shall be suitably amended to provide for and reserve voting rights on the OCPS.

The OCPS shall carry a rate of interest payable as dividend which shall be cumulative and payable within one year from:

The above Shareholders Agreement has also been listed at S1. No.5 in part V of the Application filed by the Applicant, Mr. Mahesh Sharma in Form 1 for the purpose of furnishing details of “Financial Debt Documents, Records and Evidence of Default” for initiation of CIRP against the Respondent Corporate Debtor. Relying on this agreement and referring to Article 8.2(b) and 8.5(d) of this agreement providing terms and conditions for redemption of OCPS as reproduced in previous para no.12, it is contended by the Applicant that he did not exercise option to convert the OCPS in equity share within 2 years of allotment and the said period of 3 years expired on 14.06.2019 and hence, OCPS was automatically redeemed at the end of 3 years as provided in Article 8.5(d) and for this purpose, he also gave notice to the Corporate Debtor vide his letter dated 09^th July, 2019 and then letter dated 29.07.2019 to exercise PUT option for redemption of 1486 OCPS along with interest of 6%. However, as per the Applicant, as the Company failed to redeem OCPS along with interest at the rate of 6% simple interest p.a., this OCPS was automatically converted into “debt” on failure of redemption of OCPS after expiry of 3 years on 14.06.2019. Therefore, the Applicant demanded the principal amount of Rs.14,86,000/- along with 6% simple interest p.a. of Rs.2,70,000/-, totalling to Rs.17,70,000/- that became due on 31.07.2019 from the Company, treating this amount as “financial debt”, himself as “lender” and the Company as “Corporate Debtor”, as the Company failed to pay the redemption amount to the Applicant, Mr. Mahesh Sharma. Being aggrieved due to non-payment of the above amount of Rs.17,70,000/-, the Applicant sent a notice dated 01^st Aug, 2019 to the Company treating it as Corporate Debtor and himself as Financial Creditor for initiation of CIRP due to default on non-payment of this amount, and gave an opportunity to the Company/Corporate Debtor to pay the requisite amount within seven days of receipt of the Notice but no payment was made and hence, treating the Company as defaulter Corporate Debtor, this application u/s 7 has been filed before us by the Applicant as Financial Creditor for our consideration.

We have carefully considered the above fact brought before us by the Applicant canvassing his view that the OCPS automatically got converted into debt of the Company on failure of redemption of OCPS by the Company. It is undisputed fact that the Applicant is an investor in the Company as per the Shareholders Agreement, investing in its 1486 OCPS of Rs.1000/- each and 1 equity share of Rs.14000/-. The Applicant is never shown as creditor in the Financial Statement of the Company produced before us and always treated as shareholder of the Company in the documents produced before us. Now, the question as raised before us is whether the OCPS which is nothing but “preference share” would automatically get converted into “debt” of the company in case of default on part of the Company, to redeem such OCPS to a particular investor on exercising of PUT option of redemption by him, in case if any such default has occurred in terms of the Shareholders Agreement.

In this regard, we have considered a similar case decided by the Hon’ble Supreme Court in case of “Indus Biotech Private Ltd. Vs. Kotak India Venture (Offshore) Fund &Ors in Arbitration petition (Civil) No.48/2019 with Civil Appeal No.1070/2021 @ SLP(C) No.8120 of 2020 dated 26.03.2021” in which also, dispute arose between parties on the issue whether default on payment of amount becoming due on redemption of OCPS would be in the nature of default in payment of debt. In this case, decision was taken in a board meeting of the issuer company to redeem OCPS on the date as mentioned in the agreement but dispute arose on computation of redemption value and hence, delay occurred in payment and therefore, holder of OCPS i.e. Kotak India Venture moved petition u/s 7 for initiating CIRP but the Corporate Debtor, Indus Biotech Pvt. Ltd. moved petition for arbitration u/s 8 of the Arbitration Act, 1996. The Adjudicating Authority did not admit the petition u/s 7 holding that they are not satisfied that default has occurred because there was dispute on valuation of shares, calculation and conversion formula and fixing of QIPO date and all these disputes are arbitral. Therefore, it was held by the Adjudicating Authority that an attempt must be made to reconcile the difference between the parties and their respective perceptions. Due to dispute on the question of determination of redeemable value, it is also held by the Adjudicating Authority that no meaningful purpose will be served by pushing the Corporate Debtor into CIRP at this stage.

This order of Adjudicating Authority on appeal, has been found to be reasonable by the Hon’ble Supreme Court holding that it is the satisfaction of the Adjudicating Authority on the occurrence of default before admitting the petition u/s 7 and in the facts and circumstances of the case, the Hon’ble Supreme Court was in agreement with the satisfaction drawn by the Adjudicating Authority that default has not occurred due to redemption value being not determinable in view of dispute on computation of its value being pending at that stage. In this decision, the Hon’ble Supreme Court categorically held that “it would not have been appropriate to hold that there is default and admit the petition merely because a claim was made by Kotak Venture (Financial Creditor in that case as claimed by it) as per the originally agreed date and a petition was filed”. It is also held by the Hon’ble Supreme Court in this decision that “it would be premature at this point to arrive at a conclusion that there was default in payment of any debt until the said issue is resolved and the amount repayable by Indus Biotech Private Ltd. (Corporate Debtor as claimed by petitioner) to Kotak India Venture with reference to shares being issued is determined. In the process, if such determined amount is not paid, it will amount to default at that stage”.

As it is clear from the provision of the Companies Act, 2013 that the holder of OCPS are basically shareholder and as held in the above decision of the Hon’ble Supreme Court, they cannot become creditor of loan/ debt automatically just by making claim for redemption on the agreed date unless and until the amount to be paid on redemption of OCPS is determined. After determination, if it is not paid, it will amount to default at that stage. The relevant para of the decision of Hon’ble Supreme Court wherein the above referred decisions have been taken are reproduced as under:-

(Emphasis supplied)

In the present case under consideration, though matter of determining the redemption value is not taken to arbitration panel as there is initial dispute on the act of redemption becoming due itself in terms of the Shareholders Agreement and Section 55 of the Companies Act, 2013, the arising of debt cannot be said to have happened on the agreed date in the Shareholders Agreement. While disputing the claim of the Applicant on OCPS becoming due for redemption, the Respondent Company contended that the Applicant relies on Article 8.5(d) of the Shareholders Agreement which stipulates that at the end of three years, the OCPS would become redeemable but on referring to Article 8.6 and Article 11.8 of the Shareholder Agreement, it can be seen that Applicant’s right under the Shareholders Agreement to claim redemption of the OCPS is crystallized only when all other investors under the Shareholder Agreement collectively agree to seek redemption of their OCPS as well and it is shown by the Respondent Company clearly that at present, this condition has not been fulfilled. Respondent Company has also pointed out that the Applicant has not adhered to the set out mechanism prescribed for communication for sorting out the dispute with the Company as provided in Article 6, through the Authorized Representative (i.e. Mr. Abhishek Sanghvi) and Facilitator (i.e. Swan Investment Management Services, LLP) to represent their interests as well as liaise with the Company. It is also pointed out that notice for redemption given by the Applicant vide letter dated 9^th July and 29^th July, 2019, was duly replied by the Company for discussion on redemption of OCPS. The same is reproduced as under:-

In response to the above letter of the company, no steps were taken by the Applicant to settle the dispute with the company in respect to redemption of OCPS as per the various Articles of the Shareholders Agreement, which are reproduced in para 12 of this order for a ready reference.

On point of “default”, it is contended by the Respondent Company/Corporate Debtor referring to definition given in Section 3(12) of the I & B Code, 2016 that default occurs only when debt is not paid either as whole or any part or instalment of the amount of debt that has become due and payable and is not paid by the Corporate Debtor. Therefore, it is essential for the Applicant to show that the debt against the Corporate Debtor has become due and payable, for it to constitute an event of default. In the present case, the Applicant is undoubtedly an “investor” as per the Shareholders Agreement and his conversion to a “creditor” will happen only after his investment in OCPS is redeemed as per the terms of the Shareholder Agreement read with the provision of the Companies Act, 2013. The Respondent Company/Corporate Debtor in its reply has already explained that OCPS are not redeemed as all the investors under the Shareholder Agreement have collectively not exercised their right to seek redemption as per Article 8.6 and 11.8. In case of their being any dispute in this regard, the Applicant being an investor, could have attempted to find out solution through Authorised Representative and Facilitator as per Article 6, which he failed to adhere to as per the set out mechanism in the Shareholder Agreement and therefore, the claim of the Applicant about any “debt” arising to him and becoming due for payment is premature and hence, question of any “default” on non-payment of such debt which is still not “determined”, does not arise as redemption of the OCPS has itself not taken place.

The Respondent Company/Corporate Debtor, apart from showing to us that no redemption of OCPS is done due to non-fulfilment of the terms and conditions of Shareholders Agreement, he also drew our attention to the provisions of Section 55 of the Companies Act, 2013 applicable for redemption of preference shares. These provisions have already been reproduced in para 6 of this order for a ready reference along with relevant Rule 9. As per these provisions, preference shares shall be redeemed out of the profits of the company or out of the proceeds of a fresh issue of shares made for the purpose of such redemption. It has been explained by the Respondent Company/Corporate Debtor that it is not a profit making enterprise and hence, as per the statutory provision, it cannot redeem the OCPS held by the Applicant otherwise if any redemption is done on the claim notice sent by the Applicant, it will be in violation of the applicable law. In support of its claim of not doing redemption of OCPS due to non-availability of the required profit, annual returns of the Company has been produced. Thus, even as per the relevant statutory provision under the Companies Act, 2013, which will override any express provision of an agreement/contract, the liability of the Respondent Company/Corporate Debtor to redeem the OCPS, has not yet arisen in the instant case.

It is also shown to us by the Respondent Company/Corporate Debtor from the Shareholder Agreement that remedy for non-redemption of OCPS is available to the Applicant being an “Investor” under the Shareholders Agreement itself from the “Promoter Shareholders” and the “Facilitator” and not from the Corporate Debtor. As per Article 8.3 of the Shareholder Agreement, where the Corporate Debtor is not capable of redeeming the OCPS, the “Promoter Shareholder” shall make suitable arrangement to buy such OCPS along with the accumulated interest thereon to enable the exit of the Investors from the Company, failing which, the “Facilitator” shall identify a third party to buy the OCPS at a price not less than that offered by the “Promoter Shareholder”. In view of this Article in the Shareholders Agreement providing remedy for non-redemption of OCPS, we find that the resorting to provision of Section 7 of the I & B Code, 2016 for initiating CIRP is premature exercise when redemption of OCPS has not yet taken place converting preference share into debt and remedy provided in the Shareholder Agreement for non-redemption is also not exhausted.

Against the facts and circumstances brought before us by the Respondent Company/Corporate Debtor explaining the non-redemption of OCPS, the Applicant through his Ld. Counsel filed rejoinder disputing the interpretation made by the Respondent Company/Corporate Debtor from the Articles of the Shareholders Agreement and provisions of the Companies Act, 2013 for not redeeming the OCPS and it was contended that OCPS automatically got converted into debt on redemption becoming due after three years and no payment of redemption value is made resulting into default and therefore, justified initiation of CIRP against the Respondent Company/Corporate Debtor. The Applicant in its rejoinder emphasised the word “Simple Interest” mentioned in 8.2(b) to be paid on redemption of OCPS, and stated that it is self explanatory and implies “Financial Debt” or liability (by whatever name called) and he being the Financial Creditor was allotted OCPS on 15.06.2016, disregarding the fact of him being an Investor as mentioned in the Shareholders Agreement. He even went to the extent of stating that the nomenclature “OCPS” is nothing but the “debt” to be paid by the Corporate Debtor as creditor. Such submission made by the Applicant even disregards the provisions of the Companies Act by equating a “preference share” with “debt” just because one Article of Shareholder Agreement says that OCPS shall be redeemed with simple interest ignoring the fact that such redemption has not taken place.

In case of Aditya Prakash Entertainment Pvt. Ltd. Vs. Magikwand Media Pvt. Ltd. in Company Petition No.404 of 2016 decided by the Bombay High Court vide order dated 05.03.2018, the Petitioner approached the Court as creditor seeking winding up of the Respondent Company despite being preference shareholder but claiming to be a creditor as redemption of preference share has become due but redemption not done due to non-availability of profit with the Respondent Company. On these facts, Bombay High Court held as under:-

[Emphasis supplied]

[Emphasis supplied]

From the above decision, it is clear that a preference shareholder cannot become creditor just on redemption becoming due and such redemption can be made only out of the profit of issuer company and in absence of profit, if redemption is not made, preference shareholder will not become creditor. Therefore, this contention of the applicant that OCPS is nothing but debt due to “Simple Interest” of 6% being mentioned in the Article of Shareholder Agreement relating to redemption is rejected.

Another argument of the Applicant that decisions pertaining to preference shares shall not apply to OCPS, and OCPS is nothing but the Debt is also fallacious. Optionally Convertible Preference Shares i.e. OCPS are those preference shares which carry an option to be converted into equity shares. Such OCPS can be redeemed if not converted to equity shares, for which the company must create a Capital Redemption Reserve or CRR out of the profits of the company which are available for dividend distribution. CRR is required only to the extent of the face value of preference shares to be redeemed. CRR is not required if the redemption is made out of proceeds of fresh issue of shares. The fresh issue could be of equity or preference shares. CRR is also not required in respect of the premium on redemption of preference shares. The premium component can be redeemed out of the shares premium account standing in the account of Company’s book. With these details of OCPS, it is very clear that it is a preference share and not debt, though can be redeemed but only out of the profits of the company which would otherwise be available for dividend or out of the proceeds of a fresh issue of shares and unless and until OCPS is redeemed, it cannot be regarded as debt, as held by Courts as discussed by us in forgoing paras.

It is also contended by the Applicant that OCPS in this case are automatically converted into debt and is payable with the simple interest of 6% p.a. at the end of 3 years and clearly indicates the existence of “Time Value of Money” and hence, a financial debt is due on Corporate Debtor. This contention of the applicant is also not tenable as because of non-redemption of OCPS due to profit not being available with the company, it is not converted into debt. Therefore, question of existence of “Time Value of Money” does not arise and hence, we do not find any financial debt as being due on the Respondent Company/Corporate Debtor towards the Applicant.

Decision of Bombay High Court in case of Bombay Cotton Mfrg Co. Re (1909) 11 BomLR1302 cited by the Applicant for making any claim of debt by creditor to future time is not found relevant as it does not pertain to any such matter of arising of debt on redemption of OCPS becoming due and hence, not relevant to present case. In his rejoinder, the Applicant repeatedly kept on discussing about his right of redemption disregarding the fact that such redemption has not taken place in absence of profit and also, all terms and conditions of Shareholders Agreement are not fulfilled and unless such redemption takes place, no debt can be said to have become due on account of the Respondent Company/Corporate Debtor payable to him. He even countered the provision of Section 55 of the Companies Act; 2013 placing reliance on Rule 9 of the Companies (Share Capital and Debentures), Rules, 2019 ignoring the well settled principle of interpretation of a statute that Rules are subservient to the substantive provisions of the Act and therefore, cannot be read in derogation of the substantive law. The Rules are subordinate legislation and cannot go beyond the ambit and scope of the main enactment. Rules only provides a procedural law in respect of a substantive provision in the Act. Therefore, Rule 9 cited by the Applicant only provides a procedure to be followed for redemption of preference shares but it cannot overrides the substantive provision of Section 55 that redemption can be only made out of profit. In judicial pronouncements as discussed by me in paras 15, 16 & 22 also, it is held that redemption of preference share can be made out of profit of the issuer company.

Even otherwise also, while going through the contents of the Shareholders Agreement, we find that the tenor of the language used in the said agreement is that the redemption is possible on the happening of incidents when the investors have not exercised their rights to convert prior to the stipulated period and collectively decide for conversion or redemption. As the relevant provisions of the aforesaid shareholder agreement have been reproduced above, we observe that this Tribunal as an Adjudicating Authority would enter jurisdiction only when there is already a clear debt established and then would examine that whether the debt has become due or not. This Adjudicating Authority however, would not be inclined to decide about the creation of the debt itself on happening of some events and the provisions of Section 7 of the Code can be actuated when there is already a debt established/determined and then this Adjudicating Authority would deal with the matter in accordance with the provisions of the I & B Code, 2016. Once, there is no determination or establishment of the debt, this Adjudicating Authority would not enter into a question of arising of the debt or otherwise. This Adjudicating Authority therefore, would also not be inclined to interfere on question of default of such debt in view of the mandate U/s 7 of I & B Code, 2016 as elaborately discussed hereinabove.

After considering all our findings discussed in foregoing paras, we are satisfied that no debt has become due from the Respondent Company/Corporate Debtor to be paid to the Applicant due to non-redemption of OCPS in view of the profit not being available with the Respondent Company in terms of provision of Section 55 of the Act and non-fulfilment of all terms and conditions of Shareholder Agreement. We do not feel it to be appropriate to hold that there is default and admit the petition u/s 7 merely because a claim for redemption of OCPS was made by the Applicant as per the originally agreed date in the Shareholder Agreement and a petition in this respect is filed. We feel that it would be premature at this point to arrive at a conclusion that there was default in payment of any debt until issue of redemption of OCPS is resolved between the Applicant and Respondent Company as per all the Articles of the Shareholders Agreement and extant provisions of the Companies Act and amount payable by the Respondent Company to the Applicant is determined taking into consideration the profit earned by the Company later. In the process, if such determined amount is not paid, it will amount to default at that stage. Therefore, the twin condition of admitting a petition u/s 7 for a financial debt becoming due and default taking place in not paying the due debt, as laid down by the Hon’ble Supreme Court in case of Innovative Industries Ltd. Vs. ICICI Bank and Another (2018) 1 SCC 407, has not been found to be in existence at present, as no financial debt has become due, is established, hence, question of its default within the meaning of Section 7 of the I & B Code, 2016 would not arise.

Accordingly, application for initiation of CIRP against the Corporate Debtor M/S Onspon Services Private Ltd. is rejected and CP (IB) No. 392/ALD/2019 is hereby dismissed.