REC Limited & Ors. vs Rattan India Power Limited

ORDER

“A shareholder is not a creditor of the company for his share capital, although he undoubtedly has a contractual right to share in the company's assets in a winding up after its creditors have been paid, and if the company has traded successfully, his share may amount to very much more than the money he originally subscribed. The reason why share capital is shown on the liabilities side of the company's balance sheet is that a balance sheet shows what payments would fall to be made out of the company's assets if it were wound up immediately, and one of these payments, is, of course, share capital. It does not follow that all such payments are debts of the company; share capital is one of the payments which is not.

Share capital, then, is the amount contributed by the shareholders to the company's resources. The money with which the contribution is made becomes the company's property forthwith, but the company does not become the shareholder's debtor for its repayment. The shareholder has a number of contractual and statutory rights against the company, among which are a right to share in its assets when it is wound up, and a right to receive dividends out of its profits when duly declared in accordance with the articles and it is primarily these two rights which give his shares a value, and make them saleable.”

“22.

That, in the matter of Radha Exports v. KP Jayaram reported in (2020) 10 SCC 538 para 42, it was held as under:

"The definition of 'financial debt' in Section 5(8) makes it clear that 'financial debt' means a debt along with interest, if any, disbursed against the consideration for time value of money and would include money raised or borrowed against the payment of interest; amount raised by acceptance under any acceptance credit facility or its de-materialised equivalent; amount raised pursuant to any note purchase facility or the issue of bonds, notes, debentures, loan stock or any similar instrument; the amount of any liability in respect of any lease or hire purchase contract which is deemed as a finance or capital lease under the Indian Accounting Standards or such other accounting standards as may be prescribed; receivables sold or discounted other than any receivables sold on non-recourse basis or any amount raised under any other_ transaction, including any forward sale or purchase agreement, having the commercial effect of a borrowing .... The payment received for shares, duly issued to a third party at the request of the payee as evident from official records, cannot be a debt, not to speak of financial debt. Shares of a company are transferable subject to restrictions, if any, in its Articles of Association and attract dividend when the company makes profits. "

23.

Further, in the matter of Aditya Prakash Entertainment Private Limited v. Magikwand Media Private limited reported in 218 SCC Online Bom 551 para 9, it was held as under:

"In this case, there is no dispute to the fact that petitioner was a shareholder holding preferential redeemable preference shares. The only question that requires to be considered is whether petitioner would be a creditor of the company. Sub-section 1 of Section 80 says, subject to the provisions of this section, a company limited by shares may, if so, authorised by its articles, issue preference shares which are, or at the option of the company are to be liable, to be redeemed. Proviso, however, states that no such shares shall be redeemed except out of profits of the company which would otherwise be available for dividend or out of the proceeds of a fresh issue of shares made for the purposes of the redemption. This aspect, in my view, shows that where redeemable preference shares are issued but not honoured when they are ripe for redemption, the holder of those shares does not automatically assume the character of a "creditor". The reason is that his shares can be redeemed only out of the profits of the company which would otherwise be available for dividend, or by afresh issue of shares. This is a limitation which is not applicable to any other creditor of the company. The shareholders of redeemable preference shares of the company do not become creditors of the company in case their shares are not redeemed by the company at the appropriate time. They continue to be shareholders,. no doubt subject to certain preferential rights mentioned in Section 85 of the Companies Act, 1956. If they do not become the creditors of the company, they cannot apply for winding up of the company under Section 433(e) of the Companies Act, 1956."

24.

Further, in the matter of Lalchand Surana v. Mis Hyderabad Vanaspathu Ltd. reported in 1988 SCC Online AP 290 para 6, it was held as under:

"The only question is whether, in case of failure of the company to repay the amount due thereunder, such shareholders become "creditors". It is in this context that proviso (a) to sub-section (I) of section 80 becomes relevant. Sub-section (I) of section 80 says that subject to the said section, a company limited by shares may, if so authorised by its articles, issue (i) preference shares which are to be redeemed, or (ii) preference shares which are liable to be redeemed at the option of the company.... This aspect, in my opinion, shows that where redeemable preference shares are issued but not honoured when they are ripe for redemption, the holder of those shares does not automatically assume the character of a "creditor". The reason is that his shares can be redeemed only out of the profits of the company which would otherwise be available for dividend, or by afresh issue of shares. This is a limitation which is not applicable to the case of an ordinary creditor. In the face of this position in law, and in the absence of any authority on the subject, I hold that the holders of redeemable preference shares do not and cannot become creditors of the company in case their shares are not redeemable by the company at the appropriate time. They continue to be shareholders, no doubt subject to certain preferential rights ... "

25.

Further, in the matter of State Bank of India v. Alstom Power Boiler Ltd. reported in 2003 SCC Online Bom 321 para 25, it was held as under:

"The right given under clause (b) of Sub-section (2) is "to vote on every resolution placed before the company at any meeting. " 1n our opinion, the words "before the company at any meeting" refer to a meeting of the company i.e., a meeting of the members of the company .... A preference share is not a debt instrument. Preference share amount is a capital and not a debt. Thus, in the meeting of the creditors, it would not be possible to assign a value to the vote of a holder of preference share. "

26.

Further, in the matter of Hindustan Gas & Industries Ltd. v. Commissioner of Income Tax reported in 1978 SCC Online Cal 410 para 4, 10, 11, 12, 13, it was held as under:

"... obtaining capital by issue of shares is different from obtaining loan on debentures and that a loan obtained cannot be treated as an asset or advantage for the enduring benefit of the business of the assessee .... '

" ... the holder of a redeemable preference share did not stand on the same footing as a creditor and could not sue the company for redemption of the shares as an ordinary creditor ... '

"Consequently, when the date for the redemption of redeemable preference shares has passed, their holders cannot sue the company for the repayment of their capital as creditors though they may petition for the winding up of the company as shareholders."

27.

That, in the matter of M.F.R. D'Cruz v. K.N. Vishwanathan reported in (1941) 54 LW 745: AIR 1941 Mad 806, it was held as under:

"No dividend shall be payable except out of the net profits arising from the business of the company.

10.

No dividend can be paid unless the company makes profits. This company never made any profits, but always incurred losses. No dividend can therefore be paid. The priority of the preference shares for payment of 7 1/2 per cent. is in regard to dividend. As there were no profits which could justify a dividend, there can be no dividend payable to the preference shareholders. The contention put forward on behalf of the preference shareholders is that each share is entitled to a sum equivalent to 7 1/2 per cent. from the amount of the capital. That would amount to interest being payable each year. Neither the Memorandum nor the Articles provide for any interest. In my view, as there were no profits no dividends could be declared and were not declared; nothing is payable to the preference shareholders in respect of dividend or interest and they are entitled only to repayment of the actual share capital. There will be an order accordingly. "

“29.

Reliance also placed on the judgment titled "EPC Constructions India Limited Through its Liquidator -Abhijit Guhathakurtha Vs. Mis Matix Fertiliser and Chemicals Limited", Company Petition (J.B.) No. l 56/KB/2022, wherein the Hon'ble Adjudicating Authority, Kolkata bench has inter-alia held that a Preference Shareholder is not a Financial Creditor unless· the Preference Shares become due for redemption.”

“2.

Brief facts of the case necessary to be noticed for deciding this appeal are:

(i)

The Appellant executed an EPC contract with the Respondent for setting up a fertilizer complex for production of ammonia-urea complex at Panagarh Industrial Park, Distict Burdwan, West Bengal on 11.12.2009. Contracts for onshore supply, offshore supply as well as engineering and construction were entered between the parties in the year 2010.

(ii)

Amounts became due and payable by the Respondent towards the Appellant in pursuance of the contract. The Respondent on 28.04.2015 wrote a letter to the Appellant requesting Essar Projects (India) Ltd. (earlier name of the Appellant) to consider converting the amounts outstanding as subordinated debt.

(iii)

The Appellant sent its agreement vide letter dated 08.05.2015 to give an extended credit upto Rs.403 Crores against their receivables from Matix.

(iv)

A resolution dated 30.07.2015 was passed by the Appellant giving consent to make investment upto Rs.400 Crores into 8% Cumulative Redeemable Preference Shares (hereinafter referred to as ‘CRPS’) of Rs.10/- each of Matix Fertilizer and Chemicals Limited (Matix) in one or more tranches.

(v)

The Respondent responded to the e-mail of the Appellant dated 31.07.2015 on 26.08.2015 that the decision of Appellant in converting outstanding receivables from Matix to the Appellant towards work done under EPC contract into 8% Cumulative Redeemable Preference Shares of Matix has also been approved by the board in its meeting dated 14.08.2015 as well as in meeting of the shareholders. Matix in consequence allotted 25,00,00,000 8% Cumulative Redeemable Preference Shares of Rs.10/- each to Appellant and Essar Projects in terms and conditions mentioned therein. The Cumulative Redeemable Preference Shares were renewable within three years.

(vi)

NCLT initiated CIRP against the Appellant by order dated 20.04.2018. The Appellant issued a letter on 28.08.2018 to the Matix asking the Matix for redemption of CRPS including dividend, aggregating to Rs.310 Crore.

(vii)

Matix sent a reply dated 24.08.2018 informing that liability towards redemption of CRPS along with cumulative dividend, aggregating to Rs.310 Crores have been adjusted against the claim which Matix has against the Appellant. It was also informed that Matix has submitted a claim in the CIRP of Appellant of Rs.377.87 Crores, information of which was also sent on 05.06.2018 for adjustment of total liability of CRPS against the aforesaid claim.

(viii)

The Resolution Professional of the Appellant also wrote a letter on 27.10.2018 to the Matix claiming total amount of debt of Rs.632.71 Crores which included amount of Rs.250 Crores towards investment in CRPS with dividend of Rs.60 Crores totaling to Rs.310 Crores.

(ix)

The Liquidator of the Corporate Debtor moved an application before the Adjudicating Authority seeking leave under Section 33 of the I&B Code for taking proceeding for recovery of the debt of the Appellant. Consequently, an application under Section 7 was filed by the Liquidator of the Appellant on 25.04.2022 against the Matix claiming default amount of Rs.250 Crores + Rs.60 Crores totaling to Rs.310 Crores. Date of default was mentioned as August, 2018.

(x)

Notice was issued under Section 7 to the which reply was filed by the Matix. Matix contested the claim of the Appellant. Rejoinder and Sur-rejoinder were also filed before the Adjudicating Authority. The Adjudicating Authority heard both the parties and by the impugned order dated 26.07.2023 has rejected Section 7 application.

(xi)

The Adjudicating Authority framed three issues for consideration, as noted in Para 14.2 of the order, which are as follows:

“14.2.

The issues that have cropped up for determination are as follows:

(i)

Whether a Preference Shareholder is a Creditor of a Company.

(ii)

Whether an application under Section 7 of I&B Code filed by a Preference Shareholder is maintainable.

(iii)

Whether Cumulatively Redeemable Preference Shares ("CRPS" for brevity) was in the nature of an investment or a financial debt having commercial effect of borrowing.”

(xii)

The Adjudicating Authority after considering various facts and circumstances and precedent relied by the parties held that the Cumulative Redeemable Preference Shares are not payable, hence, no default is established. In Para 14.4 the Adjudicating Authority made following observations:

“14.4.

It is evident that ‘Preference Shares’ are not defined in the I&B Code. Therefore, one must then look into its definition and meaning assigned to preference shares under the Companies Act. Companies Act is a complete code enacted to consolidate and amend the law relating to companies and the legislature was conscious of this fact in drafting the I&B Code. It is accordingly that Section 3(37) of the I&B Code states that "words and expressions used but not defined in this Code but defined in the ...Companies Act, 2013(18 of 2013) shall have the meanings respectively assigned to those Acts." Therefore, the definition and relevant provisions of the Companies Act must be looked into in order to determine whether a preference share is an instrument "having the commercial effect of borrowing" as contended by the Petitioner.”

(xiii)

The Adjudicating Authority further held that preferential share is not a financial debt unless the preferential shares becomes due for redemption. In Para 14.9 following was observed:

“14.9.

Thus, Section 55 is explicit that if the issuing company is not making profits which are available for dividend or has not raised any equity investments specifically for the purpose of redemption of preference shares, then the preference shares cannot be redeemed. Thus, shareholders cannot receive any payment before the debt of the company is fully discharged, unless preference shareholders are paid out of dividend/ profits of the company and thus, the non-redemption of preference shares does not result in preference shareholders becoming creditors or the carrying value of preference shares and dividends becoming a debt. Therefore, a Preference Shareholder cannot step into the shoes of a creditor of the Company unless their Preference Shares become redeemable in above terms.”

xiv) The Adjudicating Authority came to the conclusion that no case of any debt due to the Appellant and no existence of default on part of Respondent has been made out, hence, Section 7 application is not maintainable. In Para 15 of the order following was observed by the Adjudicating Authority:

“15.

Such being the factual and legal position, we are constrained to hold that no case of any "debt" due to the Applicant and no existence of "default" on the part of Respondent within the meaning ascribed to the terms "debt" and "default" in the Code, is made out. In the aforesaid backdrop, we hold that this Petition, filed under Section 7 of IBC, 2016, is not maintainable.”

(xv)

Application under Section 7 was thus rejected by order dated 29.08.2023, aggrieved by which order this appeal has been filed.

7.

We have considered the submissions of learned counsel for the parties and perused the record. Before we proceed to enter into the respective submissions of learned counsel for the parties, it is necessary to notice the transaction between the parties which is basis of filing of Section 7 application by the Appellant. Appellant in the appeal has brought on record relevant correspondence between the parties with respect to allotment of Cumulative Redeemable Preference Shares. Appellant has brought on record as Annexure A-5, the copy of resolution passed by the Directors of Essar Projects dated 30.07.2015 where consent was given by the Board to make investment upto Rs.400 Crores into 8% Cumulative Redeemable Preference Shares of Rs. 10/-each of Matix Fertilizer and Chemicals Limited. It is useful to extract Annexure A-5, which is as follows:

"RESOLVED THAT subject to such statutory approvals as may be required, if any and pursuant to the provisions of Section 179, 186 and any other applicable provisions, if any, of the Companies Act. 2013 read with rules made thereunder and subject such consents and approvals, if any, as may be required, the consent of the Board of Directors of the Company be and is hereby accorded to make investment upto Rs. 400 Crores into 8% Cumulative Redeemable Preference Shares of Rs. 10/- each of Matix Fertilizer and Chemicals Limited (Matix) in one or more tranches.

RESOLVED FURTHER THAT either of the followings namely 1) Mr, A V. Amarnath 2) Mr. Chander Krishnamoorlhy 3) Mr. Vasant Savla 3) Mr. D. V Prasad 4) Mr Raghupati Mishra 5) Ms. Yogita Purohit (hereinafter referred to as "the Authorised Executives”) be and are hereby severally authorised to take all decisions and steps in respect of the above investment as may deem appropriate, and to do and perform all such acts, deeds, matters and things, as may be necessary or expedient in this regard and to exercise all the rights and powers which would vest in the Company in pursuance of such investment.

RESOLVED FURTHER THAT a copy of the foregoing resolution duly certified by any Director or Company Secretary be forwarded as may be required.”

14.

The proviso to the Section 55 provides that no such shares shall be redeemed except 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 made for the purposes of such redemption.

28.

Present is a case where CRPS were allotted to the Appellant, there is no Share Subscription and Shareholders Agreement entered between the parties nor CRPS is hedged by any such condition which may lead to accepting the transaction as financial debt. We, thus, are of the view that judgment of this Tribunal in Sanjay D. Kakade is clearly distinguishable and has not applicability in the facts of the present case.

29.

In view of the above discussion and conclusions, we are of the view that the Appellant who is holder CRPS is holder of shares which is in the nature of equity in capital, which is part of preferential share capital as defined in Section 43. Preferential shares being part of the preferential share capital of the Company shall not transfer any debt so as to initiate any Section 7 proceeding. Further, the Company having not earned any profit nor any dividend having been declared, no redemption was permissible by the statutory provision, hence, no debt was due on basis of which Section 7 application could be filed by the Appellant. There is also no material that any proceeds of a fresh issue of shares made for the purpose of such redemption was available. We, thus, fully endorse the finding of the Adjudicating Authority that there did not exist any default. We, thus, do not find any merit in this appeal. Appeal is dismissed.”