Compulsory Convertible Debentures ("CCD"): Equity or Debt
Author: Utkarsh Srivastava
Advocate-on-Record, Supreme Court of India
Whether Compulsory Convertible Debentures (“CCD”) are equity, or debt has always been a never-ending debate. Every time the result depends on the terms of the Debenture Subscription Agreement (“DSA”). Each time, the court’s decision varies from situation to situation and no straight jacket formula has been framed till date to characterize the CCD.
A recent decision of the Hon’ble National Company Law Appellate Tribunal (“NCLAT”) has again sparked this debate.
To understand CCD, we need to know what debenture is and to understand debenture we must first understand what debt and equity are and how they both play part in building a company.
In order to run its day-to-day business, installation of manufacturing units and upkeep of the same, a company needs capital. To raise capital a company has two ways, equity share and debt stocks.
Equity means share capital of the company, i.e. at the time of investment, company issues a share of the company to the investor in lieu of the amount invested by the investor in the company. Thereby, making the investor a shareholder in the company to the extent of amount invested. A shareholder is also an owner of the company to the extent of amount invested.
Debt, on the other hand, is an instrument which is issued by the company for raising capital to the person giving money in the form of loan to the company. The money paid is to be returned by the Company along with interest after completion of period of time. In this way, although company is able to raise its capital but parting away a share of the company.
Section 3(11) of the Insolvency and Bankruptcy Code 2016 (“IBC”) defines debt as,
“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.”
Whereas, “Debenture” has been defined under Section 2(30) of the Companies Act 2013 as:
“debenture stock, bonds or any other instrument of a company evidencing a debt, whether constituting a charge on the assets of the company or not”.
The term “evidencing a debt” is very important. It signifies that a debenture means an instrument which shows that a company has taken the money in the form of debt. By issuing a debenture the company raises money for capital. It is an instrument which states that the company in order to raise capital has taken debt from the investor.
In furtherance to the above, Section 5(8) of IBC defines Financial Debt as a debt along with interest disbursed against the consideration for the time value of money and includes debenture.
Section 5(8)(c) of IBC reads, Financial Debt includes,
“any amount raised pursuant to any note purchase facility or the issue of bonds, notes, debentures, loan stock or any similar instrument”.
However, CCD is altogether a different species and as it is amphibious in nature. It is an instrument meant to create an equity share in the company at later point of time on fulfilment of certain terms and conditions. The terms and conditions are laid down in DSA entered between the company and the investor at the time of issuance of CCD. These terms and conditions very from company to company, issue to issue and situation to situation.
It is compulsory for the company to convert the CCD into equity share at the option of the investor. But the situation goes out of control, when the Company defaults and is not able to convert the CCD. When the company is bankrupt and is under insolvency, it is in no position to convert the CCD into equity shares. Thus, at the time of consolidating the claims the question arises before the Resolution Professional and before the Adjudicating Authority/NCLT under the IBC as to whether CCD is to be treated as an equity or a debenture as the name suggests.
Hon’ble Supreme Court of India in Narendra Kumar Maheshwari v. UOI, (1990) Supp SCC 440 while dealing with CCD, held that,
“…A compulsorily convertible debenture does not postulate any repayment of the principal. Therefore, it does not constitute a ‘debenture’ in its classic sense. Even a debenture, which is only convertible at option has been regarded a ‘hybrid’ debenture by Palmer’s Company Law (Para 44.07 at page 676).….any instrument which is compulsorily convertible into shares, is regarded as an “equity” and not as a loan or debt.”
In IFCI v. Sutanu Sinha, 2023 INSC 1023 Hon’ble Supreme Court of India while dealing with DSA agreed between the parties in that particular case held that,
“24. ….The investment was clearly in the nature of debentures which were compulsorily convertible into equity and nowhere is it stipulated that these CCDs would partake the character of financial debt on the happening of a particular event.”
However, recently, Hon’ble NCLAT in Indian Renewable Energy Development Agency Limited v. Waaree Energies Limited, Company Appeal (AT) (Insolvency) No.1380 of 2024 vide judgment dated 06.12.2024 has held that,
“15. Clause 7 deals with ‘Event of Default’. Clause 7.1 contains 17 sub-clauses, containing events or circumstances, under which event of default occurs. One of the circumstances triggering the event of default is Clause XVI, which is “failure to redeem one or more debentures by the Company in accordance with this Agreement.” Clause 8 provides for ‘Remedies on an event of default’. Clause 8 and 8.1 are as follows:
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- REMEDIES ON AN EVENT OF DEFAULT
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8.1 Upon the occurrence of one or more Event. of Default, the Debentures and the amounts payable towards redemption thereof, fees, costs, charges, expenses· and other monies whatsoever stipulated in the Transaction Documents payable. by the Company or the Promoters shall forthwith become payable by the Company, the Security shall become enforceable and the Debenture Holder shall be entitled to exercise its rights in accordance with this Agreement and the Transaction Documents in relation to such Security and otherwise under Applicable Law. The Debenture Holder shall have the right to require the Promoters or any of them to purchase its Debentures. In addition, in case of default by the Company in repaying or paying amounts on the due date, the Company shall pay on the defaulted amounts, interest from the due date for payment until payment or repayment, at Twenty Four (24%) per cent per annum. However, in the event the Company redeems the Debentures in accordance with the debenture return formula within 30 days from the date of the. Occurrence of the Event of Default, the Debenture Holder shall not enforce the Security.
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- From the judgments relied by the parties as noticed above, it is clear that for finding nature of transaction, the documents entered between the parties are the best guide to find out nature of debt, as to whether there was time value of money or not. When we look into the clauses of DSA pertaining to the present case, we are of the considered opinion that the transaction, which was entered between the parties has time value of money and the redemption of debenture was also contemplated and conversion of debenture was operational at the option of Investor. The Issuer has raised the amount by issuance of debenture, which was clearly a ‘financial debt’ within the meaning of Section 5, sub section (8).”
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Therefore, even as on date, for finding nature of transaction, the documents entered between the parties are necessary to find about the nature of debt and whether the CCD had the element of time value of money or not in order to characterize it into an equity share or debt stock.
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