Navigating Valuation Anomalies and Regulatory Complexities in Compulsorily Convertible Debentures

[Atharv is a student at OP Jindal Global University.]

In Indian corporate finance, compulsorily convertible debentures (CCDs) have become very popular, especially for companies that are raising foreign investment or conducting cross-border transactions. CCDs, which are hybrid instruments that start as debt but must eventually convert into equity shares, provide a sophisticated route for businesses looking to manage their capital structure with flexibility while guaranteeing investors' eventual equity participation. This flexibility does, however, come with a complex web of regulatory requirements, particularly with regard to corporate governance, foreign exchange management, and valuation accuracy. In April 2025, Delta Corp increased its ownership of Peninsula Land from 4.64% to 6.87% by converting 77.27 lakh CCDs into equity shares. This action demonstrates how businesses strategically employ CCDs to strengthen their stakes in investee businesses. It also acts as a reminder, though, that these conversions need to be done very carefully. Delta might have been challenged by regulators as well as minority shareholders who claimed oppression and poor management if the valuation supporting the conversion had been questioned or later determined to be incorrect. Despite its apparent simplicity, the Delta Corp. deal perfectly captures the fine line that businesses must walk between corporate strategy and legal compliance.

The component of valuation is at the core of every CCD issuance. An error at this stage, whether by oversight or flawed methodology, can have significant legal and financial repercussions. In light of India's increasingly strict regulatory framework, valuation anomalies are not just technical errors but rather significant violations of the law that may lead to action under the Foreign Exchange Management Act 1999 (FEMA) and the Companies Act 2013, among others.

Significance of Precise Valuation

In CCD transactions, valuation is much more than simple maths. It is essential to maintaining equity for both current and potential investors. Inaccurate valuation can cause existing equity to be disproportionately diluted. Further, in accordance with FEMA's framework, specifically Rule 21 of the Foreign Exchange Management (Non-Debt Instruments) Rules 2019, CCDs must be issued and converted using valuations based on globally recognized pricing methodologies that have been duly certified by qualified experts like chartered accountants or merchant bankers registered with SEBI. By prohibiting share under-pricing or overpricing, this regulatory measure protects the integrity of international financial transactions.

This structure is supplemented by Section 52 of the Companies Act 2013, which stipulates the treatment of premiums received on share issuances and requires their transfer to a securities premium account. Valuation errors can disrupt the appropriate separation of securities premium and share capital, compromising the integrity of financial reporting and possibly deceiving stakeholders about the actual state of the company's finances.

Navigating Regulatory Compliance

Private placement of securities is governed by Section 42 of the Companies Act 2013, which establishes requirements for issuing CCDs to a specific investor group. When it is suggested that CCDs be converted into equity, Section 62 addresses the preferential issuance of shares and requires the consent of current shareholders. The application of securities premiums, including the premium obtained upon the issuance of CCDs, is covered in Section 52. In the event that CCDs are converted into equity shares and there are inaccurate or missing entries, Section 59 offers procedures for correcting the member register. The procedure for reducing share capital is described in Section 66, which may be pertinent if capital adjustments are required following CCD conversion. Companies need to be aware that undervaluation exposes them to regulatory penalties in addition to endangering internal equity structures.

FEMA's Section 13 penalty system is one such example. If convicted of a violation, such as issuing shares below the certified fair market price, a company may be fined up to three times the amount in question. Additionally, Section 68 of the Companies Act 2013, which holds management accountable for errors in corporate governance, may subject directors and officers who commit such violations to personal liability.

Errors in cross-border CCD issuance are seen as potential routes for capital flight, tax evasion, and financial irregularities rather than as harmless mistakes in an economy that is becoming more interconnected by the day. As a result, Indian regulators have demonstrated an increasingly low threshold for failures in this domain.

Judicial Guidance on Valuation Anomalies

A road map for understanding the practical implications of valuation errors is provided by judicial precedents which have not only warned the corporate entities about the valuation regime of CCDs but have also provided ways of reforming the same. For example,  in the Deerfield Logistics Private Limited case the company issued a lot more equity shares than were appropriate because it misjudged the value of its CCDs. After realizing the mistake, Deerfield applied for and was granted permission by the National Company Law Tribunal to formally reduce share capital in accordance with Section 66 of the Companies Act 2013. Notifying creditors, meeting regulatory requirements, and proving that the suggested reduction was fair and compliant with accounting standards under Section 133 were all part of this process.

While giving its approval, the Tribunal made it clear that the company still needed to independently resolve FEMA violations through compounding proceedings, even though it had fixed the domestic legal compliance aspects. Remedial action under one law does not necessarily remove violations under another, hence the regulatory compliances are considered multifaceted.  

However, it was in the case of Relisys Medical Devices Limited, wherein the company requested that the register of members be corrected under Section 59, even though the valuation error was relatively small. Given that the mistake did not significantly change the corporate structure, the Tribunal approved this remedy. Importantly, the Tribunal provided a quicker and less disruptive remedy for businesses dealing with smaller discrepancies by clarifying that reclassification between securities premium and paid-up share capital does not amount to a reduction of capital in the strict sense.

FEMA Considerations and Regulatory Enforcement

The second essential pillar of compliance for CCD transactions involving foreign investors, in addition to corporate law, is FEMA and its implementing regulations. The FEMA's pricing guidelines aim to prevent Indian assets from being bought at exorbitant prices to support illegal financial flows or sold to foreign investors for too low a price.

Businesses have the option to voluntarily correct violations by paying a penalty under the FEMA Compounding Proceedings Rules 2024, avoiding more severe enforcement action. Not every violation, though, can be made worse. Compounding cannot be used to resolve serious infractions, especially those involving deliberate deception or violations of the anti-money laundering regime.

The RBI Master Directions from January 2025 also made it clear that swap arrangements and deferred consideration are acceptable in downstream investments as long as they closely adhere to the rules of the FDI policy. Companies now have more options for structuring CCD transactions thanks to this regulatory update, but it also puts more pressure on them to perform thorough legal and financial due diligence.

Strategic Approaches to Rectify Valuation Errors

Companies need to carefully plan their next course of action when valuation errors are discovered. The decision between amending the register of members and reducing share capital is not just a formality; it also reflects the seriousness of the irregularity. Section 66 of the Companies Act 2013, dealing with capital reduction is the proper course of action when excess shares have been distributed and material shareholder rights are impacted. However, Section 59 of the Companies Act 2013, provides for rectification in a less disruptive remedy when the error is restricted to a misallocation between paid-up capital and securities premium. Stakeholder engagements, documentation, and disclosures vary depending on the pathway. When developing a rectification strategy, businesses must consider not only the legal viability of the plan but also the potential regulatory perceptions and the impact on the company's reputation.

Conclusion 

Corporate strategy, financial intelligence, and regulatory discipline interact cautiously in the CCD ecosystem. Companies must view CCD transactions as long-term commitments to governance, transparency, and shareholder fairness rather than just as capital-raising activities. Even unintentional valuation errors have the potential to upset this equilibrium, leading to expensive corrections, fines from the authorities, and unhappiness among shareholders. Companies are expected to get it right the first time, according to Indian jurisprudence and regulatory trends. Proactive compliance, careful valuation procedures, professional advisory assistance, and a dedication to complete disclosure are, therefore, essential requirements rather than choices. Navigating CCD transactions with caution, foresight, and precision is not only good practice but also necessary for corporate survival and success in a time when corporate errors are quickly brought to light and penalized.