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  • Ritvik Mishra

The Case of Sutanu Sinha: Misunderstood Law and Damaging Consequences

[Ritvik is a graduate of Jindal Global Law School.]


The decision of the Supreme Court in IFCI v. Sutanu Sinha (Sutanu Sinha) has drawn considerable attention in legal circles as it appears to have crystallized the legal status of compulsorily convertible debentures (CCDs) by classifying them as equity. This comes amidst a backdrop of conflicting decisions on the treatment that is to be accorded to these instruments under the regime of the Insolvency and Bankruptcy Code 2016 (IBC). One side understood these instruments as debts prior to conversion and equity post conversion, and the other, winning the approval of the Supreme Court, treated these instruments as equity instruments irrespective of the status of their conversion.


The case concerns CCDs issued to IFCI by an entity named ICTL, a wholly owned subsidiary of another entity named IVRCL. Subsequently, ICTL and IVRCL ran into financial troubles and corporate insolvency resolution process was initiated against them. When IFCI tried to recover the amount invested by it, the resolution professional of ICTL rejected this request on the ground that the amount invested was in the nature of equity and not debt. IFCI disputed this before every possible forum available to it, the National Company Law Tribunal (NCLT), the National Company Law Appellate Tribunal (NCLAT) and finally the Supreme Court (SC). To IFCI’s dismay over the decision of the resolution professional was upheld in all of these forums.


The article looks closely at certain aspects of reasoning adopted by the SC in this case and shows that the same are based upon a misunderstanding of relevant law. What results is the rediscovery of the true nature of CCDs; debt prior to conversion, equity post conversion. It is further argued that the position taken by the SC will have an adverse effect on the holders of CCDs.


Close Look at Sutanu Sinha: Blanket Treatment as Equity


In arriving at their decisions, the tribunals and the SC relied on the following factors. First, the debenture subscription agreement (DSA) placed the repayment obligations entirely upon the holding company IVRCL; second, the DSA categorised these CCDs as equity; third, the Reserve Bank of India’s guidelines on Foreign Direct Investment (RBI Guidelines) treat CCDs as equity instruments; fourth, the SC in its decision in the case of Narendra Kumar Maheshwari v. Union of India (Narendra Kumar Maheshwari) held that any instrument which was compulsorily convertible into shares was in the nature of equity and not loan or debt; finally, the CCDs had converted into shares on December 2017.


Interestingly, if the tribunals and SC had restricted themselves to the fact of the conversion of debentures alone, this decision would have been in alignment with the divergent view. Consider, for example, the case of SGM Webtech v. Boulevard Projects where NCLT Delhi treated an investment made through CCDs as debt, as these debentures had not been converted at the time of admission to initiate insolvency. Again, in the case of Agritrade Power Holding Mauritius Limited v. Ashish Arjunkumar Rathi, NCLT Mumbai observed that CCDs were to be classified as debt as long as they are not converted into equity.


However, the reliance placed on the RBI Guidelines and Narendra Kumar Maheshwari has a different effect of according blanket treatment to CCDs as equity, irrespective of their conversion. Therefore, the reliance placed on these aspects require a closer look.


Hybrid Securities: Separating Regulatory Identity from True Identity


The SC began its judgement in Sutanu Sinha taking note of the existence of hybrid varieties of what used to be simple securities. But how does the law understand hybrid securities? The observation of the SC in Sahara India Real Estate Corporation Limited v. SEBI (Sahara) answers this as follows:Hybrid securities, therefore, generally mean securities, which have some of the attributes of both debt securities and equity securities; means a security which, in the term of a debenture, encompassing the element of indebtedness and element of equity stock as well” (emphasis supplied). The rigid classification of CCDs as equity in Sutanu Sinha, however, is at odds with this understanding as it completely eliminates the “element of indebtedness”. But what led to this rigid classification of the instrument as equity?


A great deal of reliance was placed on the fact that the DSA entered into between the parties treated the CCDs as equity. However, the value of the provisions of the DSA arose from the fact that in categorising CCDs as equity, the document was in “compliance” with the RBI Guidelines. This evident from the excerpts in the NCLT’s decision: “In compliance with the RBI Guidelines, all the important contracts… executed between NHAI, IFCI, IVRCL and ICTL…have treated the compulsorily convertible debentures as equity…”. Subsequently, the NCLAT observed that the NCLT rightly relied on the RBI Guidelines to arrive at the conclusion that debentures which are fully, compulsorily and mandatorily convertible are to be treated as equity instruments. The reliance placed on the RBI Guidelines to determine the nature of CCDs, however, is misconceived.


Earlier, foreign investments in securities were governed by the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations 2000, which permitted a person resident outside India to purchase equity/preference shares or convertible preference shares or convertible debentures of a company. RBI in a circular observed that companies were raising funds from abroad by the issue of debt-like hybrid instruments such as optionally convertible debentures or partially convertible debentures, circumventing the framework in place for regulating debt flows in the country. Accordingly, the regulator provided that only investments by way of instruments which were fully and mandatorily convertible into equity i.e., CCDs, would be considered as a part of equity under the FDI policy.


The Income Tax Appellate Tribunal (ITAT) in CIT v. CAE Flight Training (India) Private Limited, taking note of the circular, held that the master directions on FDI could not be used to determine the nature of CCDs as an instrument. The ITAT rightly observed that the purpose of such classification was to exercise control over future repayment obligations and since CCDs carried no repayment obligation, they were treated as equity under the FDI policy. In light of this, it appears fallacious to apply RBI's master directions to make a determination on the nature of CCDs as an instrument. Their treatment as debt pending conversion and equity thereafter seems to best align with how they have been understood in Sahara. 


Addressing the Narendra Kumar Maheshwari Confusion


Both the tribunals in this case gave a great deal of importance to the observations made by the SC in the case of Narendra Kumar Maheshwari. According to the court, in this case, since a CCD does not envision the repayment of principal, it is not a debenture in the ‘classic sense’. The court further went on to observe that instruments that were compulsorily convertible into shares were to be considered as equity. The tribunals, relying on these observations, accordingly held that CCDs are in the nature of equity. However, it is shown that not only are these observations strictly case specific but also that question of repayment of principal is not determinative of the nature of an instrument as equity or debt.


A thorough reading of the judgement, aids in capturing the context underlying the observations of the court on the nature of CCDs. The case was initiated as public interest litigation challenging the grant of consent, by the erstwhile Controller of Capital Issues, to an issue of CCDs to the public by Reliance Petrochemical Limited. One of the objections against the issue was that the security provided for these CCDs was illusory. The observations of SC in the paragraph above were made to counter this objection. The factor of repayment of principal was taken into account to determine the adequacy of the security for the CCDs and not for determining the nature of CCDs as an instrument. The comments on the treatment of compulsorily convertible instruments as equity too must necessarily be seen in this light. The case specific nature of the observations and the inapplicability of the “repayment of principal” test is corroborated by the existence of certain views of the SC in matters of tax.


For instance, in CWT v. Spencers, the SC observed that merely because a particular debt was repaid by way of providing shares and not merely cash, did not change the character of the liability. While, this decision does not pertain to CCDs, it brings into question the usage of ‘repayment of principal’ doctrine to understand the nature of a liability. In the case of Secure Meters Limited, the Rajasthan High Court, disagreeing with the argument that convertible debentures are to be treated differently from non-convertible debentures due to the method of repayment, held that debentures, when issued, whether convertible or non-convertible, are to be treated as debt. The SC later upheld the views of the High Court.


Problem for CCD Holders


The views of the SC in Sutanu Sinha on the nature of CCDs diverge from the approach of the courts on their identity as well as their tax treatment. CCDs are treated as debt prior to conversion and taxed as such. A diverging treatment given to them under insolvency laws may cause problems for holders of such securities.


From the perspective of a holder, debt is of lower risk when compared to equity. Investors prefer using CCDs as a mode of investment into companies due to their flexible hybrid nature, which ordinarily would enable them to recover their money in case the company fails. However, blanketly classifying them as equity, irrespective of their conversion, destroys the flexibility of these instruments, as investors then lose recourse to the insolvency process to recover their monies. Therefore, in order to safeguard the utility of these instruments, it is important for courts to steer clear of the treatment accorded to CCDs under the RBI Guidelines and strictly have regard to the status of their conversion, when classifying them as debt or equity.


Concluding Remarks


The SC in Sutanu Sinha chose from the diverging set of views on the nature of CCDs and their treatment under the IBC. Relying on the RBI Guidelines and its judgement in Narendra Kumar Maheshwari, the courts categorised CCDs as equity and not debt. It has been argued that the reliance on these sources is misconceived and creates a situation adversely affecting the holders of CCDs by destroying the flexibility of these instruments.

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