Preference Shareholding Does Not Convert Into Financial Debt, Court Rules in Section 7 Challenge

A bench of Justices J. B. Pardiwala and K. V. Viswanathan heard an appeal against the National Company Law Appellate Tribunal’s order confirming the National Company Law Tribunal’s dismissal of a Section 7 insolvency petition; the principal question was whether cumulative redeemable preference shares (CRPS) held by the appellant amounted to a “financial debt” under the Insolvency and Bankruptcy Code, 2016 (IBC) and whether a default had occurred enabling initiation of CIRP.

The Court dismissed the appeal and affirmed the NCLAT and NCLT findings that the CRPS issued to the appellant were in the nature of share capital and not a financial debt, and that no default under Section 3(12) IBC had occurred because redemption could only occur out of profits or fresh issue proceeds. The judgment emphasised the statutory and conceptual distinction between share capital and debt and held that preference shareholders did not acquire creditor status merely because redemption was not effected. The Court, in its reasoning, observed: The Court also reiterated established company law principles, quoting that “preference shareholders are only shareholders and not in the position of creditors,” and referred to Section 55 of the Companies Act, 2013 which prescribes that preference shares may be redeemed “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.”

Background

The dispute arose from construction contracts between the appellant, EPC Constructions India Limited (formerly Essar Projects India Ltd.), and the respondent, Matix Fertilizers and Chemicals Ltd., under which the appellant claimed receivables totalling approximately INR 572.72 crore. By correspondence in July–August 2015 the parties agreed to convert part of those receivables into 8% Cumulative Redeemable Preference Shares (CRPS), and the appellant’s board approved conversion of up to INR 400 crore; Matix allotted CRPS aggregating INR 250 crore. The CRPS were stated to be redeemable at par at the end of three years, with Matix having discretion to redeem earlier; dividends were cumulative at 8% per annum.

Corporate Insolvency Resolution Process (CIRP) proceedings against the appellant commenced in April 2018 and the appellant’s liquidator issued a demand notice in October 2018 claiming about INR 632.71 crore (including INR 310 crore as maturity of CRPS). Matix disputed liability. The appellant filed a Section 7 petition in 2022 alleging failure to pay redemption amount; the NCLT dismissed the petition observing that (inter alia) preference shares could be redeemed only out of profits or fresh issue proceeds and non-redemption did not convert preference claims into debt. The NCLAT affirmed, holding that preference shares were capital and not debt and that Matix had not earned profit or declared dividend to enable redemption.

On appeal to this Court the appellant argued that the transaction’s commercial effect was borrowing and thus constituted a financial debt under Section 5(8)(f) IBC, relying on authorities that looked to substance over form. The respondent contended that company law definitions governed and preference share capital could not be treated as debt or give rise to financial creditor status. The Court analysed company law provisions (Sections 43 and 55 Companies Act), definitions in the IBC, and precedents, and held that the paid-up amount on preference shares constituted share capital, not a loan; the statutory prerequisites for a Section 7 petition — existence of a financial creditor and occurrence of default — were not met. The Court rejected attempts to deem CRPS as disguising a borrowing and declined to treat accounting entries as determinative of legal character. The appeal was dismissed with no order as to costs.

Case Details: Case No.: CIVIL APPEAL NO. 11077 OF 2025 Case Title: EPC Constructions India Limited Through Its Liquidator - Abhijit Guhathakurta v. M/s Matix Fertilizers And Chemicals Limited Appearances: For the Petitioner(s): Mr. Niranjan Reddy, Senior Advocate For the Respondent(s): Mr. Mukul Rohtagi, Senior Advocate; Mr. Ritin Rai, Senior Advocate