Court’s Decision
The Supreme Court held that investment made through Compulsorily Redeemable Preference Shares (CRPS) constitutes a financial debt under the Insolvency and Bankruptcy Code because such instruments embody the commercial effect of borrowing, involve time value of money, and impose contractual obligations of repayment similar to a loan.
Reversing the findings of the National Company Law Appellate Tribunal, the Court clarified that the legal classification of “shares” is not determinative; instead, the economic reality, redemption structure, secured returns, and mandatory repayment reflect a debt-like relationship.
The Court further held that accounting designations under Ind AS do not control IBC interpretation, although they have persuasive value. It ultimately restored the creditor’s status as a financial creditor.
Facts
The dispute concerns a large industrial project in West Bengal. To fund the construction and development, the corporate entity issued Compulsorily Redeemable Preference Shares worth Rs. 250 crores under a detailed contractual framework. The investor subscribed to the CRPS based on a promise of mandatory redemption, assured internal rate of return, security, and strict repayment timelines.
The project failed, and the corporate entity defaulted. The investor initiated insolvency proceedings, asserting the status of a “financial creditor.” The corporate entity resisted, arguing that CRPS were equity instruments, not debt, because they were termed “shares” and carried voting restrictions.
The NCLT admitted the insolvency petition, but the NCLAT reversed it, relying heavily on the formal classification of the instrument as “shares,” and concluding that the investment lacked the “commercial effect of borrowing.” The Supreme Court undertook a detailed factual and legal examination to reconcile conflicting jurisprudence and determine the true nature of the transaction. 10
Issues
- Whether CRPS structured with fixed redemption obligations constitute financial debt under the Code.
- Whether the “commercial effect of borrowing” must be determined by the form of the instrument or the substance of the transaction.
- Whether accounting standards and balance-sheet classifications influence the statutory definition of “financial debt.”
- Whether contractual clauses such as fixed IRR, redemption timelines, security, and put options can convert an equity instrument into a debt instrument for IBC purposes.
- Whether the NCLAT erred in disregarding the economic substance and focusing on the legal label of the instrument.
Petitioner’s Arguments
The petitioner argued that CRPS, though termed “shares,” were structured exactly like a loan, with strict contractual obligations of repayment, a pre-agreed redemption schedule, and a defined internal rate of return. It was submitted that the transaction was a means of financing the project and created a creditor-debtor relationship.
The investor pointed to clauses obligating the corporate entity to redeem the CRPS irrespective of profitability, to provide security, to pay returns comparable to debt instruments, and to face consequences for default. These features, according to the petitioner, demonstrated the commercial effect of borrowing, which is the controlling factor under the Code.
It was further argued that Ind AS 32 classifies such instruments as financial liabilities, strengthening the case that the investment was debt in substance.
Respondent’s Arguments
The corporate entity argued that CRPS are, by law, equity instruments, and that shareholders cannot simultaneously be treated as creditors. It emphasized the legal form, pointing out that preference shares sit in the equity segment of the balance sheet, and that laws on share capital and return of capital impose limits on redemption.
It contended that since shareholders assume the risk of the enterprise, the investment cannot be recharacterized as debt. The respondent argued that contractual provisions for return and redemption do not convert CRPS into a borrowing and that the legislative intent was to keep shareholders distinct from creditors.
The corporate entity argued that the NCLAT was correct in concluding that equity cannot be treated as a financial debt merely because the investor seeks repayment.
Analysis of the Law
The Court undertook a detailed analysis of Section 5(8) of the Code (definition of financial debt), which encompasses debt disbursed against time value of money and transactions having the commercial effect of borrowing.
It held that the Code intentionally adopts a broad and functional definition, enabling courts to look beyond labels. The Court examined the detailed CRPS terms and found features akin to a loan:
• Assured returns
• Mandatory redemption
• Security rights
• Repayment obligations
• Financial consequences for default
The Court emphasized that time value of money is a critical determinant, and the presence of fixed IRR and binding redemption dates satisfied this requirement.
On accounting treatment, the Court held that while Ind AS classification is not determinative, it has persuasive relevance, particularly because Ind AS 32 classifies compulsorily redeemable instruments as financial liabilities. The Court stressed that accounting standards and commercial realities converge in this case. 10
Precedent Analysis
The judgment discusses several important decisions:
1. Ind AS 32 and AS 19 Line of Cases
These decisions emphasize substance over form, treating instruments with mandatory redemption as liabilities, not equity. The Court relied on this framework to confirm the debt-like nature of CRPS.
2. Cases on “Commercial Effect of Borrowing”
The Court referenced earlier rulings interpreting the phrase widely, holding that transactions structured as financing arrangements — even if unconventional — fall within the definition of financial debt.
3. Tax and Accounting Precedents
The Court cited decisions explaining how the true nature of a transaction, rather than its label, determines tax and financial liability consequences.
4. NCLAT’s Earlier Decisions
The Court distinguished judgments where CRPS lacked mandatory redemption or fixed returns, holding that those cases involved quasi-equity, not debt-structured instruments.
Court’s Reasoning
The Supreme Court held that the NCLAT erred by treating CRPS as equity merely because they were called “shares.” What matters is the economic bargain. The Court held:
“When redemption is compulsory and return is guaranteed, the instrument performs the function of borrowing.”
The Court emphasized that repayment obligation is independent of profits, which is the hallmark of debt. It also relied on the observation that CRPS investors were not sharing entrepreneurial risk, but were functioning like secured lenders.
The Court found that the entire CRPS structure — from redemption schedule to security package — demonstrated a financing transaction. The NCLAT’s narrow formalistic approach was rejected as contrary to the objectives of the Code.
Conclusion
The Supreme Court held that the CRPS investment amounted to a financial debt, restoring the investor’s status as a financial creditor and overturning the NCLAT’s contrary finding. The Court directed that the corporate entity’s default triggers remedies available under the Code and emphasized that financial jurisprudence must reflect commercial reality rather than rigid labels.
Implications
• Strengthens creditor rights by recognizing debt-like instruments beyond traditional loans.
• Clarifies that CRPS with mandatory redemption constitute financial debt.
• Establishes “substance over form” as a binding principle in insolvency law.
• Reinforces broad interpretation of “commercial effect of borrowing.”
• Influences structuring of hybrid instruments in corporate finance.
• Ensures investors receive IBC protections where investments imitate borrowing.
