Introduction

Conventionally, there are two methods by which a company may raise capital – by way of either “equity instruments” or “debt instruments”. Various sub-categories/instruments under these two methods are used by companies to meet their respective capital or corporate finance requirements. Although both these methods, in ordinary course, involve a disbursal of monies by the lender/investor, it is the categorisation and intent of such “disbursal” that are examined by the courts/tribunals in India to determine its qualification as a “debt” upon the basis of which the right to invoke the insolvency law is conferred upon such lender.

Indian Insolvency Landscape

The Indian insolvency landscape is governed predominantly by the Insolvency and Bankruptcy Code, 2016 (Code). Section 5(8) of the Code defines “financial debt” to mean a debt along with interest, if any, which is disbursed against the consideration for the time value of money. The current definition of “financial debt” under Section 5(8) of the Code uses the word “includes”, so the list of financial debts illustrated under the provision is not exhaustive.

Given the wide amplitude of this provision, it is evident that holder(s) of both equity and debt instruments have sought to invoke the insolvency provisions to seek recovery of their monies from the debtor company. This has given rise to a plethora of jurisprudence surrounding the treatment of financial instruments under the Code.

Share Application Money

Share application money is the amount of advance received from a prospective shareholder that is later transferred to a share capital account on the issue of shares or refunded if the issue fails to take place and is regarded as an equity instrument. The question of the qualification of share application money as a financial debt came up for consideration before the National Company Law Appellate Tribunal (NCLAT), which is the appellate insolvency tribunal in India, in the case of Kushan Mitra v Amit Goel (2021 SCC Online NCLAT 5003), where the NCLAT – while relying on certain provisions of the Indian companies law – held that the share application money, upon non-allotment, statutorily partakes the character of a loan with interest and therefore qualifies under the essential ingredients of Section 5(8) of the Code to be treated as a financial debt.

This position, however, was unable to hold sway in the case of G.S. Constro & Infra Pvt. Ltd. v Gajesh Labhchand Jain (2022 SCC Online NCLAT 3468), where the NCLAT held that monies advanced to a debtor company solely for the purpose of the acquisition and purchase of shares could not be construed to be a financial debt under the Code. Pursuant to this, in the case of Pramod Sharma v Karanaya Heart Care Pvt. Ltd. (2022 SCC Online NCLAT 296), a three-judge Bench of the NCLAT followed the position taken in law and held that an amount advanced as share application money cannot be treated as a financial debt in order to trigger the Code since it is not a debt that has been disbursed and no time value has been attached with such share application money.

In Sanjay D. Kakade v HDFC Ventures Trustee Company Ltd. (2023 SCC Online NCLAT 2241), the NCLAT further examined the issue and opined that the surrounding circumstances, the intent and the construct of the contracts entered into between the parties ought to be examined to conclude if the monies extended on the basis of such contracts can be classified as a “financial debt”. In this case, the contract under examination was a Share Subscription-cum-Shareholder Agreement, which was held to be an “investment” and was therefore in the nature of “financial debt” to trigger the Code. The case is currently pending appeal before the Supreme Court of India.

Optionally Convertible Debentures (OCDs) and Compulsorily Convertible Debentures (CCDs)

Debentures are instruments of a company evidencing a debt, and are treated as a debt instrument. However, not all classes of debentures can be regarded as pure debt instruments. While an OCD involves the repayment of the principal amount along with interest, if any, a CCD does not postulate any repayment of the principal and therefore may not constitute a “debenture” in its classic sense. Even a debenture that is only convertible at option must be regarded as a “hybrid” debenture.

The classification of OCDs as a financial debt came to be tested before the NCLAT in the matter of Santosh Kumar v ASK Trusteeship Services Pvt. Ltd. (2024 SCC Online NCLAT 64), wherein the debenture holder failed to redeem the debentures upon the redemption date. While allowing the invocation of the Code by the debenture holder, the NCLAT held that, as long as the debenture instrument contemplates an option of repayment of the principal upon non-redemption, such character of the OCDs was sufficient to qualify as a financial debt under the tenets of the Code. The case is currently pending appeal before the Supreme Court of India.

On the other hand, in IFCI Ltd. v Sutanu Sinha (2023 SCC Online SC 1529), the Supreme Court of India dealt with the classification of CCDs as financial debt and relied upon the contractual obligations and the nature of representation of such CCDs made to third parties. It was held that, since the CCDs did not cast any financial obligation on the debtor company per se, it could not be regarded as a debt for the purposes of the Code. The Court further opined that “it should certainly not be an endeavour of commercial courts to look into implied terms of contract” when the instrument was clear in its depiction as one of “equity” that would not take the character of “debt” in any event.

Conversely, it remains to be seen if the contractual terms of CCDs along with the conduct of the parties with respect to the CCDs (if indicative of the same as a debt instrument) may qualify as a financial debt under the Code.

To Invoke or Not to Invoke

In conclusion, all equity instruments do not currently fall within the scope of financial debt, nor do all debt instruments ipso facto qualify as a financial debt. While this area of law continues to evolve, what emerges with clarity is that the court/tribunal shall consider the terms and tenets of the contract agreed between the commercially seasoned parties while deciding the treatment of the instrument, as well as the orientation and positioning of the transaction by the parties that resulted in the creation of the instrument.