Preference Shareholders Can’t Invoke Insolvency Proceedings, Rules Supreme Court

In a landmark judgment, the Supreme Court of India has ruled that holders of preference shares cannot be treated as financial creditors under the Insolvency and Bankruptcy Code, 2016 (IBC). The ruling in EPC Constructions India Ltd. v. Matix Fertilizers and Chemicals Ltd. (Civil Appeal No. 11077 of 2025; decided on October 28, 2025) settles a recurring question in corporate insolvency jurisprudence — whether preference shareholders can invoke Section 7 of the IBC for initiating insolvency proceedings against a company.

The Court, speaking through Justice K.V. Viswanathan (with Justice J.B. Pardiwala concurring), held that preference shares are capital instruments, not debt instruments, and therefore, preference shareholders are investors, not creditors.

Their right to claim redemption or dividend is conditional upon the company’s profits or fresh issue of shares as per Section 55 of the Companies Act, 2013.

This decision reinforces the distinction between equity and debt and prevents the misuse of IBC proceedings by investors attempting to recover investments under the garb of “financial debt.”

Background of the Case

The Parties and Transaction

The appellant, EPC Constructions India Limited (formerly Essar Projects India Ltd.), entered into engineering and construction contracts with the respondent, Matix Fertilizers and Chemicals Ltd., in 2009–2010 for establishing a fertilizer complex in West Bengal. Due to delays and liquidity issues, Matix proposed converting part of its outstanding dues into Cumulative Redeemable Preference Shares (CRPS).

In July 2015, EPC agreed to convert ₹400 crores of receivables into CRPS carrying an 8% cumulative dividend. Matix subsequently allotted 25 crore CRPS of ₹10 each aggregating to ₹250 crores, redeemable at par after three years. These shares were not listed, and their redemption was subject to company profits or proceeds from fresh share issues.

Initiation of Insolvency Proceedings

EPC later went into insolvency and was represented by its liquidator, Abhijit Guhathakurta. The liquidator issued a demand notice in 2018 seeking ₹632.71 crores from Matix — ₹310 crores on account of matured CRPS and ₹322.71 crores as other dues.

When the demand was denied, EPC filed an application under Section 7 of the IBC before the NCLT, Kolkata, claiming that Matix had defaulted in redeeming the preference shares and was, therefore, a “corporate debtor.”

Findings of the NCLT and NCLAT

Both the National Company Law Tribunal (NCLT) and the National Company Law Appellate Tribunal (NCLAT) dismissed the petition. Their reasoning included:

1. Non-redemption does not create debt: Under Section 55 of the Companies Act, 2013, preference shares can be redeemed only out of profits available for dividends or from proceeds of a new share issue. If these conditions are unmet, no enforceable debt arises.
2. No default under the IBC: Since Matix had not earned profits or raised fresh capital, redemption was legally impossible. Therefore, no default had occurred.
3. Nature of CRPS: The preference shares represented capital investment, not a loan or borrowing. Once EPC accepted shares in place of receivables, the earlier debt stood extinguished.

Aggrieved, EPC appealed to the Supreme Court, contending that the CRPS had the commercial effect of borrowing and thus qualified as “financial debt” under Section 5(8)(f) of the IBC.

Issue

• Whether holders of Cumulative Redeemable Preference Shares (CRPS) are “financial creditors” entitled to initiate insolvency proceedings under Section 7 of the IBC?

The appellant argued that despite the nomenclature of “shares,” the transaction’s true intent was to grant a subordinate loan, satisfying the test of a “financial debt.” The respondent countered that preference shares, being part of the company’s capital, cannot be equated with borrowings or loans.

Supreme Court’s Analysis

Preference Shares are Capital, Not Debt

The Court held that preference shares form part of the company’s share capital, not its borrowings. Referring to Sections 2(84) and 43 of the Companies Act, 2013, the Court observed:

“Preference share capital is that part of the issued share capital which carries a preferential right with respect to payment of dividend and repayment of capital on winding up.”

Therefore, preference shareholders remain investors — not lenders — who enjoy preferential rights over dividends and capital repayment but not creditor rights.

Redemption Depends on Profits or Fresh Issue of Shares

Section 55(2) of the Companies Act mandates that redemption of preference shares must occur only out of:

• Profits available for dividend, or
• Proceeds from a fresh issue of shares.

Since Matix had not made profits or raised fresh capital, redemption could not occur lawfully. Consequently, no liability had crystallised, and no “default” could be said to exist under Section 3(12) of the IBC.

The Court cited Lalchand Surana v. Hyderabad Vanaspathy Ltd. (1988 SCC OnLine AP 290), where Justice B.P. Jeevan Reddy held that non-redeemed preference shareholders do not become creditors merely because redemption is delayed.

“Debt” and “Default” Under the IBC

Under Section 3(11) of the IBC, a debt means a liability or obligation in respect of a claim that is “due.” A “default” occurs only when such debt is not paid after becoming due and payable. The Court reiterated the principle from Innoventive Industries Ltd. v. ICICI Bank (2018) 1 SCC 407:

“A debt may not be due if it is not payable in law or in fact.”

Since redemption was legally prohibited without profits or new equity, no debt was payable in law, and thus no default could occur.

Essential Elements of “Financial Debt”

Section 5(8) IBC defines financial debt as a debt disbursed “against the consideration for the time value of money.” The Court emphasised that to qualify as financial debt, three core elements must exist:

1. Disbursal of funds,
2. Time value of money, and
3. Obligation to repay.

Preference shares failed this test — there was no disbursal, no interest for time value, and no unconditional repayment obligation.

Citing Anuj Jain v. Axis Bank Ltd. (2020) 8 SCC 401, the Bench held that “disbursal against the consideration for time value of money” is the essence of a financial debt. Preference shares, by their nature, lack this characteristic.

“Commercial Effect of Borrowing” Argument Rejected

EPC’s counsel argued that the CRPS were issued with the commercial effect of borrowing since they were meant to temporarily finance Matix’s project. The Court rejected this, holding that the transaction was an equity investment consciously accepted by EPC through its board resolution, which stated that “there will be no outflow of funds, only conversion of receivables into RPS.”

Justice Viswanathan noted:

“The egg having been scrambled, the attempt to unscramble it must necessarily fail.”

Once the receivables were converted into share capital, the earlier debt was extinguished. The company’s board deliberately chose this form of investment to help Matix maintain its debt-equity ratio and access bank funding. The nature of the transaction, therefore, could not later be recharacterized as a loan.

Accounting Treatment Not Determinative

EPC argued that Matix’s financial statements categorised CRPS as “unsecured loans” and “financial liabilities,” indicating acknowledgement of debt. The Court dismissed this, clarifying that accounting entries cannot override legal character. Referring to State Bank of India v. CIT (1985) 4 SCC 585, the Court reiterated:

“The way in which entries are made in the books of accounts is not determinative of the true nature of a transaction.”

Similarly, Union of India v. Association of Unified Telecom Service Providers of India (2020) 3 SCC 525 was cited to emphasise that accounting standards cannot supersede statutory definitions.

Precedents Reinforcing the Decision

The Court relied on earlier rulings distinguishing equity from debt:

1. Radha Exports (India) Pvt. Ltd. v. K.P. Jayaram (2020) 10 SCC 538: Payments for shares cannot be treated as financial debt; shareholders are investors, not creditors.
2. Global Credit Capital Ltd. v. Sach Marketing Pvt. Ltd. (2024 SCC OnLine SC 649): For any transaction to constitute financial debt, there must be disbursal for consideration of the time value of money.
3. Pioneer Urban Land v. Union of India (2019) 8 SCC 416: Clarified the scope of “commercial effect of borrowing” but maintained the necessity of repayment obligation.

By synthesising these authorities, the Court reaffirmed that preference shareholders remain part of the company’s capital structure and cannot claim the rights of lenders.

Key Observations

1. Preference shareholders are not creditors. They cannot sue for recovery of investment except during winding-up proceedings.
2. Unredeemed preference shares do not create a debt. The right to redemption is conditional upon profits or proceeds from new equity, not an absolute repayment obligation.
3. IBC proceedings cannot substitute for shareholder remedies. Insolvency proceedings are meant for creditors, not investors seeking exit.
4. Legal character overrides accounting treatment. The substance of the corporate relationship, not financial reporting, determines rights under the IBC.

Conclusion

The Supreme Court’s judgment in EPC Constructions India Ltd. v. Matix Fertilizers and Chemicals Ltd. is a definitive pronouncement on the status of preference shareholders under the IBC. By declaring that preference share investments are equity contributions, not financial debt, the Court has:

• Clarified the limits of IBC’s jurisdiction,
• Reinforced statutory harmony between the Companies Act, 2013 and Insolvency and Bankruptcy Code, 2016, and
• Ensured that insolvency law remains a remedy for creditors, not disgruntled investors.

This ruling will have far-reaching implications for corporate finance, restructuring, and insolvency practice in India. It safeguards the sanctity of the equity-debt distinction and discourages the misuse of insolvency proceedings for the recovery of capital investments.

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