Rights of Preference Shareholders under the Insolvency and Bankruptcy Code, 2016

In India, there are so many companies which are under the Insolvency and Bankruptcy Code (IBC) and where the shareholders are thinking that to get a fair deal to secure their shares in the companies.

Preference shares are considered as quasi-debt instruments since they combine the features of equity as well as debt. On one side, they carry a preferential right over the ordinary shares to receive dividend at a fixed rate and on the other, they carry an equity risk of not being secured, except to the preferential right of repayment in case of winding-up of the company. Preference shares have proved beneficial for investors, since such quasi-debt instrument provides protection to their investment by possessing voting rights on matters affecting their interest, more so with the fixed rate of dividend. For the promoters, issue of preference shares to investors ensures access to capital without a need to provide any security, with a continued control.

Rights of Preference Shareholders under Companies Act, 2013

Some of the Rights of Preference Shareholders under companies Act, 2013 are as follows: 

• The Preference Shareholders enjoy a preferential right in the payment of dividend during the life time of the company.

• The claim of Preference shareholders is prior to the claim of Equity shareholders or any other class of shareholders.

• The dividend rate is fixed for the preference shareholders, whether the company makes profit or not.

• If the company will skip preference dividends for three years, then it has to grant voting right to preference shareholders, on matters affecting them.

• When the company is wound up, then the repayment of capital will paid first to the preference shareholders, prior to the equity shareholders or any other class of shareholders.

Redemption of Preference Shares

Section 55 of the companies Act, 2013 deals with issue and redemption of Preference Shares. No company limited by shares shall, after the commencement of this Act, issue any preference shares which are irredeemable. A company limited by shares may, if so authorized by its articles, issue preference shares which are liable to be redeemed within a period not exceeding twenty years from the date of their issue subject to such conditions as may be prescribed

A Company may issue preference shares for a period exceeding twenty years for infrastructure projects, subject to the redemption of such percentage of shares as may be prescribed on an annual basis at the option of such preferential shareholders:

• Source of Redemption of Preference Shares: 

• Preference shares can be redeemed only out of the profits available for distribution to its shareholders as Dividend;

• Preference shares can be redeemed only out of Preference shares can be redeemed only fresh proceeds of shares issued solely for the purpose of funding the redemption of the preference shares.

• Conditions for Redemption of Preference Shares: 

• Company must be authorized by its Articles of Association (AoA). 

• No such shares shall be redeemed unless they are fully paid up. The partly paid up shares cannot be redeemed. If they are partly paid in that case a final call be made to convert them from partly paid to fully paid only then redemption can be carried out. 

• A Company may redeem its preference shares only on the terms on which they were issued or as varied after due approval of preference shareholders under section 48 of the Act and the preference shares may be redeemed; 

• At a fixed time or on the happening of a particular event; 

• Any time at the company’s option; or 

• Any time at the shareholder’s option.

Analysis of NCLAT on Redemption of Preference Shares without Prior Approval of Shareholders

The National Company Law Appellate Tribunal (NCLAT) in Brij Bhushan Singhal v Bhushan Steel Ltd. (August 10, 2018) allowed the preference shares to be redeemed outside the purview of section 55 of the Companies Act, 2013 when required by the resolution plan. In this case, with Tata Steel Ltd.

• The appellate tribunal also rejected the claims of engineering and construction major L&T, an operational creditor of Bhushan Steel Ltd, opposing Tata Steel’s resolution plan seeking a higher priority in debt resettlement. An NCLAT bench headed by Chairman Justice S J Mukhopadhaya rejected the claims of its promoters Neeraj Singal that Tata Steel was ineligible to bid for Bhushan Steel under section 29 A of the Insolvency & Bankruptcy Code (IBC).

As the resolution applicant, the appellant, a preference shareholder of Bhushan Steel (corporate debtor), filed an appeal that the resolution plan sought to automatically redeem and cancel his preference shares, in contravention of section 55 of the Companies Act, 2013. That provision mandates that preference shares can only be redeemed in the manner, and after fulfillment of the conditions, prescribed in the terms of issue. According to section 30(2)(e) of the Insolvency and Bankruptcy Code, 2016 (IBC), a resolution plan cannot be approved if it contravenes any provision of law.

However the NCLAT, without a consideration of the question raised regarding section 55 of the Companies Act, 2013, upheld the impugned order of the National Company Law Tribunal (NCLT), which approved the resolution plan on April 17, 2018. Further, Paragraph 98 of the judgment states: 

“98. The ‘Resolution Plan automatically does not amount to transfer or reduction of shares, including preferential shareholding. It is merely a proposal of one or other ‘Resolution Applicants’ and once it is approved by the ‘Committee of Creditors’ and thereafter by the ‘Adjudicating Authority’ under Section 31, will be binding on all the stakeholders, including the ‘Corporate Debtor’, ‘Members’ (shareholders), ‘Financial Creditors’, ‘Operational Creditors’ etc. If the provision of Section 55 of the Companies Act, 2013 is to be complied, it can be complied only after the approval of the ‘Resolution Plan’. Before the approval of the ‘Resolution Plan’ is approved by the Adjudicating Authority, the ‘Resolution Plan’ being mere a proposal, the question of following Section 55 of the Companies Act, 2013 does not arise.” 

The decision considered the resolution plan to be a mere proposal that could not affect the position of Bhushan Steel’s preference shareholders until it was approved by the committee of creditors and the adjudicating authority. However, in order for it to be approved by the adjudicating authority, the resolution plan cannot contravene a position of law. Thus, it was essential for the NCLAT to decide upon the applicability of section 55 of the Companies Act, 2013 for the resolution plan to be approved in the first place. As a result, the contravention of section 55 of the Companies Act, 2013 was allowed without any consideration.

If such a position is held to be valid, a resolution plan may propose contravention of any law in force with full immunity and, if it receives approval like it did in Brij Bhushan Singhal, then, an aggrieved party may have no recourse at all since before approval it was merely a proposal, and after approval, it cannot be challenged.

According to section 30(2) of the Insolvency and Bankruptcy Code, 2016 a resolution plan must fulfill the mentioned conditions:

• The resolution professional shall examine each resolution plan received by him to confirm that each resolution plan –

• provides for the payment of insolvency resolution process costs in a manner specified by the Board in priority to the payment of other debts of the corporate debtor;

• provides for the payment of the debts of operational creditors in such manner as may be specified by the Board which shall not be less than the amount to be paid to the operational creditors in the event of a liquidation of the corporate debtor under section 53;

• provides for the management of the affairs of the Corporate debtor after approval of the resolution plan;

• The implementation and supervision of the resolution plan;

• Does not contravene any of the provisions of the law for the time being in force

• Confirms to such other requirements as may be specified by the Board.

The explanation to section 30(2) the Insolvency and Bankruptcy Code, 2016 came into effect from June 06, 2018, through the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018 while the resolution plan had been approved by the adjudicating authority on April 17, 2018. The explanation does not expressly mention retrospective application, unlike the proviso added to sub-section (4) dealing with rejection of resolution plans submitted by persons barred under section 29A.

The Supreme Court in Smt. Dayawati vs Inderjit 1966 has declared the law on retrospective application of legislation. A court of appeal cannot ordinarily take into account new law that came into force after the filing of the suit unless explicitly mentioned in the amendment.

Conclusion:

On a combined reading of section 55 of the Companies Act, 2013 read with Rule 9 of the Companies (Share Capital) Rules, 2014 and the explanation to section 30(2) of the Insolvency and Bankruptcy Code, 2016, preference shares may be redeemed without obtaining the approval of shareholders.

However, in the judgment in Brij Bhushan Singhal, the NCLAT erroneously denied any consideration of the question of contravention of section 55 of the Companies Act, 2013. While the judgment does not delve into the question of retrospective application of the explanation, the authors believe that the effect of the verdict may result in such an interpretation, and must thus be clarified.

Jaya Sharma and Niket Thakkar are Practising Company Secretaries in Mumbai.