Preference Share Holders Are Investors

Source: Supreme Court  

Why in News? 

Recently, the bench of Justices JB Pardiwala and KV Viswanathan has held that holders of Cumulative Redeemable Preference Shares (CRPS) are investors and not financial creditors under the Insolvency and Bankruptcy Code (IBC), ruling that non-redemption of such shares does not constitute a “default. 

• The Supreme Court held this in the matter of EPC Constructions India Limited VERSUS M/s Matix Fertilizers And Chemicals Limited(2025). 

What was the Background of  EPC Constructions India Limited VERSUS M/s Matix Fertilizers And Chemicals Limited (2025)? 

• EPC Constructions India Limited (EPCC), formerly Essar Projects India Limited, entered into an engineering and construction contract with Matix Fertilizers and Chemicals Limited (Matix) on 11th December 2009. The contract was for establishing a fertilizer complex for Ammonia and Urea production at Panagarh Industrial Park, West Bengal. Two subsequent supply contracts were executed in 2010 for Indian and non-Indian origin plant and equipment. 
• Under these contracts, ₹572.72 crores became due and payable by Matix to EPCC. On 27th July 2015, Matix requested EPCC to convert outstanding amounts up to ₹400 crores into preference shares. Matix informed that due to project delays, it required additional funding of ₹1,210 crores. Its lenders had withheld disbursements and would extend additional credit facilities only if Matix achieved a Debt-Equity Ratio of 2:1 through equity infusion. 
• EPCC's board noted that Matix lacked liquidity to repay dues or complete the project. Without additional funding, recovery prospects looked dim. On 30th July 2015, EPCC's board approved conversion of dues into 8% Cumulative Redeemable Preference Shares (CRPS). On 26th August 2015, Matix allotted 25 crore CRPS of ₹10 each, totalling ₹250 crores, redeemable at par at the end of 3 years with 8% cumulative annual dividend. 
• CIRP was initiated against EPCC on 20th April 2018. On 24th August 2018, Matix claimed to have adjusted the CRPS liability of ₹310 crores against its own claims. On 27th October 2018, EPCC's Resolution Professional issued a demand notice to Matix for ₹632.71 crores (₹310 crores for CRPS maturity and ₹322.71 crores for outstanding receivables). Matix disputed the demand on 7th December 2018. 
• EPCC filed a Section 7 petition under IBC against Matix for non-payment of ₹310 crores upon CRPS maturity. EPCC argued that CRPS constituted financial debt. The NCLT dismissed the application on 29th August 2023, holding that preference shares cannot be redeemed unless the company has profits available for dividend or proceeds from fresh equity. Non-redemption does not convert preference shareholders into creditors. The NCLAT dismissed the appeal on 9th April 2025, confirming that when preferential shares were allotted, the earlier outstanding amount stood extinguished and became share capital. 

 What were the Court’s Observations? 

• The Supreme Court observed that it is well settled that preference shares are part of share capital and amounts paid on them are not loans. Dividends are paid only when the company earns profit; otherwise it would amount to illegal return of capital. Preference shareholders cannot sue for money due on shares and cannot claim return of share money except in winding-up. An unredeemed preference shareholder does not become a creditor. 
• Section 55 of the Companies Act stipulates that preference shares shall be redeemed only out of profits available for dividends or proceeds of fresh share issue. Admittedly, the CRPS had not become due and payable since Matix had not made profits and had no reserves or proceeds from fresh equity. Therefore, no default occurred under Section 3(12) of the IBC. Even though the three-year redemption period expired, EPCC continued to be a preference shareholder, not a creditor. 
• The Court rejected arguments about unveiling underlying intent to show borrowing arrangements. EPCC's board resolution clearly showed a conscious decision to accept CRPS, knowing there would be no outflow of funds and only receivables would be converted. The conversion enabled Matix to show equity infusion for achieving the required debt-equity ratio. The earlier outstanding amount stood extinguished upon CRPS issuance, transforming the relationship to that of preference shareholder. 
• The Court held that entries in account books are not determinative of transaction nature. Though accounting standards may treat redeemable preference shares as financial liability, this cannot override the legal character of the relationship as reflected in executed documents. The IBC has its own prerequisites which must be fulfilled. 
• Section 5(8) of IBC requires disbursal against consideration for time value of money. Significantly, Section 5(8)(c) mentions bonds, debentures, loan stock but omits preference shares. The omission is significant. Paid-up money on shares being share capital does not constitute debt. For Section 5(8)(f) regarding commercial effect of borrowing, it must first be a debt. Paid-up amounts towards shares lack the character of debt. 
• Applying the real nature of the transaction, the Court concluded that EPCC, being a preference shareholder, is not a creditor. An application under Section 7 IBC was not maintainable. The appeal was dismissed. 

What is Cumulative Preferred Stock ? 

Definition 

Cumulative Preferred Stock (Cumulative Preference Shares) is a type of preference share carrying cumulative dividend rights. If dividends are not paid in any year due to insufficient profits, the unpaid dividends accumulate and must be paid to cumulative preference shareholders before any dividend distribution to equity shareholders in subsequent years. 

Key Characteristics 

• Cumulative preference shares form part of the company's share capital, not debt capital. Holders enjoy preferential rights in dividend payment and capital repayment during winding up. Unpaid dividends accumulate year after year and carry forward. 
•  All accumulated dividends must be cleared before equity dividend distribution. When redeemable (CRPS), they must be redeemed within the stipulated period, subject to availability of profits or fresh equity proceeds. 

Legal Provisions 

Companies Act, 2013 

• Section 43 defines preference share capital as part of issued share capital carrying preferential rights for dividend payment and capital repayment in winding up. 
• Section 55(1) mandates all preference shares must be redeemable. Section 55(2) stipulates redemption within twenty years (exceeding twenty years for infrastructure projects). Critically, shares can only be redeemed from distributable profits or proceeds from fresh equity issue. Shares must be fully paid before redemption. 
• Section 123 establishes dividends can only be paid from distributable profits, not from capital. 
• Section 47(2) grants limited voting rights to preference shareholders, with extended rights if dividends remain unpaid for two years or more. 

Insolvency and Bankruptcy Code, 2016 

Section 5(8) defines financial debt but notably omits preference shares. This omission is legally significant, indicating preference shares do not constitute financial debt. 

Legal Position 

The Supreme Court established that preference shareholders are investors, not creditors. Even unredeemed preference shareholders cannot claim creditor status or initiate insolvency proceedings under Section 7 of IBC. Non-redemption due to absence of profits does not constitute "default" under IBC. When debt converts into preference shares, the original debt stands extinguished and transforms into share capital.