Equity Investment Without Repayment Obligation Does Not Qualify As Financial Debt: NCLAT New Delhi

The New Delhi Bench of the National Company Law Appellate Tribunal (NCLAT) on 1 July held that an amount advanced under a Subscription and Shareholders Agreement (SSA) towards purchase of equity shares and convertible warrants does not qualify as “financial debt” under the Insolvency and Bankruptcy Code, 2016 (IBC), unless the agreement creates a repayment obligation.

Judicial Member Justice Mohd Faiz Alam Khan and Technical Member Ajai Das Mehrotra dismissed Metamorphosis Trading LLP's appeal against Kumar Motors Pvt. Ltd. and upheld an order of the Mumbai Bench of the National Company Law Tribunal (NCLT). It observed:

“On the basis of analysis of the facts of this case, in the background of SSA and judicial guidelines provided by the courts, we are of the opinion that the amount advanced by Innoventive Industries Ltd., subsequently assigned to the Appellant, does not amount to “financial debt”. There is no clear-cut clause for repayment in SSA and as the amount advanced was towards purchase of equity/convertible warrants, it is not a financial debt.”

The dispute arose from an SSA dated 6 September 2011, under which Innoventive Industries Ltd., described as the “Investor”, advanced approximately Rs. 8.70 crore to Kumar Motors. The SSA contemplated subscription to equity shares and conversion of warrants after the investor made the payment.

Innoventive Industries later went into liquidation, following which Metamorphosis Trading LLP acquired its assets and rights under the SSA in July 2021. Claiming that Kumar Motors had defaulted in repaying the amount, Metamorphosis filed a Section 7 application under the IBC before the NCLT in 2024.

The NCLT rejected the application after holding that the amount advanced under the SSA did not constitute financial debt. Metamorphosis then challenged the order before the NCLAT.

It argued that the amount advanced under the SSA had the commercial effect of borrowing and fell within Section 5(8)(f) of the IBC, which includes transactions having the commercial effect of borrowing. It further argued that Kumar Motors' failure to allot shares within 60 days under Section 42(6) of the Companies Act, 2013 converted the application money into a loan.

Kumar Motors argued that the SSA created an equity participation arrangement and only contemplated subscription of shares and warrants. It submitted that the agreement contained no provision requiring repayment, payment of interest, or assured returns. It also argued that the claim was barred by limitation and that Metamorphosis, being an assignee, did not qualify as a Financial Creditor.

The NCLAT examined the SSA and found that the agreement contemplated equity subscription, conversion of warrants into shares, and acquisition of majority control by the investor. It noted that Clause 2.5 of the SSA provided that, upon conversion, the investor would hold not less than 51% of Kumar Motors' paid-up equity share capital.

Further, the Bench found that the SSA did not contain any clause requiring Kumar Motors to repay the amount advanced. It held that the agreement only provided exit options through an initial public offering, strategic sale, or merger within 60 months, and did not create any repayment obligation.

It also rejected the reliance placed on Section 42(6) of the Companies Act, 2013, noting that the SSA was executed in 2011 when the Companies Act, 1956 governed the field. Since the earlier law did not contain an equivalent provision, the Bench held that non-allotment of shares could not automatically convert the investment into a loan.

Accordingly, the NCLAT dismissed the appeal and held that the amount advanced under the SSA represented an equity investment and could not be treated as financial debt under the IBC.