28 Dec 2010

"Shares" different from "debt": High Court

Taking note of the time-tested distinction between 'owned capital' and 'borrowed capital', a Division Bench of the Delhi High Court in a recently reported decision [COCHIN INTERNATIONAL AIRPORT LIMITED v. PRESIDING OFFICER , DRT AND OTHERS, (2010) 173 DLT 247] has declared that intrinsically "shares" are different from "debt". Required to decide to in the context of the recovery proceedings under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (which applies for recovery of "debt") as to whether such proceedings would include within its ambit a claim to share certificates, the Delhi High Court made such declaration.

The High Court inter alia observed as under;
28. Shares in a company do not constitute debts. A company has essentially two sources of funds. One, through borrowing and, the second, through share capital. Persons who contribute towards the share capital and thereby acquire shares in a company are actually owners of the company to the extent of their shareholding. On the other hand, persons who lend money to a company are creditors and money owed to them are debts. These debts can be in the form of money loans or interest bearing debentures or other instruments of debt. But, one thing is clear and that is that shares are not part of the liabilities of a company and are not part of the total debt of the company. In fact, one of the most important fianacial analysis ratios is the debt/equity ratio. Financial institutions and banks, before they lend money to a company, examine inter alia the debt/equity ratio of that company. There are, at times, stipulations by competent statutory bodies such as the Securities Exchange Board of India (SEBI) which prescribe a maximum debt/equity ratio for companies. Generally, a debt/equity ratio of 2:1 is considered as the outer limit or extent of leverage that is permissible. What this means is that the total debts of the company cannot be more than twice its equity share capital. Or, to put it in plain words, the borrowings should not exceed twice the owners (shareholders) funds. This discussion also makes it clear that debt and equity are distinct and different.
29. In Khoday Distilleries Ltd. v. CIT:(2009) 1 SCC 256 [at page 261], the Supreme Court observed that a share is a chose-in-action. A chose-in-action implies existence of some person entitled to the rights in action in contradistinction from rights in possession. In CWT v. Mahadeo Jalan & Mahabir Prasad Jalan: (1973) 3 SCC 157, [at page 161], the Supreme Court held – Firstly, a share is not a sum of money but is an interest measured by a sum of money and made up of various rights contained in the articles of association. They are of different categories such as the equity shares, preference shares, fully paid-up shares or partly paid-up shares.... Similarly, in an earlier case [CIT v. Standard Vacuum Oil Co.: (1966) 2 SCR 367], the Supreme Court had observed that – ―A share is not a sum of money: it represents an interest measured by a sum of money and made up of diverse rights contained in the contract evidenced by the articles of association of the Company..
30. On the other hand, a debenture represents a debt. In Narendra Kumar Maheshwari v. Union of India: 1990 (Supp) SCC 440 [at page 503], the Supreme Court held:-
―A debenture has been defined to mean essentially as an acknowledgment of debt, with a commitment to repay the principal with interest (Palmer‘s Company Law, p. 672, 24th edn.). Reference, in this connection, may be made to British India Steam Navigation Co. v. IRC. A debenture may contain charge only on a part of the assets of the company (Re Colonial Trusts Corporation) or it may not contain any charge on any of its assets (See Speyer Brothers v. IRC; and Lemon v. Austin Friars Investment Trust Ltd. A debenture may, therefore, be secured or unsecured (Palmer‘s Company Law, p. 675, 24th edn.). An ordinary debenture has to be distinguished from a 'mortgage debenture‘ which necessarily creates a mortgage on the assets of a company (See Palmer‘s Company Law, p. 706). A compulsorily convertible debenture does not postulate any repayment of the principal. Therefore, it does not constitute a 'debenture‘ in its classic sense. Even a debenture, which is only convertible at option has been regarded as a 'hybrid‘ debenture by Palmer‘s Company Law (para 44.07 at page 676). In this connection, reference may be made to the 'Guidelines for the Protection of Debenture Holders' issued on January 14, 1987 which have recognised the basic distinction between a convertible and a non-convertible debenture. It is apparent that these were issued for the purpose of ensuring the serviceability and repayment of debentures on time. It has been asserted before us that the compulsorily convertible debentures in corporate practice was adopted in India some time after the year 1984. Wherever the concept of compulsorily convertible debentures is involved, the guidelines treat these as ―equity'. This is clear from guideline IV(i) read with IV(iii) of the Guidelines for Issue of Cumulative Convertible Preference Shares and guidelines 8 and 11 of the Employees Stock Option Guidelines. These two sets of guidelines clearly indicate that any instrument which is compulsorily convertible into shares, is regarded as a 'equity' and not as a loan or debt. Even a non-convertible debenture need not be always secured. In fact, modern tendency is to raise loan by unsecured stock, which does not create any charge on the assets of the company (The Encyclopaedia of Forms and Precedents, 4th edn. Vol. 6 para 17 at pages 1094, 1095 and para 22 at pages 1097-1098). Whenever, however, a security is created, it is invariably in the form of a floating charge (See The Encyclopaedia of Forms and Precedents, 4th edn. Vol. 6 para 25 at page 1099). It follows, therefore, that the secured debenture almost invariably contains a floating charge. In addition to the floating charge, debentures are frequently secured by trust deed also as had happened in the present case where specific property, land, etc. has been mortgaged to trustees.
31. Now, 'goods' have been defined in the Sale of Goods Act, 1930 to mean 'every kind of movable property other than actionable claims and money; and includes stock and shares, growing crops, grass and things attached to or forming part of the land which are agreed to be severed before sale or under the contract of sale.'
32. But, as held in R.D. Goyal v. Reliance Industries Ltd.:(2003) 1 SCC 81 [at page 87], debentures, as ordinarily understood, would not come within the purview of the definition of goods 'as it is simply an instrument of acknowledgement of debt by the company whereby it undertakes to pay the amount covered by it and till then it undertakes further to pay interest thereon to the debenture-holders'. In R.D.Goyal (supra), it was further held:-
'Share' has been defined in Section 2(46) of the Companies Act to mean a share in the share capital of a company which in turn would mean that it would represent contribution of the shareholder towards the share capital of the company. On the other hand, a debenture is an instrument of debt executed by the company acknowledging its receipt to repay the same at a specified rate and also carrying an interest. It is in sum and substance a certificate of loan or a bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the company‘s capital structure yet it does not become a share capital. In any event, a debenture would not come within the purview of the definition of goods, inasmuch as, although the shares and stocks are included in the definition of goods but debentures are not.'
33. Thus it is clear that shares are included in the definition of goods in the Sale of goods Act, 1930 and are distinct from debentures, which are not goods but instruments of debt. Shares do not represent borrowings or loans or any liability, they represent the shareholders‘ contribution towards the share capital. There is no creditor-debtor relationship between a shareholder and the company merely because of ownership of shares. On the other hand an ordinary debenture holder is a creditor of the company which had issued the debenture. The value of the debenture and the interest payable thereon is a liability of the company and is a debt owed to the debenture-holder. This distinction between a share and an ordinary debenture makes it clear that a share cannot fall within the ambit and scope of the definition of 'debt' as given in section 2(g) of the said Act.
34. This analysis reveals that the word 'debt' as defined in section 2(g) of the said Act and as used in the said Act has reference to a claim or liability in money terms whether in cash or otherwise. An example of a cash liability is a money loan simpliciter. And, an example of a liability which falls in the 'otherwise' category, is an ordinary debenture or some other debt instrument. The liability has no reference to goods and, certainly not to shares.

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