The ruling brings clarity that such re-classification does not tantamount to reduction of ‘equity share capital’ per se. The NCLT said there is nothing in the existing law that says that such a conversion is disallowed.
Many companies could also look to convert equity into preference shares in situations where they wish to repay debt from group companies or give better terms to existing creditors who hold equity.
“The ruling allows more leeway in flexible capital re-organisation in case of private companies, specifically, vis-a-vis minority shareholders. Such an arrangement could also be used as a tool for minority squeeze out and family settlements,” said Yashesh Ashar, partner at tax advisory firm Bhuta Shah & Co.
Preference shares are also known as preferred stock that get dividends before other shareholders.
In case a company files for bankruptcy, preference shareholders are entitled to be paid before other equity shareholders.
Equity shareholders only get dividends after all the other liabilities are fulfilled by the company, as they are essentially the owners in the company.
Even the dividend can be fixed for preference shareholders, which is not possible for equity shareholders.
According to the details of the case some minority shareholders were seeking dividends from their investments, but at the same time they were not interested in holding any position or management control. The company then started the process of converting equity shares into optionally convertible redeemable preference shares.
The Registrar of Companies (ROC) had objected to such a conversion claiming there was no provision in the law to do it.
The company had argued that the conversion of shares is not barred by any provision of the law, and that such conversion only amounts to reorganization of the share capital.
The NCLT allowed the conversion.
“In such a case, rights of the dissenting minority shareholders require further evaluation – whether the NCLT shall approve the scheme or further apply the majority of the minority rule would need to be seen,” said Ashar.
Industry trackers say the NCLT ruling would also help several companies restructure indebted companies. Many companies currently find it difficult to repay loans drawn from holding entities in certain situations. In certain cases where creditors hold equity in the company, this route could be used to give an exit.
