CCDS In Insolvency: Form Follows Substance

Author: Pragati Agarwal

Fifth year student at Gujarat National Law University, Gandhinagar

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I.  Introduction

Over the last decade, Compulsorily Convertible Debentures (CCDs) have become a preferred tool for raising capital, particularly among start-ups and companies seeking to attract long-term investment without immediate equity dilution. For instance, recently, fintech startup Credwise raised ₹20 crores in a bridge round using CCDs, allowing early investors to convert their debt into equity at a 20% discount in the next funding round. CCDs, by their inherent nature, are hybrid securities—debt instruments at inception that are mandatorily convertible into equity shares after a defined period or upon the occurrence of specific events. Structurally, they benefit both sides: companies receive upfront funding without immediate dilution, while investors gain the security of debt along with future equity upside.

However, the hybrid nature of CCDs has led to persistent ambiguity and litigation under the Insolvency and Bankruptcy Code, 2016 (IBC), particularly regarding their classification. This controversy is not incidental - it stems from the inconsistent treatment of CCDs across different legal regimes. For instance, under the Foreign Exchange Management Act 1999 ,CCDs are treated as equity instruments for FDI compliance purposes. In contrast, under the Companies Act 2013, they are considered debentures, and thus a form of debt. This legal divergence complicates their status under the IBC, where classification has material consequences.

Whether CCDs fall within the definition and more specifically within the scope of “financial debt” determines whether the holder qualifies as a “financial creditor” under IBC. This classification is critical, if CCDs are treated as financial debt, holders may initiate insolvency proceedings and participate in the Committee of Creditors with voting rights. Conversely, if they are deemed equity instruments, CCD holders are relegated to the bottom of the distribution waterfall under Section 53 of the IBC, effectively losing priority to all secured and unsecured creditors. In this context, the IBC lens becomes not only relevant but determinative and judicial interpretation has increasingly focused on the commercial substance of CCDs rather than their nominal classification.

II. Evolving Jurisprudence on CCD Classification

The Supreme Court (SC), in Narendra Kumar Maheshwari v. Union of India (Narendra Kumar Maheshwari) laid down a guiding test to assess whether a convertible debenture should be classified as a debt or equity instrument. The test hinges on a fundamental question: do the terms of the debenture provide for repayment of the principal amount?

• If they do, even if such repayment is optional or unlikely to occur at maturity, the instrument retains the character of debt.

• Where, the terms stipulate a compulsory conversion into equity upon maturity, without any provision for principal repayment, the instrument is to be treated as equity.

Accordingly,  SC observed that a CCD does not envisage repayment of principal and therefore constitutes an equity instrument. However, this remark cannot be read as a blanket rule laying down that CCDs can never constitute financial debt. Subsequent jurisprudence has demonstrated that the classification of CCDs is, in essence, a question of contractual interpretation.

The National Company Law Tribunal (NCLT) in an order in the matter of SGM Webtech Pvt. Ltd. v. Boulevard Projects Pvt. Ltd., clarified that the legal character of CCDs must be assessed based on their status at the time of insolvency proceedings. This approach has since been reaffirmed in subsequent NCLT and NCLAT decisions, including those delivered in 2024–2025, which emphasize that classification must be determined as on the date of insolvency initiation or conversion. Until such conversion occurs, enforceable repayment or coupon rights may support treatment as financial debt, but upon conversion, the instruments shed their debt character and only equity rights subsist. 

In a subsequent order in the matter of Agritrade Power Holding Mauritius Ltd. v. Ashish Arjunkumar Rathi dated March 17, 2023, the NCLT adopted a nuanced approach by bifurcating the CCD into its principal and interest components. While it concluded that the principal amount ceased to be a financial debt upon the initiation of insolvency, treating the triggering of insolvency as the event that effectuated conversion, the accrued interest on the CCDs up to that date constituted a financial debt only if the coupon was absolute and not profit-contingent.. The rationale rested on the fact that the interest payments reflected a disbursal made against consideration for the time value of money, aligning with the core definitional requirement under Section 5(8) of the IBC. The NCLT made it clear that even where the principal is no longer repayable due to conversion, the contractual obligation to pay interest  up to the date of conversion (if unconditional) creates a financial liability that survives and remains enforceable under the Code.

In November 2023, the SC in IFCI Ltd. v. Sutanu Sinha examined the classification of CCDs under the IBC. The CCDs in this case were issued pursuant to a Debenture Subscription Agreement (DSA) that clearly identified them as equity instruments, in line with a broader financial package approved by the National Highways Authority of India. The SC unequivocally held that where commercial contracts like a DSA explicitly define the nature of an instrument, courts must interpret such agreements on an “as-is” basis, without importing implications that contradict the parties’ negotiated terms. Since the DSA did not provide for repayment or reclassification of the CCDs as debt, the SC concluded that the instruments were equity in substance. In doing so, the Supreme Court also upheld the “repayment of principle” test as emphasized in the case of Narendra Kumar Maheshwari. The ruling also emphasized that parties’ contractual intent, as reflected in binding agreements, must form the basis for classification under IBC.

The most recent judicial pronouncement on the classification of CCDs came in the recent NCLT order in the matter of L&T Finance Ltd. v. Tikona Infinet Pvt. Ltd. In this case, the CCDs were issued pursuant to a Share Subscription Agreement and reflected in the Articles of Association, which together formed the contractual backbone of the investment. A key feature of the instrument was that L&T Finance, the investor, would receive structured coupon payments beginning from the third anniversary of the subscription date. These payments were not tied to distributable profits but were contractually assured until the achievement of a pre-determined Internal Rate of Return thereby representing a financial entitlement distinct from dividend rights typically associated with equity instruments.

The NCLT carefully examined the commercial arrangement and concluded that the structured coupon payments, being time-linked, non-discretionary, and not contingent on profit availability, clearly embodied consideration for the time value of money. This placed the instrument within the scope of financial debt under Section 5(8) of the IBC. Importantly, the NCLT rejected the argument that the compulsory conversion clause alone was sufficient to negate its debt character, especially where the investor retained enforceable rights to periodic monetary returns prior to conversion. The judgment emphasized substance over form, noting that where an instrument functions like a financial facility in all but name, it must be treated accordingly under insolvency law. Although the insolvency petition was later withdrawn pursuant to a settlement under Section 12A of the IBC, the ruling nonetheless offers valuable insight into the judiciary’s evolving stance.

III. Analysis

These cases collectively underscore that there is no one-size-fits-all rule for classifying CCDs under the IBC. Courts have relied on a case-specific, substance-over-form approach, assessing the real nature of the rights and obligations attached to CCDs rather than their labels. Key indicators—such as the presence of interest payments, enforceable repayment obligations, timelines for conversion, and linkages to the time value of money—help determine whether an instrument functions more like debt or equity. Where these features are present, CCDs exhibit the characteristics of debt, even if conversion to equity is mandated in the future. Conversely, instruments lacking repayment terms or financial entitlements and hinging solely on speculative conversion are more appropriately treated as equity. This framework, rooted in the actual commercial intent and contract terms, has guided recent judicial thinking.

In light of the foregoing, the absence of a consistent framework for the treatment of CCDs under the IBC has not only led to fragmented jurisprudence but has also left many CCD-holders who are often significant lenders without effective remedies during insolvency. Where the conversion terms are unclear or silent on insolvency-triggered events, such creditors are frequently excluded from the creditor pool altogether, despite having infused capital under structured instruments. Typically, CCDs are issued during restructuring under the RBI’s circular dated June 7, 2019 on the Prudential Framework for Resolution of Stressed Assets to offset unsustainable debt. However, given that the position is not fully settled, lenders may refrain from opting for CCDs in cases of debt restructuring. This underscores the need for parties to proactively incorporate explicit clauses in CCD-related agreements, clearly stipulating the nature and treatment of the instrument upon winding up, dissolution, or insolvency whether as debt or equity. In doing so, they can ensure that their rights are preserved, and that adjudicating authorities are not compelled to infer commercial intent from silence or ambiguity. Given that courts are bound to interpret contracts based on their express terms, such clarity would allow for consistent outcomes and reduce interpretive uncertainty.

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Note: This article has been reviewed by Mr. Abir Lal Dey (Partner, Saraf and Partners), at the Tier II Stage.