Treatment of Compulsorily Convertible Debentures (CCD)

One Instrument, Many Hats: Different Laws, Different Perspectives on Financial Instruments

In corporate finance, a single financial instrument can take on different identities depending on the legal or regulatory lens through which it is analyzed. One such example is the treatment of Compulsorily Convertible Debentures (CCD), which, despite being a straightforward debt-to-equity instrument, is subject to different interpretations across various laws.

1. Companies Act: CCDs are treated as debt until conversion, after which they are reclassified as equity. Courts have clarified that CCD holders, until the point of conversion, maintain the rights of debenture holders, giving them creditor status.

2. Income Tax Act: CCDs are treated as debt until conversion, with companies claiming interest as a tax-deductible expense. However, disputes have arisen around the valuation of CCDs and the treatment of interest expenses, particularly in cross-border transactions and various judicial precedents have held that the instrument cannot be recharacterized retrospectively as an equity instrument.

3. FEMA: For foreign investment purposes, CCDs are classified as equity from the date of issuance. Courts and regulators have emphasized that mandatory convertible instruments like CCDs should be treated as equity for the purposes of FDI caps and sectoral restrictions, even before conversion, and therefore, an assured return on the same cannot be permitted under FEMA.

4. SEBI Takeover Code: CCDs are seen as as non-equity until they are converted into shares. This means that open offer obligations are deferred until conversion, allowing companies to structure deals without triggering takeover requirements prematurely.

5. IndAS 109: CCDs are generally reckoned as equity because of their mandatory conversion feature. However, if a CCD includes an interest component, it can be classified as a hybrid instrument. 

6. IBC: CCDs are typically treated as debt if there is a repayment obligation in the event of liquidation. However, if no such liability exists, CCDs may be classified as equity. This distinction is crucial in insolvency proceedings, where creditors and debenture holders vie for recovery, and courts have provided guidance on how CCD holders should be treated in such cases.

7. Competition Law: CCDs can lead to the upfront acquisition of voting rights upon conversion, which triggers competition law requirements. Regulatory authorities have emphasized the need for early notifications in large acquisitions where CCDs are involved, to prevent anti-competitive practices.

The multifaceted treatment of any financial instrument across these legal frameworks highlights the need for a nuanced approach when structuring financial instruments, since it could result in significant implications for the investor or the investor.