RIGHTS OF PREFERENCE SHAREHOLDERS UNDER

INSOLVENCY/LIQUIDATION/IBC

Riya, student of 3 year, Indian Institute of

Technology Kharagpur, batch of 2025,
Department of Law.

In this blog, the author will be talking about the rights of preference shareholders when a
company becomes insolvent and also will try to delve into what rights they have under
IBC(INSOLENCY AND BANKRUPTCY CODE,2016) and also concerning the COMPANIES
ACT,2013.

Preference and equity shares make up a company's share capital according to the Companies Act
of 2013 and the Companies Act of 1956's surviving provisions (the "Act"). Preference shares are a
portion of a company's share capital that have a preferential right to dividend payments at a set
rate or amount and capital payback in the event of a company winding-up. As a result, under the
Act, preference shareholders automatically get a preferred shares in the event of a company's
bankruptcy or liquidation.1

Before delving into the intricacies of the rights of preference shareholders under insolvency, let
us first talk about the critical attributes of preference shareholders: preference shareholders
get preference in dividend distribution, they have the first claim over the dividends declared by
the company. In the event of liquidation or insolvency preference shareholders have a
preferential claim over the company's assets. They are entitled to recover their investment and
any unpaid dividends before common equity shares receive anything. The IBC explicitly
recognizes this hierarchy, ensuring that they are not left empty-handed in the event of a
company financial distress.

Preference shares are the shares included in a company's ownership that give their owner the
right to a fixed dividend rate that will be successfully paid by an issuer, according to section 55
of the Companies Act of 2013. The enterprises that can distribute dividends to their common
shareholders must be paid the dividend amount early.2

In addition, if the businesses are dissolved or become insolvent or went into liquidation, the
holders of the preference shares are redeemed back before the owner of the common
stock(common shareholders). Though, the owner of these preference shares never has the
voting control over certain affairs of the businesses, as do the owners of the common stock.
They have a differential voting rights. Preference shareholders are preferred over equity shares
on winding up of the company or when company being insolvent.3

1
Companies act,2013.
2
(mondaq, n.d.)
3
(monadaq, n.d.).

1
The question which arises is when does companies become insolvent and what happen to
preference shareholders when companies are unable to redeem the shares? The company could
be insolvent, if it is unable to pay its debt when it is due, the reason maybe behind this could
be asset is more and liquid liabilities are less, owes more than the company owns on balance
sheet , and has received legal enforcement action, upon winding-up.

What does section 55 of companies act says?4

 It explicitly makes it clear that no company limited by shares
shall, after the commencement of this Act, issue any preference
shares which are irremediable. It bar from issuing any preference
shares which is irremediable.

 Section 55, subsection (3) If a corporation is unable to redeem

any preference shares or make dividend payments, such shares
(unredeemed preference shares) may be issued with the approval
of the holders of three-fourths of the preference share's value and
upon filing a petition with and receiving tribunal approval. When
additional redeemable preference shares equal to the amount
due, including the dividend due thereon, in respect of the
unredeemed preference shares are issued, the unredeemed
preference shares shall be regarded to have been redeemed.
However, if a person has not consented to the issuing of more
redeemable preference shares, the tribunal must compel the
prompt redemption of their preference shares.

The way or manner in which preference shares may be redeemed is provided by Rule 9 of the
Company's Share Capital and Debentures Rule, 2014 or by Section 55 of the Companies Act,
2013. Preference shares may be redeemed at a predetermined time or in response to a specific
occurrence. whenever the company chooses. At the shareholder's discretion, at any moment.
Companies are required to abide by the conditions established in the Companies (Share Capital
and Debentures) Rules, 2014, which, among other things, include maintaining a continuous
history of distributable profits over the previous three years. It is necessary to incorporate the
liquidation preference clauses in the full encapsulation of the articles of organization. The

4
(comapanies act 2013)

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rights of the shareholders therein set forth in line with the winding up provisions of the Act
would be the liquidator's guide once expressed in the articles. It is also suggested to use
preference shares to pursue the special legal protection that is offered to them in the case of a
winding up.

Although it is recommended that agreement on liquidation preference should be incorporated

in AoA. According to the Act, the court has the authority to restructure the contributors' rights
among one another and distribute any surplus among those who are eligible to receive it.
Similar to this, the Act states that in the event of a voluntary winding up, the assets must first
be used to satisfy all outstanding debts in a Pari passu manner, saving the company's articles
of association provide otherwise, and then they must be distributed to the members in
accordance with their respective rights and interests in the company.

In the scenario the author will describe, may the preference share be redeemed without the
shareholders' approval? In the case of BRIJ BHUSHAN SINGHAL v. BHUSHAN STEEL LTD., the
National Company Law Appellate Tribunal (NCLAT) interpreted section 55 of the Companies Act
of 2013 to allow the redemption of preference shares outside of the time frame stipulated in the
resolution plan. The corporate debtor in this case, Bhushan Steel, whose appellant is a
preference shareholder, filed an appeal, arguing that section 55 was violated by the resolution
plan's attempt to automatically redeem and cancel his preference shares. The applicant for the
resolution was Tata Steel Ltd. The section states that only the procedures and conditions
outlined in the terms of issue may be followed in order to redeem preference shares. The
Insolvency and Bankruptcy Code, 2016 (IBC), section 30(2)(e), states that a resolution plan
that violates any legal provision cannot be accepted.(If the law is broken) 5

The resolution plan was viewed as only a suggestion that, until it was authorized by the
adjudicating body and the committee of creditors, could not change the position of the
preference shareholders in Bhushan Steel. The settlement plan, though, cannot go against a
court's ruling in order to be accepted by the adjudicating authority. Therefore, in order for the
resolution plan to be accepted in the first place, the NCLAT had to evaluate whether or not
section 55 applied. The violation of section 55 was therefore approved without any sort of
penalty.
Section 30(2)e(IBC),talks about the submission of the resolution plan in
which resolution applicant may submit a RESOLUTION PLAN. Resolution
professional shall examine that each plan.6

 That plan should provide for payment of insolvency resolution

process cost.
 Implementation and supervision of plan
5
(Insolvency and Bankruptcy Code , 2016)
6
(Insolvency and Bankruptcy Code, 2016)

3
 
Provides for payment of debt of operational creditors

Provides for management of affairs of debtor

The most and foremost important it does not contravene with the
law.7
These all plan should be presented by resolution professional to CoC(committee of creditor) .
CoC may approve a resolution plan by 66% vote then RP shall submit the approved
RESOLUTION PLAN to NCLAT. Here, the RP is appointed by CoC.

However, the National Company Law Tribunal (NCLAT) affirmed

the assailed ruling of the National Company Law Tribunal (NCLT),
which had accepted the resolution plan on April 17, 2018,
without giving any thought to the section 55 question that had
been raised. According to paragraph 98 of the ruling: 8
"98. The 'Resolution Plan' automatically does not amount to
transfer or reduction of shares, including preferential
(Placeholder2)shareholding. It is merely a proposal of one or other
'Resolution Applicants' and once it is approved by the 'Committee
of Creditors' and thereafter by the 'Adjudicating Authority' under
Section 31, will be binding on all the stakeholders, including the
'Corporate Debtor', 'Members' (shareholders), 'Financial
Creditors', 'Operational Creditors' etc. If the provision of Section
55 of the Companies Act, 2013 is to be complied, it can be
complied only after the approval of the 'Resolution Plan'. Before
the approval of the 'Resolution Plan' is approved by the
Adjudicating Authority, the 'Resolution Plan' being mere a
proposal, the question of following Section 55 of the Companies
Act, 2013 does not arise."

Under the insolvency code, in an waterfall arrangement ( section 53, IBC) which is basically
done after when the company is in liquidation process. So, in this waterfall arrangement
preference shareholders come at seventh position and after that equity shareholders or
partners come in. Here, IBC played an huge role in giving preference to the particular class of
shareholders. In companies Act, government was given more weightage and they stood in the
first line for unpaid taxes. IBC changed the whole scenario and put IRP( insolvency resolution
process) and liquidation costs first. To ensure a just and equal distribution of assets among
stakeholders, including preference shareholders, the resolution process is overseen by
insolvency experts(IP) and the NCLT under the IBC, a complicated legal framework. To
safeguard their interests, preference

shareholders should consult legal counsel and participate in the insolvency procedure.
However, preference shareholders may have the opportunity to negotiate with the resolution
professional or the committee of creditors to reach a settlement or restructuring agreement
that is acceptable to both the parties. Since, they come at last that is at seventh position under
IBC(waterfall arrangement). So, to secure their rights they can initiate negotiation or settlement
prior to the above classes of waterfall arrangement.

7
(Insolvency and Bankruptcy Code, 2016)
8
IndiaCorpLaw

4
A combined interpretation of section 55 of the Companies Act, rule 9 of the Share Capital
Rules, and section 30(2) of the IBC reveals that preference shares may be redeemed without
the approval of shareholders. But the NCLAT incorrectly excluded consideration of the issue of
section 55 violation from its ruling in Brij Bhushan Singhal. The author contend that the
impact of the ruling may lead to such an interpretation even though the judgment does not
address the issue of retrospective application of the explanation and that it must therefore be
explained. However in this case of BRIJBHUSHAN SINGHAL v BHUSHAN STEEL LTD, court did
not talk about the retrospective application of an act and court erred in the judgement. 9

9
(SCC online, n.d.)