Hybrid securities, in simpler terms, refer to a fusion of multiple types of securities, often involving both debt and equity components. These innovative financial instruments offer companies and financial institutions a means to secure funds from investors, presenting an alternative avenue to traditional bonds or stock offerings. True to their name, hybrid securities possess the capacity for conversion. Notable examples include Optionally Fully Convertible Debentures (OFCDs), Compulsory Convertible Debentures (CCDs), and Convertible Preference Shares.
LEGALITY OF HYBRID SECURITIES: The term ‘Securities’ under Section 2(81) of the Companies Act, 2013 has been defined to mean ‘securities’ as defined in Section 2(h) of the Securities Contracts (Regulation) Act, 1956 (SCRA). Under section 2(h) of SCRA, the term ‘securities’ include the following:
- Shares, scrips, stocks, bonds, debentures, debenture stocks etc. in or of any incorporated company or another body corporate.
- Derivatives
- Units issued by any Collective Investment Scheme to the investors in such schemes.
- Security receipt as defined in Section 2(zg) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002.
- Units or any other such instruments issued to the investors under any Mutual fund scheme.
- Government Securities
- Such other instruments, rights or interest therein shall be declared by the government to be securities be declared by the government to be securities.
Under Section 2(19A) of Companies Act, 1956 “hybrid” means any security which has the character of more than one type of security, including their derivatives.
THE SAHARA GROUP CASE: Recently SEBI has imposed penalties on Sahara India Real Estate Corporation and Sahara Housing Investment Corporation which issued OFCDs during 2008-2009. They raised money through public issue of securities by issuing OFCDs without following the various procedures intended to protect the interest of the investors, in respect of public issues, prescribed under the SEBI’s ICDR regulations. The main issues were as follows:-
1. Whether the hybrid OFCDs come under the definition of “Securities” within the meaning of SEBI Act, Companies Act and The Securities Contracts (Regulation) Act (SCRA) for vesting SEBI with the jurisdiction to adjudicate and investigate.
2. Whether the issue of the OFCDs to the people who had subscribed to that issue is a Private Placement so as not to come within the scope of SEBI Regulations and various other provisions of Companies Act.
3. Whether the Public Unlisted Companies (Preferential Allotment Rules) 2003 will be applied in this case or not.
Supreme Court Verdict
1. Defining the Hybrid Nature of OFCDs: The issuance of Optionally Fully Convertible Debentures (OFCDs) by two companies raised a fundamental legal question regarding their classification as “hybrid” instruments. Despite their hybrid characteristics, the Supreme Court firmly asserted that the classification of OFCDs as “Securities” under the SEBI Act, Companies Act, and SCRA remained intact. The Court’s ruling underscored the resilience of the term “Securities,” even though the SCRA’s Section 2(h) lacked a direct mention of “hybrid instruments.” Notably, the SCRA’s definition, encompassing “Marketable securities,” rendered the issue of marketability moot, given that these OFCDs were offered to numerous individuals.
2. Interplay of Terminology and Composition: The appellants contended that the absence of “hybrid instruments” in the SCRA definition warranted a reconsideration of the OFCDs’ classification. However, the Court’s verdict found the inclusion of the term “Debenture” within the OFCD nomenclature pivotal. The use of this term substantiated the OFCDs’ status as securities, aligning with the stipulations of the SEBI Act, Companies Act, and SCRA. This interpretation underscored the significance of names and terminology in financial instruments’ legal characterization.
3. Mandatory Listing Requirement and Corporate Autonomy: The legal battleground extended to the mandatory listing requirement specified in Section 73 of the Companies Act. The appellants, representing the Sahara Group, argued that this requirement was discretionary, applicable only to companies intending to seek listing. They contended that imposing such a mandate would infringe upon corporate autonomy. However, the Supreme Court firmly countered this notion, asserting that Section 73(1) of the Act was an obligatory legal provision, irrespective of a company’s intention to list. Furthermore, the Court highlighted the stipulation that if securities were offered to fifty or more persons, it would constitute a public offering under Section 67(3) of the Companies Act.
4. Navigating Regulatory Exclusions: A critical juncture in the legal discourse centered on Section 28(1)(b), which excluded certain convertible bonds and shares from the SCRA’s purview. The Court clarified that this exclusion was limited to those specific categories, and debentures, as another category of securities, remained subject to the SCRA’s provisions, as delineated in Section 2(h) of the SCRA. This clarification underscored the Court’s commitment to ensuring the precise application of regulatory exclusions.
5. Intentions and Actions: A Tangled Web Unraveled: The Court delved into the intentions and actions of the companies issuing the OFCDs, deciphering whether they genuinely sought to engage in a private placement or masked a public offering. The issuance of Information Memorandum under Section 60B of the Companies Act, typically reserved for public issues, served as a clear indicator of public intent. The Court concluded that the companies’ actions aimed to issue securities to the public under the guise of a private placement, bypassing crucial laws and regulations.
6. Limit-Breaching Violations: The Supreme Court’s verdict also encompassed a meticulous examination of Section 67(3) violations committed by the Sahara companies. The issuance of securities to a number exceeding the statutory limit was a direct violation of this provision, further bolstering the Court’s findings.
In Summation
The legal saga revolving around the hybrid nature of Optionally Fully Convertible Debentures (OFCDs) elucidates the intricate intersection of financial innovation and regulatory frameworks. The Supreme Court’s landmark ruling reinforces the inclusivity of the term “Securities,” even in the absence of explicit “hybrid instruments” language. The verdict underscores the interplay between nomenclature and legal classification, while also establishing the non-negotiable nature of mandatory listing provisions and their implications for corporate autonomy. Through this ruling, the Court delineates the fine line between genuine intentions and regulatory evasion, ensuring the integrity of India’s financial market regulations.
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