HYBRID SECURITIES: LEGAL ANALYSIS AND SUPREME

COURT VERDICT
AUTHOR :VARUN CHIKHALE

https://taxguru.in/company-law/hybrid-securities-legal-analysis-supreme-court-verdict.html

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.