Issuance of Debentures by a Private Company under Companies Act, 2013

A Practical Guide to Issuance of Debentures by a Private Company under Companies Act, 2013

Introduction

Debentures are one of the most widely used instruments for raising debt capital by companies. Unlike equity shares, debentures represent a borrowing by the company and generally carry a fixed rate of interest. Companies may issue debentures to meet their funding requirements without diluting ownership or management control.

This article provides an overview of the legal framework, types of debentures, key compliance requirements, and the procedure for issuance of debentures by a private company under the Companies Act, 2013.

Legal Framework

The issuance of debentures by a private company is primarily governed by:

1. Section 71 of the Companies Act, 2013 read with Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014.

2. Section 42 of the Companies Act, 2013 relating to Private Placement.

3. Section 62(1)(c) of the Companies Act, 2013 relating to Preferential Allotment (applicable in case of convertible debentures).

4. Rule 18 of Companies (Share Capital and Debentures) Rules, 2014

Meaning of Debentures

Section 2(30) of the Companies Act, 2013 defines a “Debenture” as including debenture stock, bonds, or any other instrument of a company evidencing a debt, whether constituting a charge on the assets of the company or not.

Debenture holders generally do not possess voting rights in the company. However, they may vote in meetings concerning matters affecting their rights as debenture holders.

Types of Debentures

1. Based on Security

(a) Secured Debentures: Secured debentures are backed by a charge on the assets of the company. In case of default, debenture holders have a claim against the charged assets.

(b) Unsecured Debentures: Unsecured debentures are not backed by any charge on the assets of the company. Debenture holders rank as unsecured creditors of the company.

2. Based on Tenure

(a) Redeemable Debentures

Redeemable debentures are repayable upon the expiry of a specified period as per the terms of issue. Such debentures may be redeemed at par or at a premium.

As per Section 71 of the Companies Act, 2013, debentures are generally required to be redeemable and cannot ordinarily be issued as perpetual instruments.

3. Based on Convertibility

(a) Convertible Debentures

Convertible debentures are converted into equity shares of the company after a specified period and in accordance with the terms of issue.

(b) Non-Convertible Debentures (NCDs)

These debentures are not convertible into equity shares and are redeemed in accordance with the terms of issue.

(c) Partly Convertible Debentures

Partly convertible debentures consist of two components:

• A portion that is converted into equity shares after a specified period; and
• A portion that remains debt and is redeemed as per the terms of issue.

4. Based on Negotiability

(a) Bearer Debentures

Bearer debentures are transferable by mere delivery and are payable to the bearer.

(b) Registered Debentures

Registered debentures are transferable only through a proper transfer process and registration in the records of the company. The registered holder is the person whose name appears in the Register of Debenture Holders.

Conditions for Issuance of Secured Debentures

A company may issue secured debentures subject to the following conditions:

1. Redemption Period

The redemption period shall generally not exceed ten years from the date of issue.

However, the following classes of companies may issue secured debentures for a period exceeding ten years but not exceeding thirty years:

• Companies engaged in infrastructure projects;
• Infrastructure Finance Companies;
• Infrastructure Debt Fund NBFCs; and
• Such other companies permitted by the Central Government, RBI, National Housing Bank, or other statutory authorities.

2. Creation of Security

The issue shall be secured by creating a charge on the assets of:

• The company;
• Its holding company;
• Subsidiary company; or
• Associate company,

having sufficient value to ensure repayment of principal and interest.

3. Appointment of Debenture Trustee

The company shall appoint a Debenture Trustee before issuing the offer document and execute a Debenture Trust Deed within the prescribed period to protect the interests of debenture holders.

4. Security in Favour of Trustee

The charge or mortgage securing the debentures shall be created in favour of the Debenture Trustee over:

• Specific movable property; and/or
• Specific immovable property.

Private Placement and Preferential Allotment

Debentures are generally issued through private placement under Section 42 of the Companies Act, 2013.

In the case of convertible debentures, the provisions relating to preferential allotment under Section 62(1)(c) may also become applicable.

Key Points

• Offer can be made to a maximum of 200 identified persons in a financial year.
• Qualified Institutional Buyers (QIBs) and ESOP recipients are excluded from this limit.
• The limit is calculated separately for each class of security.
• Any offer exceeding the prescribed limit may be deemed to be a public offer.
• Approval of shareholders by way of a Special Resolution is generally required.

Debenture Trustee – When Required?

Appointment of one or more Debenture Trustees is mandatory in the following cases:

• Where secured debentures are issued; or
• In such other cases as prescribed under Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014.

The trustee acts as a representative of debenture holders and safeguards their interests throughout the tenure of the debentures.

Duties of a Debenture Trustee

Some of the important duties of a Debenture Trustee include:

• Ensuring compliance with the terms of issue;
• Monitoring creation and maintenance of security;
• Calling for periodic reports from the company;
• Informing debenture holders about defaults, if any;
• Taking steps to protect the interests of debenture holders;
• Convening meetings of debenture holders whenever required;
• Ensuring timely redemption or conversion of debentures.

In case the company defaults in payment of interest, redemption of debentures, or creation of security, the trustee may take appropriate legal action and seek remedies available under the Companies Act, 2013.

Debenture Redemption Reserve (DRR)

The provisions relating to Debenture Redemption Reserve (DRR) have undergone significant changes over the years through various amendments and notifications.

Companies proposing to issue debentures should verify the latest applicable provisions regarding:

• Creation of Debenture Redemption Reserve (DRR);
• Debenture Redemption Investments (DRI); and
• Exemptions available to specific classes of companies.

Professional advice should be obtained to ensure compliance with the latest legal requirements prevailing at the time of issuance.

Procedure for Issuance of Debentures by a Private Company

Stage 1 – Pre-Issue Preparations

1. Obtain a valuation report from a Registered Valuer where required, particularly in the case of convertible debentures.

2. Review the Articles of Association to ensure that the company has the necessary borrowing powers.

Stage 2 – Board Approval

Convene a Board Meeting to:

• Approve the issue of debentures and terms of issue.
• Identify the proposed investors.
• Approve the draft offer letter.
• Fix the date, time and venue of the General Meeting.
• Approve the draft notice and explanatory statement.
• Approve alteration of Articles, if required.

Stage 3 – Shareholders’ Approval

Hold an Extraordinary General Meeting and obtain approval by way of Special Resolution for:

• Issue of debentures;
• Increase in borrowing limits under Section 180(1)(c), wherever applicable;
• Alteration of Articles, if required.

Thereafter, file Form MGT-14 within 30 days of passing the Special Resolution.

Stage 4 – Private Placement Process

1. Open a separate bank account for receipt of application money.

2. Prepare the list of identified persons.

3. Issue the offer letter in Form PAS-4.

4. Maintain records in Form PAS-5.

5. Receive application money only through banking channels and not in cash.

Stage 5 – Allotment and Post-Issue Compliances

Within 60 days of receipt of application money:

• Convene a Board Meeting for allotment of debentures.
• Approve charge creation documents, if applicable.
• Approve the Debenture Trust Deed, where applicable.
• Approve issuance of Debenture Certificates.

Thereafter:

• File Form PAS-3 within 15 days of allotment.
• File Form CHG-9 for registration of charge, where applicable.
• Update the Register of Debenture Holders.
• Update the Register of Charges.
• Issue Debenture Certificates within six months from the date of allotment.

Conclusion

Debentures remain an effective and flexible instrument for raising debt capital by private companies. However, the issuance process involves compliance with multiple provisions relating to private placement, shareholder approvals, charge creation, trustee appointment, and post-allotment filings.

A properly structured debenture issue not only ensures regulatory compliance but also enhances investor confidence and facilitates efficient fund raising. Companies should therefore carefully evaluate the applicable provisions of the Companies Act, 2013 and allied rules before proceeding with any debenture issuance.