Issue of Secured, Non-Convertible Debentures (NCD) by a Private Company

Introduction

Non-Convertible Debentures (‘NCD’) is a type of debt instrument which offers fixed income in the form of interest to the debenture holders over a tenure of NCD. Section 2(30) of the Companies Act, 2013 defines Debentures – as it includes debenture stock, bonds or any other instrument of a company evidencing a debt, whether constituting charge on the assets of the Company or not. It can be secured or unsecured or convertible or non-convertible etc.

Types of Debentures

Convertible and Non-Convertible Debentures

Convertible Debentures are the kind of debentures which initially issued as a debt but it will be mandatorily converted into equity shares of the company on happening of some specified event or by efflux of time. This kind of instrument offers features of both fixed income instrument as well as equity shares. Hence, this is also called as hybrid / deferred equity instruments. While, Non-Convertible Debentures are the kind of debentures which are purely a debt instrument and which is / will not convertible into any other security / instrument.

Secured and Unsecured Debentures

Secured Debentures offers security to the debenture holders against the default in the repayment by the company. It is backed by the assets of the issuing Company, acting as a collateral and in case of default, debenture holders can exercise their claim on the collateral assets. While, unsecured debentures are not secured and doesn’t have any collateral assets as a security for repayment. According to Companies (Acceptance of Deposit) Rules, 2014, company can’t issue unsecured non-convertible debentures without being listed on the recognized stock exchange in India otherwise it will be treated as deposit which is expressly prohibited under Section 73 of the Companies Act, 2013.

Non-Convertible Debentures

NCD is preferred instrument for companies operating across all growth stages. For e.g: A Company in its initial stage / startups often encounter with a situation where equity dilution is not desirable to raise capital due to many reasons like under valuation, excessive stake dilution concerns etc. Hence, it may resort to raise funds via unlisted secured NCD while a Company in its growth / expansion stage may resort for listed NCD because it finds NCD cheaper than traditional borrowings from banks and financial institutions.

Regulatory framework for issue of Non-Convertible Debentures (‘NCD’)

A Private Company may issue secured NCD after following the due process as per the Companies Act, 2013 read with rules made thereunder. The regulatory framework for issue of secured NCD includes the following:

• Section 23, 42, 71, 77, 179 and 180 of the Companies Act, 2013;
• Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014;
• Rule 14 of the Companies (Prospectus and Allotment of Securities) Rules, 2014.

Conditions for issue of Secured Non-Convertible Debentures (‘NCD’)

The below conditions have to be fulfilled for issue of Secured NCD:

• The date of redemption shall not exceed ten (10) years from the date of issue. Provided that Infrastructure finance companies, Companies engaged in Infrastructure projects, Infrastructure Debt Fund Non-Banking Financial Companies and Companies permitted by Ministry or Department of Central Government or by RBI can issue Debenture beyond a period of 10 years but up to 30 years.
• Such an issue of debentures shall be secured by the creation of a charge on the properties or assets of the company or its subsidiaries or its holding company or its associates companies, having a value which is sufficient for the due repayment of the amount of debentures and interest thereon.
• The company shall appoint the debenture trustee before the issue of prospectus or letter of offer for subscription of its debentures and not later than sixty days after the allotment of the debentures, execute a debenture trust deed to protect the interest thereon.

Process of issue of Non-Convertible Debentures (‘NCD’)

A NCD can be issued by following process of private placement of securities as per Section 42 of the Companies Act, 2013 read with read with Rule 14 of the Companies (Prospectus and Allotment of Securities) Rules, 2014. ‘Private Placement’ means any offer or invitation to subscribe or issue of securities to a select group of persons (“identified persons”) by a Company (other than by way of public offer) through private placement offer-cum-application letter in form PAS-4. The following are the detailed step by step procedure for issue of NCD by private company:

• The Company must identify the persons / group of persons to whom offers shall be made and thereafter shall prepare the list of such identified persons.
• In case of issue of secured NCD, the Company shall appoint debenture trustee before the issue of letter of offer for subscription of its NCD and not later than 60 days after the allotment of the NCD and execute a debenture trust deed to protect the interest thereon.
• The Company shall in place a separate bank account for the receipt of NCD subscription amount. If not, it needs to open it.
• The Company shall identify the assets on which charge will be created for issue of secured NCD.
• The Company shall call a meeting of Board of Directors to discuss and approve the following matters:
  • Approval of the Board for issue of NCD and approval of the terms of issue;
  • Approval of draft form PAS-4 i.e Private placement offer cum application letter;
  • Appointment of debenture trustee, if required;
  • Approval of debenture trust deed to be executed with the debenture trustee;
  • Opening of separate bank account, if required;
  • Convening General Meeting of shareholders for their approval*.

* It is applicable for Public Companies where approval of shareholders by way of special resolution is required if the amount of NCD along with the existing borrowing exceeds the threshold specified in the Section 180.

•  Post Board approval, the Company shall have to file form MGT-14 with the Registrar of Companies (ROC) within 30 days of passing the Board resolution for issue of NCD.
• The Company shall prepare a record private placement offer letter in form PAS-5.
• The Company shall dispatch / email the private placement offer cum application letter in form PAS-4 together with all attachments to all identified persons, after filing of board resolution / special resolution, as the case may be, with the ROC.
• Every identified person willing to subscriber the issue shall apply in the private placement along with subscription money to be paid either by cheque or demand draft or other banking channel and not by cash. The Company shall receive the subscription amount from all the subscribers in the separate bank account opened for this purpose.
• Post receipt of subscription money, the company shall call a Board meeting for allotment of NCD by issuing a notice to all the Directors of the Company.
• The Board shall make allotment of NCD within 60 days from the date of receipt of subscription money. The Board shall pass the following resolutions:
  • Allotment of NCD to the subscribers who have paid subscription money;
  • Authorize one or more directors to issue and sign the debenture certificate;
  • Creation of Charge on the assets of the Company;
  • Filing of Return of Allotment in form PAS-3 with ROC within 15 days from the date of allotment of NCD.
• The Company shall file Return of Allotment in form PAS-3 with the ROC within 15 days from the date of allotment. The Company shall not utilize monies raised through private placement unless allotment is made and the return of allotment is filed with the ROC.
• The Company shall file form CHG-9 for creation of charge on the assets of the Company in favor of debenture trustee within 30 days from the date of creation of charge.
• The Company shall update its register of debenture holders.
• The Company shall pay the required stamp duty on debenture certificate and issue the same to the debenture holders.

Debenture Redemption Reserve and Debenture Redemption Investment

Debenture Redemption Reserve (DRR)

The creation of DRR is an accounting adjustment for keeping portion of profit for payment to debenture holders. The company shall create a DRR, which shall be 10% of the value of the outstanding debentures, out of profits of the company available for payment of dividend.

Exemption: NBFCs registered with RBI and for Housing Finance Companies registered with National Housing Bank, DRR is not required in case of privately placed debentures.

FAQs for DRR

1. Whether DRR is required for secured NCD or unsecured NCD?

DRR is required to be created for both secured as well as unsecured debentures subject to the provisions / exemptions provided in Rule 18(7) of Companies (Share Capital and Debenture) Rules, 2014.

2. It is required to be created in case of loss / inadequacy of profits?

It is required to be created out of profits of the company available for distribution of dividend. Hence, loss making companies need not create a DRR.

3. Is it required for compulsorily / partly convertible debentures?

It is required to be created only for NCD and not for compulsorily convertible debentures. If debentures are partially convertible then, DRR is required to be created only for the non-convertible portion.

Debenture Redemption Investment

In case a Secured NCD issued by a company, it shall on or before the 30^th day of April in each year, invest or deposit, as the case may be, a sum which shall not be less than 15% of the amount of its debentures maturing during the year, ending on the 31st day of March of the next year in any one or more methods of investments or deposits as provided in below:

• in deposits with any scheduled bank, free
• in unencumbered securities of the Central methods of deposits or from any charge or lien; Government or any State Government;
• in unencumbered securities mentioned in sub-clause (a) to (d)and (ee) of section 20 of the Indian Trusts Act, 1882;
• in unencumbered bonds issued by any other company which is notified under sub-clause (f) of section 20 of the Indian Trusts Act, 1882.

Provided that the amount remaining invested or deposited, as the case may be, shall not any time fall below 15% of the amount of the debentures maturing during the year ending on 31st day of March of that year.

Provided that the amount invested or deposited as above shall not be used for any purpose other than for redemption of debentures maturing during the year referred above. The amount credited to Debenture Redemption Reserve shall not be utilized by the company except for the purpose of redemption of debentures.

Conclusion

This article tries to cover the issues and process around issuance of secured NCD by a private limited company covering the provisions of the Companies Act, 2013. The process of issuance of NCD is a stringent and requires compliance of multiple sections and rules of the Companies Act, 2013. Hence, it is advisable to have professional supervision while issuance of NCD.