Abstract
As we all know share capital is the main source of finance of a company. Such capital is raised by issuing shares. Those who hold the shares of the company are called the shareholders and are owners of the company. The company may need an additional amount of money for a long period. It cannot issue shares every time. It can raise loans from the public. The amount of loan can be divided into units of small denominations and the company can sell them to the public. Each unit is called a ‘debenture’ and the holder of such units is called a Debenture holder. The amount so raised is a loan for the company.
A debenture is the most important instrument and method of raising the loan capital by the company. A debenture is like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the company’s capital structure, it does not become share capital.
Introduction
In every organization, whether it operates on any scale, there is a need for funds, for conducting various business activities. There has to be sufficient capital, based on the appetite of the company, in order to ensure smooth functioning. There are various methods adopted by companies to raise funds and capital, but some companies might opt for issuing debentures, especially when there is a need for raising funds for the long term.
The shareholders are the company’s investors/owners. As the company’s equity assets are depleted, it must seek financing help from outside sources such as External Commercial Borrowing (ECB), Debentures, Bank Loans, and Public Fixed Deposits. A provision for borrowing powers for the company is included in the memorandum of association of a company. . As the funds raised by the issuance of shares would not be enough to satisfy the company’s long-term financial needs. As a result, companies choose to raise long-term capital through debentures.
A debenture is an amount of a loan that a company has to raise from the public that’s why a company issues debenture. A person who purchased and holds a debenture is called a debenture holder who becomes the creditor/ charge holder of the company a debenture is a document that bears the company’s seal and is issued by it. A debenture is a document that acknowledges the fact that the company has earned funds in the sum of the debenture’s nominal value. It entails paying a fixed rate of interest before the principal is repaid.
It specifies the redemption date as well as the interest rate and method of payment. The Indian capital market has evolved at a much faster pace in recent years, owing to the introduction of new instruments and changes to existing technology. Debentures are proving to be a valuable contributor to the corporate sector’s financial needs in the current situation. In comparison to other ways of raising capital from the market, such as preferred shares, bonus shares, equity shares, and rights issues, the issuance of debentures is a major means of raising capital from the market.
The Companies Act provides an expansive definition of debentures rather than an exhaustive definition. According to Section 2(30) of the Companies Act 2013, the company has the authority to issue bonds or debentures, which are debt instruments that can be both secured and unsecured by establishing a fee on the company’s assets. Debentures are a form of long-term unsecured bond that a company may issue if it agrees to repay it at a specified future date. The company normally pays interest to debenture holders at the end of each year before maturity, but if it is unable to pay either the interest or the principal amount of the loan, the creditors of the company have the right to request the competent authority that the company be liquidated to recover their money by selling the company’s properties.
Meaning of Debenture
The word ‘debenture’ has been derived from the Latin word ‘debere’ which means to borrow. A debenture is a written instrument acknowledging a debt under the common seal of the company. It contains a contract for repayment of principal after a specified period or at intervals or the option of the company and for payment of interest at a fixed rate payable usually either half-yearly or yearly on fixed dates.
According to section 2(12) of The Companies Act,1956 ‘Debenture’ includes Debenture Inventory, Bonds, and any other securities of a company whether constituting a charge on the assets of the company or not.
Another term used in companies in the same perspective is ‘Bond’. Bond is an instrument of acknowledgment of debt. Traditionally, the Government issued bonds, but these days, bonds are also being issued by semi-government and non-governmental organizations. The terms ‘debentures’ and ‘Bonds’ are now being used interchangeably.
Characteristics of Debentures
1. It is in the form of a certificate of indebtedness of the company and issued by the company itself. It generally creates a charge on the assets/ undertaking of the company. There is usually a specific date of redemption.
2. The debenture holders are creditors to the company and they do not have any claim of ownership of the company, unlike shareholders.
3. As the debenture holders are not the owner of the company so they are not entitled to the administration and management of the company.
4. The debenture holder need not be concerned with the profits or loss of the company, they have a fixed rate of interest on the principal amount which they get every year irrespective of the financial condition of the company.
5. Debentures usually have a charge on the assets of the company, which means that if the company goes into liquidation and is not able to repay the amount, the debenture holders can also sell the property of the company through the legal process under the applicable law to recover the money of the debenture holders.
6. There is an undertaking given by the company to repay debenture holders the principal amount along with the interest at the stated time.
7. The debenture holders cannot claim the privilege to vote in any meeting of the company.
8. When the company is in winding up, the priority of the company is to repay the debenture holders of the company as per the applicable law hence, there is no risk involved of loss of money of the debenture holders.
Kinds of Debenture
Debentures are generally classified into different categories on the basis of:
(1) Convertibility of the instrument
(2) Security of the instrument
(3) Redemption ability
(4) Registration of Instrument
1. On the basis of convertibility, Debentures are classified into the following categories:
(A) Non-Convertible Debentures- This form of debenture can’t be converted into equity or preference shares. These debentures are typically repaid only after they reach their maturity date, which is normally 10 or 20 years. These instruments keep their debt status and can’t be converted into stock of the company.
(B) Partly Convertible Debentures – These partly convertible debentures will be converted into equity shares at the issuer’s discretion in the future. The conversion ratio is set by the issuer. The ratio is normally determined when the debentures are subscribed. If a debenture holder converts any of his debentures into equity, he becomes a shareholder for those converted shares and his rights are amended accordingly. Thus, convertible debentures are debentures that can be converted by the debenture holder as agreed upon after a set period of time.
(C) Fully Convertible Debentures – These are debentures that can be exchanged into equity or preference shares at a fixed rate of exchange after a set period of time. If a debenture holder converts his debentures into shares, he ceases to be the company’s creditor and becomes a member as an additional shareholder. Thus, convertible debentures are debentures that can be converted by the debenture holder after a set period of time. The rate at which the debenture is exchanged is determined at the time of issue of such debentures. Only interest is paid to the debenture holder before the conversion, after which the rights exercised are the same as those of a shareholder. The approval of the shareholders of the company is required prior to the issuance of convertible debentures.
(D) Optionally Convertible Debentures- The debenture holder has the option/ability to convert his or her debentures into stock. The issuer determines the price of conversion, which was agreed upon by all parties at the time of the issue of such debentures
2. On the basis of security, Debentures are classified into the following categories:
(A) Secured Debentures- The instruments of secured debentures are secured with the charge on the company’s fixed assets. This is to protect the debenture holder in the event that the issuer company defaults on either the principal or interest payment, the issuer’s assets can be sold off to satisfy the debenture holders’ obligation as per the due process of law. Section 71(3) of the Companies Act of 2013 states that a company has the right to issue secured debentures subject to the government of India’s conditions.
(B) Unsecured Debentures- These debentures are unsecured in the sense that if the principal or interest is not paid, the debenture holder will be forced to join other unsecured lenders and will be unable to sell any property or other assets to repay the debt, thus the name “unsecured debentures.”
3. On the basis of Redeem ability, Debentures are classified into the following categories:
(A) Redeemable Debentures – Redeemable debentures are those which are payable on the expiry of the specific period either in a lump sum or in Installments during the lifetime of the company. Debentures can be redeemed either at par or at a premium.
(B) Perpetual or Irredeemable Debentures “An irredeemable debenture is one in which the borrower does not have a set period to repay the principal. The debenture holder has no right to claim payment of the principal unless the company defaults in making regular interest payments. If a company goes bankrupt, it must pay off all of its debentures, whether redeemable or irredeemable.
4. On the basis of Registration, Debentures are classified into the following categories:
(A) Registered Debentures- The debentures issued in the name of a specific person who is listed as a debenture holder on the company’s register of debenture holders and whose name appears on the debenture certificate. These debentures may be transferred in the same manner as shares are transferred, by the use of a proper instrument that is stamped, executed, and meets the demands set forth in Section 56 of the Companies Act, 2013.
(B) Bearer Debentures- These debentures, on the other hand, are a negotiable instrument that is made payable to the bearer and can only be transferred by delivery, similar to share warrants. An individual who receives a bearer debenture bond becomes a “holder in due course,” with the right to recover and collect the principal sum as well as interest.
Difference between share and debenture.
| BASIS | SHARE | DEBENTURE |
| 1. OWNERSHIP | A share is a part of the owned capital. So, a shareholder is an owner of the company | A debenture is a part of the borrowed capital. So, a debenture holder is only a creditor. |
| 2. RETURN | The return on shares is known as a dividend, (which is part of the profits of the company) | The return on debentures is known as interest, which is fixed from the day of the issue of debentures |
| 3.CHARGE Vs. APPROPRIATION | The payment of a dividend is an appropriation out of profits | The payment of interest is a charge and is to be paid even if there is no profit |
| 4. REPAYMENT | The amount of share is not returned during the life of the company although it can be transferred to another person | Debentures are issued for a fixed period and the amount is returned after that period |
| 5. SECURITY | Shares are not secured by any charge on the assets of the company. | Debentures are generally secured and carry a fixed or floating charge over the assets of the company |
| 6. CONVERTIBILITY | Shares cannot be converted into debentures | Debentures can be converted into shares of the company |
| 7. VOTING RIGHTS | Voting rights are available to the Shareholders | Debenture holders do not normally enjoy any voting right. |
Legal Provisions of Debenture
A debenture is the most important instrument and method of raising the loan capital by the company. A debenture is like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the company’s capital structure, it does not become share capital.
Rules and Guidelines on Debentures
SEBI issue of capital and disclosure requirement (ICDR) Regulations 2009
“Specified securities” are defined as equity shares and convertible securities under the SEBI Regulation 2009. The term “convertible securities” refers to a bond that can be exchanged for or converted into equity shares of a company after its maturity date, with or without the debenture holder’s consent, which also includes convertible preference shares and convertible debt instruments. As a result, the conditions to be addressed below apply not only to equity securities but also to public issues of convertible debt instruments. The issuer of such convertible debt instruments must meet the following requirements:
i. To get a ranking from one or more credit agencies.
ii. Appointment of one or more trustees in accordance with Section 71(5) of the Companies Act, 2013 and certain other laws.
iii. Establishment of a Debenture Redemption Reserve in accordance with Section 71(4) of the Companies Act of 2013.
iv. If the company offers to establish a guarantee or fee on its assets in connection with the secured convertible debt instruments, it must ensure the following:
a) Those assets are sufficient to pay off the entire principal sum at any time.
b) Such properties must be protected from all forms of interruption.
c) If the convertible debt instruments are backed by a second or subsequent payment, the assets or security should come after the liabilities constituting the prior charge.
d) The issuer is responsible for redeeming the convertible debt securities in accordance with the terms and conditions of the offer contract. These rules apply to partially convertible debt instruments as well
Provisions of Companies Act, 2013 (Share Capital and Debentures) Rules, 2014
- As per section 71(2), the company is not entitled to issue debenture which carries the voting rights, Secured debentures must abide by the terms and conditions set out.
- Secured debentures may be issued by a company if certain terms and conditions are met, according to Section 71(3).
Further Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014 (‘2014 Rules’) which prescribes certain conditions to be fulfilled by a company in order to issue secured debentures provides that:
The company shall not issue secured debentures, unless it complies with the following conditions, namely:-
(1) The company shall issue secured debentures, provided that the date of redemption does not exceed 10 years from the date of issue. The exception to this is companies involved in setting up infrastructure projects, which can exceed up to 30 years but not beyond that.
(2) The issuance of a debenture shall be protected by the establishment of a charge on the company’s assets and properties, the value of which shall be sufficient to ensure the timely repayment of the principal amount of the debentures, as well as the interest thereon.
(3) Prior to the issuance of a letter of offer or prospectus for the subscription of the company’s debentures, the company must nominate a debenture trustee. To avoid injustice and protect the interests of the debenture holders, the company must execute a trust deed within 60 days of the debenture being issued.
(4) When a company issues a debenture that is completely backed by a guarantee from the federal government, the state government, or both, there is no need to create a tax on the company’s properties.
Issue of Debentures
Debentures are normally issued in the same way as they issue shares like, through a prospectus accepting applications for debentures, with the money to be charged in installments on application, allotment, and particular dates. There are three ways to issue a debenture.
At par: It is said to have been issued at par when the sum received for it is equal to the nominal value of the debentures. For example, the issue of debentures worth Rs. 300/- for Rs. 300/- is said to have been issued at par.
At Discount: A debenture is said to have been given a discount when the amount received is less than the nominal value. Consider the issue of Rs. 300/- debentures for Rs. 270/-. The difference of Rs. 30/- is the discount, which is referred to as discount on Debenture.
At Premium: If the price paid for a debenture is higher than the nominal value, it is said to be issued at a premium. For example, if you issue 300 rupee debentures for 320 rupees, the excess sum over the nominal value, i.e. Rs. 20, is the premium on debentures. A capital gain is a premium gained on the issuance of debentures. This premium on debenture issuance could not be used for dividend distribution. Premium on debentures is expressed on the liability side of the Balance Sheet under Surplus and Reserves.
The time limit for issue of debenture certificate
The allottee is entitled to receive the debenture certificate within six months of the date of allotment. It is provided for in Section 56(4) of the Companies Act of 2013. According to Section 56(6) of the Companies Act, 2013, if a company fails to grant the debenture certificate within the time limit, it will be fined a minimum of 25,000 rupees and a maximum of 5,00,000 rupees. A fine of at least 10,000 rupees and up to 10 lakh rupees will be imposed on the officer who is in default.
In addition, Section 71 of the Companies Act, 2013 contains the following provisions about the issuance of debentures:
(a) The company may issue debentures that can be exchanged into shares in part or entirely at the time of redemption with the approval of a special resolution passed at a general meeting.
(b) Company shall not issue debentures carrying any voting rights.
(c) There will be no voting rights attached to any debenture.
(d) The company is only allowed to issue secured debentures if certain terms and conditions are met. Only secured debentures of redeemable nature may be given, according to rule 18 of the Companies (Share conditions and Debentures) Rules [6], 2014.
The conditions are as follows: Rule 18
The redemption date for secured debentures cannot be more than 10 years from the date of issue. There are a few types of companies that may issue protected debentures that are longer than 10 years but not longer than 30 years.
Companies that are active in the creation of infrastructure projects.
i. Infrastructure Finance Companies.
ii. Infrastructure Debt Fund Non-Banking Financial Companies.
i. Infrastructure Debt Fund Non-Banking Financial Companies: The issuance of a debenture shall be protected by the establishment of a charge on the company’s assets and properties, the value of which shall be sufficient to cover the due repayment of the principal amount of the debentures, as well as the interest thereon. Prior to the issuance of a letter of offer or prospectus for the subscription of the company’s debentures, the company must nominate a debenture trustee. To avoid injustice and protect the interests of the debenture holders, the company must execute a trust deed within 60 days of the debenture being issued.
- A mortgage or charge shall be created as the security for debenture in favor of the debenture trustee acting for the benefit of the Debenture holders.
i. Any particular movable property of the company that is not in the form of a pledge or
ii. Any specific immovable property situated anywhere or any interest therein.
Debenture Trust Deed
It is impractical to establish individual charges in favor of thousands of debenture “holders” when issuing debentures for public subscriptions. So as a result, executing a trust deed conveying the company’s property to the trustees and declaring trust in favor of debenture-holders is the most convenient and popular method of securing all debenture holders. Except for the freeholds and leaseholds property on which it has fixed charge, a trust deed typically gives the trustees a charge on the company’s land. A trust deed is a document that contains the terms and conditions of the debentures as well as the rights of the debenture holders and the company. The trust deed gives the debenture trustees the following powers:
1. To obtain a mortgage on a company’s land, in which case the title deeds will be transferred to them and the company will be unable to make additional charges in the priority of debentures.
2. Renewal of leases, as well as leasing or selling the land.
3. To exchange the mortgaged property for a suitable alternative.
4. To make claims adjustments.
5. To protect as well as initiate action.
6. Amend any existing contracts that apply to any portion of the land.
7. When the protection becomes enforceable, a receiver is appointed.
(a) The advantage of a trust deed is that it is the trustees’ responsibility to look after the debenture holders’ well-being and interests, as well as to behave honestly and with care. Any provision or clause in the trust deed that protects trustees from responsibility or relieves them of their responsibilities as trustees is null and void.
(b) Because the trustees have a valid mortgage on the company’s land, someone who loans money later cannot give the debenture holders priority.
(c) The trustees have the power to impose protection on behalf of the debenture holders in the event of a default by the company.
d) The trustees are responsible for ensuring that the secured property is properly managed and insured. It would be impossible for a wide group of debenture holders to do so.
(e) No company may make an invitation, bid, or issue a prospectus to the public or its members for more than 500 for the subscription of its debenture unless it has named one or more debenture trustees prior to any offer or issue.
(f) The debenture trustee has a responsibility to resolve the debenture holder’s concerns and take action to safeguard their rights in accordance with the applicable laws.
Rights/Remedies of Debenture Holder
According to rule 18[11], it is the duty of the debenture trustee to communicate any debenture holder defaults, if any, with respect to the redemption of debentures or payment of interest, as well as any action was taken by the trustee himself. Furthermore, if the company fails to pay interest to the debenture holder for two consecutive years or fails to redeem the debentures, the debenture trustee appoints a nominee director to the board of directors.
i. A debenture holder is entitled to interest and redemption of debentures in accordance with the terms of their issue, according to section 71(8) of the Companies Act, 2013.
ii. Section 71(10) of the Companies Act, 2013 provides that if the company fails to pay the interest due or redeem debentures on their maturity date, the Tribunal may, on the application of the debenture trustee or any or all of the debentures and after hearing the parties involved, direct the company to redeem the debentures by an order.
Furthermore, if the company fails to comply with the tribunal’s order, section 71(11) of the Companies Act, 2013 provides that the tribunal may punish the officers in default with imprisonment for up to three years or a fine of at least 2,00,000 rupees and up to 5,00,000 rupees, or both. Both secured and unsecured debenture holders are covered by this provision. The holder of a debenture will ask the Tribunal to issue a payment order for the company that has defaulted. Before reaching a decision, the Tribunal considers the circumstances surrounding the company’s payment default.
i. Section 164(2) (b) provides for the disqualification of directors of a company who have failed to redeem debentures on the maturity date for a period of one year or more. For the next 5 years following the date on which the company fails to redeem the debentures, that individual will be barred from serving as a director of that company or any other company.
ii. Under Section 186(8) of the Companies Act of 2013, any company that has failed to repay any deposits or make any interest payments is prohibited from making any loan, guaranteeing any acquisition, or providing any protection until the default has been resolved.
Redemption of Debenture
The word “redemption of debentures” refers to the company repaying the entire sum of the debentures in compliance with the terms and conditions of the debentures. The company is not discharged or absolved of its responsibility on behalf of the debentures until they are repaid. The debentures can be exchanged in four different forms.
There are the following:
1) Payment in a lump sum– At the end of the specified time period, the company redeems the debenture by making a lump sum payment in accordance with the terms of issue.”
2) Payment in installments– In this case, the payment for debenture redemption is made in installments on particular dates during the debenture’s term. The company’s gross liability is split into the number of years.
3) Purchase on the open market– Redemption of debentures by purchase in the open market occurs when a company purchases its own debentures for the purpose of cancellation.
4) By conversion into shares or new debentures- In this case, the company redeems its debentures by converting them into shares or establishing a new debenture class. If the debenture holder believes the offer is advantageous, he may exercise his right to convert the debentures.
Debenture Redemption Reserve Account
According to Section 71(4) of the Companies Act, 2013. When a company issues debentures, it is required to set up a debenture redemption reserve account with income available for dividends, and the money put into the account can only be used to redeem debentures.
Under Rule 18(7) of the Companies (Share Capital and Debentures) Rules, 2014, such requirements must be met. It is required for the company to maintain a Debenture Redemption Reserve for the purpose of redeeming debentures, as per the following conditions:-
(a) The Debenture Redemption Reserve shall be established from the company’s income available for dividend payment.
(b) Before debenture redemption begins, the company must establish a Debenture Redemption Reserve equal to at least 50% of the money raised from the debenture issue.
(c) Not later than the 30th of April of each year, create a Debenture Redemption Reserve by depositing or investing a sum equal to not less than 15% of the number of debentures maturing during the year until the 31st of March of the following year, in one or more of the following ways:
i. In free-of-charge or lien deposits with any scheduled bank.
ii. In unencumbered Central or state government securities
iii. In unencumbered securities [1]
iv. In unencumbered bonds issued by the company.[2]
v. The funds deposited or invested as mentioned above are only to be used for the redemption of debentures maturing during the year in question, given that the amount remaining invested or deposited, as the case may be, does not fall below 15% of the number of debentures maturing during the year ending on March 31st of the year in question.
(d) In the case of partially convertible debentures, a Debenture Redemption Reserve shall be established in accordance with this sub-rule for the non-convertible portion of the debenture matter
(e) The amount added to such an account is only available for redemption of debentures.
Conclusion
In business, issuing debentures is one way to raise money for the working of the company. It is very different from equity shares or other kinds of shares (both preference and equity). The basic distinction being, when one buys the shares of the company he becomes the part-owner of the company, but when one buys debentures issued by the company he becomes a creditor to the company. We can conclude that debenture is a kind of formal loan given to the company by another individual. The company is under obligation to repay the loan within a specified period of time with interest.
End Notes.
1. Meaning of debenture, http://www.legalserviceindia.com/legal/article-262-concept-of-debentures-in-india.html
2. Companies Act, 2013 https://www.mca.gov.in/SearchableActs/Section71.htm
3. How to issue a debenture By Swarthy Advisor, https://swaritadvisors.com/issue-of-debentures
4. Regulation of Debentures Issue By: G.P Sahi, General Counsel, http://www.legalserviceindia.com/articles/debentures.htm
5. Companies (Share Capital and Debenture ) Amendment Rules, 2019 By Devika Sharma https://www.scconline.com/blog/post/2019/08/17/companies-share-capital-and-debentures-amendment-rules-2019/
6. Issue of Debentures [Under Section 71 & Rule 18 of Companies (Share Capital & Debenture) Rules, 2014], By Adv Bhusan Bajaj at https://taxguru.in/company-law/issue-debentures-section-71-rule-18-companies-share-capital-debenture-rules-2014.html
7. Rule 18, The Companies (share capital and debenture) Rules, 2014
8. The Companies (share capital and debenture) Rules, 2014
Note :
[1] section 20 of the Indian Trusts Act, 1882
[2] sub-clause (f) of section 20 of the Indian Trusts Act, 1882
Author Bio
Can you please tell me that under which provisions of company law, the issue of debentures at premium is allowed ? is there any company which have made this isssue!