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Unpacking Debentures by Anjali Khanna NUJS (B.A. LL.B.(Hons))
A debenture is a financial instrument the corporation executes, admitting its responsibility to return the money at a specific interest rate. It is one of the strategies the business uses to raise loan financing.
Section 2(30) of the Companies Act of 2013 defines debentures as follows: -
“(30) ―debenture includes 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.”
Debentures can be divided into categories depending on the lenses we want to view debentures from. Debenture can be secured or unsecured, convertible, or non-convertible or partly convertible, redeemable, non-redeemable, and bearer or registered. Debentures can be issued by public or private agencies or corporations.
Debenture holders
Debenture holders are the company’s creditors who lend money to the companies via debentures. Unlike shareholders, they are not entitled to vote, and as a result, they do not influence the administration and functioning of a company. They are represented by the debenture trustee.
Issuance of debentures
The Board of Directors of the company,under sub-section 3(c) of Section 179 [Powers of the Board] of the Companies Act, 2013,is empowered to issue debenture in and outside of India. The issuance of the debentures is governed by Section 71 of the Companies Act of 2013, read along with Rule 18 of the Companies (Share Capital and Debentures) Rules of 2014. Section 71 of the Companies Act2013 allows for issuing convertible/ non-convertible debentures. Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014, lays down the conditions a company must comply with for the issuance of secured debentures.
Unlike shareholders, debenture holders are the company’s creditors and do not hold any voting rights.
Issuance of secured debentures
Issuance of secured debentures can only be made provided the redemption date for the same does not exceed 10 years from the date of issuance. However, this tenure is relaxed to 30 years for certain classes of companies.
The said debenture is secured by creatinga charge on the company’s assets issuing debentures.
Issuance of unsecured debentures
Issued without creation of charge on the asset of the company. These debentures are issued without the exchange of any collaterals. It is backed by the creditworthiness and reputation of the issuer. Here, the company gives an undertaking in the name of the debenture holder to repay him with interest in the loan advanced.
Debentures are recognized as a type of security under Section 2(h) of the Securities Contracts (Regulation) Act, 1956, and are also referenced under Section 2(81) of the Companies Act of 2013. Hence, the issuance of debentures follows the same procedures as that of any security under section 23 of the Companies Act of 2013.
Convertible debentures
Section 63(3) of the Companies Act of 2013 permits a company to expand its capital base by converting securities. Convertible securities, which also include convertible preference shares and convertible debt instruments, are bonds that, at their maturity date, may be exchanged for or converted into equity shares of a firm, with or without the approval of the debenture holder. However, the company shall approve by a special resolution the option of convertibility of the debenture before the issuance of the debenture takes place.
If a company makes a preferential offer with listed shares or other securities recognized on the stock exchange, the offer must comply with the regulations set forth by the Securities and Exchange Board and the Companies Act of 2013.
Non-convertible debentures
If the company’s shares or other securities are not listed, the offer must be made in line with the terms of Section 62 read in conjunction with Rule 13 of the Companies (Share Capital & Debentures) Rules, 2014, as well as the conditions laid in section 42 read with rule 14 of the Companies (Prospectus and allotment of securities) rules (2014). The same rules shall be followed in case of non-convertible debenture issues.
Section 42 of the Companies Act 2013
- Section 42 of the Companies Act of 2013 states explicitly about offer or invitation for subscribing to securities on private placements.
- Section 42 (2)(ii) of the act defines “private placement” as being offers or invitations to subscribe securities to only a selected group of individuals by a company. These individuals are also referred to as “identified persons.”
- Such debentures shall be allotted to not more than 50 persons or such higher number amended and capped at 200 via the Companies (Prospectus and Allotment of Securities) Rules,2014 (on prescription) for one financial year except for‘Qualified institutional buyers’ and employee of the company who are offered securities under a stock option program following the terms of clause (b) of sub-section (1) of section 62. The allotment shall not be done more than 4 times in a financial year with a gap of 60 days between two consecutive offers or invitations.
- Also, via rule 14 of the Companies (Prospectus and Allotment of Securities) Rules,2014, a company shall not make private placements until shareholders approve the same of the company through a special resolution for each offer or invitation.
Mandatory requirements before issuance of a debenture
Creation of Debenture Redemption Reserve (DRR)
Redemption of debenture refers to repayment of the loan amount by the issuer to the debenture holder with interest. Section 71 (4) of the Companies Act requiresthe creation of a debenture redemption reserve account. It is a mandatory requirement, provided it shall adhere to the conditions mentioned under Rule 18(7) of the Companies (Share Capitals and debentures) Rule 2014.
The company must create a redemption reserve out of the company’s profits available for dividend payment.
The company shall use this amount invested or deposited only to repay the debenture holders.
Every listed company, inclusive of the NBFCs and housing finance companies, in lieu of public debenture issuanceand non–listed company exclusive of NBFCs and housing finance companies, shall maintain on or before the 30th April in each year 15% amount in the DRR through investment or deposit for the debentures maturing during that year till the end of 31st of the march of the following year.
The company may choose to deposit or invest in scheduled banks (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-clauses (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.
The amount at no cost shall fall below the 15% mark of the issued dentures in the DRR to redeem the debenture maturing that financial year.
In the case of partly convertible debentures, only the non-convertible portion of the debenture shall be considered for the purpose of the DRR.
Appointment of Debenture trustee
Section 71(5) of the Companies Act (2013) requires a company issuing debentures to more than 500 people to mandatorily appoint a debenture trustee(s) vide executing a debenture trust deed for protection of the interest of the debenture holders. The debenture trustee(s) can be appointed before the prospectus or letter of allotment is issued or within 60 days of the allotment of debentures. The debenture trustee shall not have any interest in the company but only represent the debenture holder. The SEBI-issued Debenture Trustee Regulations, 1993, regulate the selection and behavior of the debenture trustee(s).
By Rule 18(2)(e) of the Share Capital and Debenture Rules, 2014, holders of outstanding debentures may, upon approval from holders of at least three-quarters of the exceptional debentures, remove a debenture trustee from office before the end of the term.
Features and duties of debenture trustee
Concerning a secured debenture, the charge on assets or mortgage shall be created in the name of the debenture trustee.
Request that the company provide regular status or performance reports;
Shall take reasonable steps to investigate any discrepancies in the debenture offer letter; the covenant of trust deed does not negatively affect the holders of debentures.
Notify the holders of debentures of any defaults regarding interest payments, debenture redemptions, and the trustee’s response thereto.
Appoint a nominee director to the company’s Board of Directors in case of
o two consecutive defaults in interest payments to debenture holders or a default in the formation of debenture security;
o or a default in debenture redemption. the appointment of a nominee director to the company’s Board of Directors in the following scenarios: two consecutive defaults in interest payments to debenture holders;
o A default in the formation of debenture security;
o or a default in Debenture redemption.
Ensure the company complies with all covenants in the trust deed and the conditions of the debenture issue and that it takes all appropriate action to address any violations.
Inform debenture holders of any breach or default of the term’s debenture or debenture trust deed at the company’s end.
ensure that the assets of the company issuing the debentures and of the guarantors, if any, are adequate always to discharge the interest and principal amount and that such investments are free from any other encumbrances aside from those that are expressly agreed to by the debenture holders;
ensure the implementation of the conditions regarding the creation of security for the debentures, if any, and debenture redemption reserve;
carry out the actions required should the security become enforceable.
Call for reports on using the funds raised by the debenture issue.
take action to call a meeting of debenture holders when and when one is required;
confirm that the debentures have been converted or redeemed in accordance with the terms of the debenture issue;
carry out any necessary actions to safeguard the interests of debenture holders and to address any other matters raised by debenture holders.
Debenture trust deed
A debenture trust deed is a legal instrument that transfers property ownership to a trustee, frequently tosecurea debt accrued via the debenture. It is a document that establishes and specifies the terms of a trust. It often includes the trustees’ names, beneficiaries’ identities, the type of property held in faith, and their responsibilities and authorities. It consists of trustees tasked with protecting the rights and interests of holders of debentures.
Within three months of the issue or offer closing, the company issuing the debentures shall execute a trust deed vide Form No. SH. 12 or as nearly as feasible in the name of the debenture trustees.
A trust deed used to secure any debenture issue will be available for inspection by any member or holder of debentures of the company, in the same way, to the same extent, and upon payment of the same fees as if it were the company’s membership register. Additionally, upon request, a copy of the trust deed will be sent to any member or holder of debentures of the company within seven days of its creation, provided they pay a fee.
Bibliography
- The Companies Act, 2013.
- The Companies (Share Capital and Debentures) Rules, 2014.
- The Securities Contracts (Regulation) Act, 1956.
- The Companies (Prospectus and allotment of securities) rules, 2014.
- Debenture Trustee Regulations, 1993.
- Securities and Exchange Board of India
