INTRODUCTION
Debentures are debt instruments enabling companies to raise capital while giving investors fixed returns. It is mainly governed by SEBI regulations and the Companies Act, 2013, which provides procedures for the issuance and redemption of debentures, among other things. Different kinds of debentures can be issued by a company, each having its features and characteristics.
MEANING OF DEBENTURES UNDER THE COMPANIES ACT, 2013
A debenture is a kind of debt instrument issued by a company to raise funds. After a specified period, the company must pay back the principal amount and the interest. The term ‘debentures’ has been defined under section 2 (30) of the Companies Act, 2013[1] To include bonds, debenture stock, or any other instrument of a company that acknowledges a debt, regardless of whether it creates a charge over the company’s assets. Therefore, as per the definition under the Companies Act, it is not mandatory to create a charge on the assets of a company to issue a debenture.
KINDS OF DEBENTURES
Several types of debentures can be issued by a company. They can be classified as:
- Debentures based on security:
Based on security, debentures can be further classified into:
- Secured Debentures – It refers to those debentures where the company creates a charge over its assets to ensure that in the event of any default, the debenture holders are repaid. Therefore, if the company defaults, debenture holders can enforce their claim over the assets charged as security for repayment.
- Unsecured Debentures – This kind of debenture is also known as a naked debenture. Unlike secured debentures, unsecured debentures are not backed by any specific charge or collateral. In case of default, debenture holders cannot claim a specific asset but are instead considered as general creditors of the company.
- Debentures based on Tenure:
Debentures can be redeemed on the maturity date. It is divided into two types:
- Redeemable Debentures – These are those debentures that must be repaid by the company upon the expiry of a specified period. The repayment can be done either in a lump sum or instalments. According to Section 18(1) in The Companies (Share Capital and Debentures) Rules, 2014[2]The redemption date cannot exceed ten years from the date of issue for secured debentures.
- Irredeemable or Perpetual Debentures – These are debentures that do not have any fixed maturity date. These debentures become repayable during the winding up of a company or can be redeemed under specific conditions defined in terms of issuance.
- Debentures based on conversion:
The company issues these debentures with an option to convert them into equity shares after a specified period. They are classified into the following two categories:
- Convertible Debentures – These are the debentures that can be converted into equity shares after a predetermined maturity period.
- Non-convertible debentures – These debentures cannot be converted into equity shares and can be redeemed only upon maturity.
- Partly convertible debentures – These debentures consist of convertible as well as nonconvertible debentures, where the convertible portion is converted into equity shares after a set period and the nonconvertible portion is repaid upon maturity. Under section 71 of the Companies Act, 2013[3] by passing a special resolution, a company may issue debentures with the option to convert them either fully or partly into shares at the time of redemption.
- Debentures based on Registration:
- Registered Debentures – Section 88 of the Companies Act[4] Mandates registration of debenture holders. A registered debenture holder refers to any person included in the debenture certificate as well as the register of debenture holders.
In the case of K. Roy and Bros v. Ramanath and others[5] the issue taken up by the court was whether debentures were required to be registered in addition to their registration under section 88 of the Companies Act, 2013. The court ruled that the priority of charge over a company’s assets is determined by the registration of debentures under the Companies Act, 2013, and this priority applies exclusively to the debenture holders. On the other hand, registration under the Registration Act applies to the company’s assets in general.
- Unregistered Debentures – These debentures are payable to debenture holders and are transferred by mere delivery
ISSUANCE AND REDEMPTION OF DEBENTURES
Section 71 of the Companies Act, read along with Rule 18 of the Companies (Share Capital and Debentures) Rules, deals with the issuance of debentures. A company has to pass a board resolution for the issuance of its debenture[6]. Section 71(2)[7] Does not permit a company to issue debentures that carry any voting rights.
Debenture Redemption Reserve
Section 71(4) of the Companies Act read with Rule 18(7) of the Companies (Share Capital and Debentures) Rules, 2014, provides for the creation of a Debenture Redemption Reserve (DRR) by the company for the redemption of debentures. The funds held in such reserve accounts are exclusively allocated for debenture redemption purposes. Further, the company must allocate a fixed percentage of its annual profits to the DRR. Therefore, in the event of default to repay the debenture holder, payment can be made through the debenture redemption reserve.
Debenture Trustees
A company is not allowed to offer debentures to over 500 individuals unless it appoints a debenture trustee. The trustee’s role is to safeguard the interests of debenture holders and address their concerns. SEBI (Debenture Trustee) Regulations, 1993,[8] Regulates the appointment of debenture trustees.
Debenture Trust Deed
The company issuing debentures must execute a trust deed in Form No. SH. 12 in favor of the debenture trustees within three months of the issue’s closure. This is the legal instrument that establishes and outlines the terms of a trust.
Procedure for Issuing Debentures
The following procedures are to be followed to issue debentures:
- Convene a General Meeting: A General Meeting should be held to consider and authorize the issuance of debentures covering all terms and conditions related to their issue by giving a notice 7 days before to all the directors. It also includes identifying persons to whom debentures are proposed to be offered. A special resolution must be passed authorizing to issue of debentures.
- Filing of Form MGT–14: Form MGT-14 has to be filed, accompanied by an explanatory statement with the Registrar of Companies within 30 days after passing the special resolution.
- Preparing a list of Debenture Allotees: A list of persons to whom debentures are being allotted must be prepared as per the PAS-4 format.
- Offer Letters: The offer letters shall be sent to the individuals within 30 days of recording the names.
- Opening of a separate bank account: A separate bank account has to be maintained at a recognized scheduled bank exclusively for holding application funds.
- Issuance of Debenture Certificates: Debenture Certificates must be issued within six months from the date when debentures were allotted.
Companies have multiple options for redeeming their debentures, often by utilizing funds obtained through fresh debenture issuances to repay existing debenture holders during the redemption process.
CONCLUSION
As seen from the above, debentures are one of the most well-regulated methods for raising capital. This financial instrument creates a mutually beneficial arrangement, wherein companies gain access to funds while investors enjoy both security as well as returns. It is at the option of a business entity that they prefer to issue debentures, which can be converted into shares or those that provide a fixed return.
Author(s) Name: Ektaa Chatterjee (Ramaiah College of Law, Bangalore)
References:
[1] The Companies Act, 2013, s 2(30)
[2] The Companies (Share Capital and Debentures) Rules, 2014, s 18(1)
[3] The Companies Act, 2013, s 71
[4] The Companies Act, 2013, s 88
[5] K. Roy and Bros v. Ramanath and others (1943) CAL 37
[6] The Companies Act, 2013, s 179(3)
[7] The Companies Act, 2013, s 71(2)
[8] SEBI (Debenture Trustee) Regulations 1993
