DEBENTURES

Synopsis

I. INTRODUCTION 2. Bearer debentures

II. DEBENTURES
III. MEANING AND DEFINITION
IV. CHARACTERISTICS OF DEBENTURES
V. KINDS OF DEBENTURES
A. On the Basis of Convertibility
1. Non Convertible Debentures (NCD)
2. Partly Convertible Debentures (PCD)
3. Fully Convertible Debentures (FCD)
B. On the Basis of Security
1. Secured Debentures
2. Unsecured Debentures
C. On the Basis of Redeemability
1. Redeemable Debentures
2. Perpetual or Irredeemable Debentures
D. On the Basis of Registration
1. Registered Debentures
VI. DEBENTURE STOCK
VII. ISSUE OF DEBENTURES
A. Issue of Convertible Debentures [S.
71(1)]
B. No debenture shall carry voting rights
[S. 71(2)]
C. Issue of Secured debentures [S. 71(3)]
D. Creation of Debenture Redemption
Reserve (DRR) account [S. 71(4)]
E. Appointment of Debenture Trustees [S.
71(5)]
F. Register Of Debenture holders [S.
88(1)]
G. Payment of Interest on, and Redemption
of Debentures
VIII. CONCLUSION

INTRODUCTION

In order to run a business effectively, adequate amount of capital is required by a company. In some
cases capital arranged by way of issuing share capital or using accumulated profit is inadequate and
the organisation is resorted to external resources of arranging capital such as External Commercial
Borrowing (ECB), Debentures, Bank Loan, etc. Thus, borrowing is a mechanism whereby the money
is arranged through external resources with an implied or expressed intention of returning the money.

DEBENTURES

Companies frequently have to borrow large sums of money. The loan requirement of a company may
not be met by a single lender. The loan may have to be split into several units. One convenient method
of doing so is to borrow by issuing debentures.

The provisions to issue debentures are covered u/s 71 of the Companies Act 2013 and Rule 18 of
Companies (Share Capital and Debentures) Rules 2014. The listed companies are additionally
governed by listing agreement and SEBI (Issue and Listing of Debt Securities) Regulations, 2008.

MEANING AND DEFINITION

The word ‘debenture’ is derived from the Latin term ‘debere’ meaning ‘to borrow’. A debenture is a
certificate of loan issued by a company.
Example: If the sum to be borrowed is Rs. 1 lakh, it may be divided into one thousand units each of
the value of hundred rupees. A lender may purchase as many units as he pleases. Against such
purchase, the company will certify the number of units held by him. Such certificate is nothing but a
debenture.

According to Section 2(30) of Companies Act 2013 “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.

PALMER defines a debenture as ‘an acknowledgement of debt, with a commitment to repay the
principal with interest.’

CHARACTERISTICS OF DEBENTURES

1. Debenture is an acknowledgement of indebtedness.

2. Debenture is usually in the form of a certificate issued under the seal of the company.
3. Debentures are generally issued in series. But a single debenture may be issued in case of sole
lender of the company.
4. Debenture generally creates a charge on the undertaking of the company or on some of its
assets.
5. The debenture holder is the creditor of the company, and not its members.
6. A debenture carries no voting rights at any meeting of the company.

KINDS OF DEBENTURES

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.

A. ON THE BASIS OF CONVERTIBILITY

On the basis of convertibility, Debentures may be classified into following categories:

1. Non convertible debentures

2. Partly convertible debentures
3. Fully convertible debentures

1. Non Convertible Debentures (NCD)

These instruments retain the debt character and cannot be converted into equity shares.
 2. Partly Convertible Debentures (PCD)

A part of these instruments are converted into Equity shares in the future at notice of the issuer. The
issuer decides the ratio for conversion. This is normally decided at the time of subscription.

3. Fully Convertible Debentures (FCD)

These are fully convertible into equity shares at the issuer’s notice. The ratio of conversion is decided
by the issuer. Upon conversion the investors enjoy the same status as an ordinary equity shareholder
of the company.

Convertible debentures, whether partly convertible or fully convertible, can be issued only with the
approval of a special resolution at a general meeting.

B. ON THE BASIS OF SECURITY

On the basis of Security, debentures are classified into:

1. Secured Debentures
2. Unsecured Debentures

1. Secured Debentures

These debentures are secured by a mortgage or charge on the property of the company. So if the
issuing company fails on payment of either the principal or the interest amount, the company’s assets
can be sold to repay the liability to the investors. Section 71(3) of the Companies Act, 2013 provides
that secured debentures may be issued by a company subject to such terms and conditions as may be
prescribed by the Central Government through rules.

2. Unsecured Debentures

These instrument are unsecured in the sense that if the issuing company defaults on payment of the
interest or principal amount, the investor has no right to proceed against the property of the company.
It is a mere promise to repay. Unsecured debentures are also known as naked debentures.

C. ON THE BASIS OF REDEEMABILITY

On the basis of redeemability, debentures are classified into:

1. Redeemable Shares, and

2. Irredeemable Shares

1. Redeemable Debentures

It refers to the debentures which are issued with a condition that the debentures will be redeemed at a
fixed date or upon demand, or after notice, or under a system of periodical drawings. Debentures are
generally redeemable and on redemption these can be reissued or cancelled. The person who has
been re-issued the debentures shall have the same rights and priorities as if the debentures had never
been redeemed.

2. Perpetual or Irredeemable Debentures

A debenture, in which no time is fixed for the company to pay back the money, is an irredeemable
debenture. The debenture holder cannot demand payment as long as the company is a going concern
and does not make default in making payment of the interest.

But all debentures, whether redeemable or irredeemable become payable on the company going into
liquidation. However, after the commencement of the Companies Act, 2013, now a company
cannot issue perpetual or irredeemable debentures.

D. ON THE BASIS OF REGISTRATION

On the basis of Registration, debentures may be classified as

1. Registered Debentures
2. Bearer Debentures

1. Registered Debentures

Registered debentures are made out in the name of a particular person, whose name appears on the
debenture certificate and who is registered by the company as holder on the ‘Register of Debenture
holders’. Such debentures are transferable in the same manner as shares by means of a proper
instrument of transfer duly stamped and executed and satisfying the other requirements specified in
Section 56 of the Companies Act, 2013.

2. Bearer debentures

On the other hand, bearer debentures are made out to bearer, and are negotiable instruments, and so
transferable by mere delivery (like share warrants). The person to whom a bearer debenture is
transferred become a “holder in due course” and unless contrary is shown, is entitled to receive and
recover the principal and the interest accrued thereon.

DEBENTURE STOCK

A company, instead of issuing debentures, each in respect of separate and distinct debt, may raise one
aggregate loan fund or composite stock known as ‘debenture stock’. Accordingly, a debenture stock
is a borrowed capital consolidated into one mass for the sake of convenience. Instead of each
lender having a separate bond or mortgage, he has a certificate entitling him to a certain sum being a
portion of one large loan. It is generally secured by a trust deed. As in the case of shares, a person
may subscribe for, or transfer any amount even a fraction amount.

Debenture stock must be fully paid, while debenture may or may not be fully paid.
ISSUE OF DEBENTURES

The power of the company to borrow money and to issue debentures is vested with its directors. The
directors cannot borrow more than the sum authorized. This power can only be exercised at a duly
convened meeting of the Board of Directors. Moreover, the power to issue debentures cannot be
delegated by the Board of directors.

A. ISSUE OF CONVERTIBLE DEBENTURES [S. 71(1)]

S. 71(1) states that allows a company to issue debentures with an option to convert such debentures
into shares, either wholly or partly at the time of redemption. However the issue of such convertible
debentures has to be approved by a special resolution passed at a general meeting.

B. NO DEBENTURE SHALL CARRY VOTING RIGHTS [S. 71(2)]

Section 71 (2) states that no company shall issue any debentures carrying any voting rights.

C. ISSUE OF SECURED DEBENTURES [S. 71(3)]

Secured debentures may be issued by a company subject to the following terms and conditions –

1. The date of its redemption shall not exceed ten years from the date of issue. (Exception: A
company engaged in the setting up of infrastructure projects may issue secured debentures for a
period exceeding ten years but not exceeding thirty years)
2. Such an issue of debentures shall be secured by the creation of a charge, on the properties or
assets of the company, having a value which is sufficient for the due repayment of the amount of
debentures and interest thereon.
3. The company shall appoint a debenture trustee before the issue of prospectus or letter of offer
for subscription of its debentures
4. The company shall execute a debenture trust deed not later than 60 days after the allotment of
the debentures in order to protect the interest of the debenture holders

D. CREATION OF DEBENTURE REDEMPTION RESERVE (DRR) ACCOUNT [S. 71(4)]

When debentures are issued by a company, the company has to create a separate account called as
the debenture redemption reserve account. The DRR account shall be created out of the profits of
the company available for payment of dividend. The amount credited to such account shall not be
utilized by the company except for the redemption of debentures. Rule 18(7) of Companies (Share
Capital and Debentures) Rules, 2014 prescribes the conditions for the same.

E. APPOINTMENT OF DEBENTURE TRUSTEES [S. 71(5)]

A debenture trust is usually created by the debenture holders to look after their interest in the
properties mortgaged or charged to them, and for this purpose they may appoint a debenture trustee.
However, where the company issues a prospectus or makes an offer or invitation to the public or to its
members exceeding 500 for the subscription of its debentures, it is mandatory for the company to
appoint one or more debenture trustees before such issue or offer.

The conditions governing the appointment of such trustees shall be such as may be prescribed.

F. REGISTER OF DEBENTURE HOLDERS [S. 88(1)]

Every company which issues or allots debentures shall maintain a separate register of debenture
holders for each type of debentures in Form No. MGT 2.

The register of debenture holders shall include an index of the names included therein.

G. PAYMENT OF INTEREST ON, AND REDEMPTION OF DEBENTURES

Pursuant to Sub-section (8) of Section 71, the company is bound to pay interest and redeem the
debentures in accordance with the terms and conditions of their issue.

If a company fails to redeem the debentures on the date of their maturity or fails to pay interest on the
debentures when it is due, the NCLT may, on the application of any or all of the debenture-holders, or
debenture trustee and, after hearing the parties concerned, direct, by order, the company to redeem the
debentures forthwith on payment of principal and interest due thereon.

If any default is made in complying with the order of the Tribunal under this section, every officer of
the company who is in default shall be punishable with imprisonment for a term which may
extend to three years or with fine which shall not be less than two lakh rupees but which may
extend to five lakh rupees, or with both.

This remedy is made available to the holders of debentures whether they are secured or unsecured.

CONCLUSION

Thus debentures are nothing but a certificate of loan issued by a company. It is of various kinds. A
company cannot issue irredeemable debentures. Further, S. 71 of the Act read with Rule 18 of the
Companies (Share Capital and Debenture) Rules prescribes an exhaustive procedure relating to issue
of debenture, formation of debenture deed, appointment of debenture trustee, payment of interest on
debentures, and redemption of debentures.