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SUBJECT: CORPORATE LAW -I

Project topic: Debentures : A critical study as a mode of


capital financing

Submitted By
RITU simran
Roll no. 1158
4 Year , 7
TH TH
Semester, B.A.LL.B(Hons.)

Submitted to
Mrs. Nandita jha
Faculty of corporate law-i

Chanakya national Law University, Patna


2017
1
declaration

I hereby declare that the project work entitled “Debentures: A critical study as a mode of
capital financing” submitted to CHANAKYA NATIONAL LAW UNIVERSITY, PATNA is
a record of an original work done by me under the guidance of Mrs. Nandita S.Jha.

Furthermore, I confirm that: −

- this work has been composed by me without assistance;

− I have clearly referenced in accordance with departmental requirements, in both the text
and the bibliography or references, all sources (either from a printed source, internet or any
other source) used in the work;

− all data and findings in the work have not been falsified or embellished;

− this work has not been published.

I confirm that I understand that my work may be electronically checked for plagiarism by the
use of plagiarism detection software and stored on a third party’s server for eventual future
comparison.

I thank all of them !

Ritu Kumari R.No.1158, Sem VII B.A.L.L.B. (H)

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TABLE OF CONTENTS

 HYPOTHESIS....................................................................4
 RESEARCH METHODOLOGY........................................4
 SCOPE OF THE STUDY...................................................4
 SOURCES OF DATA.........................................................4
 CHAPTER 1- INTRODUCTION.......................................5
 CHAPTER 2-DEBENTURE AS A FINANCIAL
INSTRUMENT…………………………………………. 6
 CHAPTER 3- PROCEDURE TO ISSUE DEBENTURES
UNDER THE COMPANIES ACT, 2013………………...9
 CHAPTER 4- KINDS OF DEBENTURE.........................11
 CHAPTER 5 REDEMPTION OF DEBENTURE.............13
 CONCLUSION..................................................................15
 BIBLIOGRAPHY...............................................................16

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HYPOTHESIS

“Debenture is a financial instrument of the company”.

RESEARCH METHODOLOGY

The researcher has adopted doctrinal method of legal research. The sources of data are books,

articles, blogs, websites, legal databases, online journals, acts, etc.

SCOPE OF STUDY

The study will deal with the debenture under the Companies Act, 2013 and Companies
(Share Capital and Debentures) Rules, 2014

SOURCES OF DATA

The primary sources of data includes bare acts.

Secondary sources includes books and online sources, articles, databases, etc

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1. INTRODUCTION
The word ‘debenture’ has been derived from a Latin word ‘debere’ which means to
borrow.1Debenture is a written instrument acknowledging a debt to the Company. It contains
a contract for repayment of principal after a specified period or at intervals or at the option of
the company and for payment of interest at a fixed rate payable usually either half-yearly or
yearly on fixed dates. A debenture means a document, which creates or acknowledges a
debt.2

The term “debenture” has been defined in the act that “Debenture includes debenture stock,
bonds and any other instrument of a company evidencing a debt whether constituting a
charge on the company’s assets or not.”3 Debenture is most important instrument to raise
capital for a company. A company use debenture to raise debt capital. Debenture holders are
known as creditors of the company. Debenture holders are paid a fixed amount of interest at
precise intervals may be, six months or a year.

Debenture issued by public sector companies with government approval is called bonds.
Debenture may be Secured Debenture or Unsecured Debenture. According to Section 44, the
shares or debentures or other interest of any member in a company shall be movable property
transferable in the manner provided by the articles of the company.

According to Chitty “Debentures means a document which either creates a debt or


acknowledges it, and any document which fulfils either of those conditions is a debenture”.4

In India the company act 1956, Section 2 (12) defines debentures as “Debenture includes
debenture stock, bonds and any other securities of a company whether constituting a charge
on the Company’s assets or not.”5 Debenture means a document, which either creates a debt
or acknowledges it, and any document which fulfills either of these two conditions is a
debenture.

1
Issue and Redemption of Debentures published on 7/11/17 available at: http://ncert.nic.in/ncerts/l/leac202.pdf
(Last seen on 20/10/17)
2
Levy v Abercorries State Co. (1887) 37 Ch D 260
3
Section 2(30), The Companies Act, 2013.
4
Levy v. Abercorris co, (1888) 37 Ch.D. 260-264
5
Companies Act, 1956 available at:
http://www.mca.gov.in/Ministry/actsbills/pdf/Companies_Act_1956_Part_1.pdf, last seen on 20/10/17

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2. DEBENTURES : AS A FINANCIAL INSTRUMENT
Debentures gives rise to the idea of the rich “clipping their coupons,” which means that a
bondholder will present their “coupon” to the bank and receive a payment each quarter (or in
whatever period is specified in the agreement).6 There are also other features that minimize
risk, such as a “sinking fund,” which means that the debtor must pay some of the value of the
bond after a specified period of time. This decreases risk for the creditors, as a hedge against
inflation, bankruptcy, or other risk factors. A sinking fund makes the bond less risky, and
therefore gives it a smaller “coupon” (or interest payment). There are also options for
“convertibility,” which means a creditor may turn their bonds into equity in the company if it
does well7.

A company may issue debentures with an option to convert such debentures into shares,
either wholly or partly at the time of redemption. The issue of debentures with an option to
convert such debentures into shares, wholly or partly, shall be approved by a special
resolution passed at a general meeting.8 Secured debentures can issued subject to such terms
and conditions as may be prescribed.9 The company has to create a debenture redemption
reserve account of the profits of the company available for the payment of dividend. The
amount credited to such account is not to be utilised by the company except for the
redemption of the debentures.10

Where the members of the public are to be invited by issuing a prospectus or where members
of the public company’s own member exceeding 500 are to be invited, there it is compulsory
that one or more debenture trustees are appointed. The conditions governing appointment of
trustees have according to what may be prescribed.11 The debenture trustee has to take steps
to protect the interest of debenture holders. He has to redress the grievances according to such
rules may be prescribed.12 A provision contained in a trust deed for securing the issue of
debentures or in any contract with the debenture holders secured by trust deed is to be void to
the extent to which it has the effect of exempting a trustee from the liability for breach of

6
Subhransu, Debentures (financial instrument) Published on 4/10/2013 available:
https://subhransu89.wordpress.com/2013/10/04/debenture-financial-instrument/ (Last seen on 20/10/17)
7
ibid
8
Section 71(2), The Companies Act, 2013.
9
Section 71(3), The Companies Act, 2013.
10
Section 71(4), The Companies Act, 2013.
11
Section 71(5), The Companies Act, 2013.
12
Section 71(6), The Companies Act, 2013.

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trust or indemnifying him against such liablility which arises by the reason of his failure to
show the requisite degree of care and due diligence. Regard has to be had to the provisions of
trust deed conferring on the trustee any power, authority or discretion. 13 The proviso to the
subsection sub-section says that the liability of the debenture trustee is to be subject to such
exemptions as may be agreed upon by a majority of debenture holders, having not less than
three-fourth in value of the total debentures at a meeting held for the purpose.

The company has to pay interest for redeeming debentures in accordance with the terms and
conditions of their issue.14 Where at any time the debenture trustee comes to a conclusion that
the assests of a company are insufficient or likely to become insufficient to discharge the
principal amount and when it becomes due, he may file a petion before the Tribunal. The
tribunal has to hear the company and other interested persons. Tribunal may then pass an
order imposing such restrictions on the company in the matter of incurring further liabilities
as tribunal may consider necessary in the interests of debenture holders. 15 Where company
fails to redeem debentures on their maturity or fails to pay interest when due, any debenture
holder or trustee may apply to the tribunal. The tribunal after hearing parties, pass an order
directing the company to redeem the debenture forth with on payment of due principle and
interest.16

The officer who default on in carrying out the orders of the tribunal have to incur criminal
penalty of imprisonment and fine.17

A contract with the company to take up and pay for any debentures of the company may been
enforced by a decree of specific performance.18

The advantage of debentures to companies is that they carry lower interest rates than, say,
overdrafts and are usually repayable a long time into the future. For an investor, they are
usually saleable on a stock exchange and involve less risk than equities.19Investors preference
to high yielding securities with minimum risk has encouraged issue of debentures by the
companies. Cost of raising money through debenture is minimum as against the cost involved

13
Section 71(7), The Companies Act, 2013.
14
Section 71(8), The Companies Act, 2013.
15
Section 71(9), The Companies Act, 2013.
16
Section 71(10), The Companies Act, 2013.
17
Section 71(11), The Companies Act, 2013.
18
Section 71(13), The Companies Act, 2013.
19
Debenture available at: http://www.oxfordreference.com/view/10.1093/oi/authority.20110803095704967 (last
seen on 20/11/17)

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in other sources of finance; Debenture issuing company is obliged now to create a debenture
redemption fund to protect the interest of debenture holders.

Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014 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:-

 An issue of secured debentures may be made, provided the date of its redemption

shall not exceed ten years from the date of issue. Provided that 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;

 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;

 the company shall appoint a 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 of

the debenture holders; and

 the security for the debentures by way of a charge or mortgage shall be created in
favour of the debenture trustee on-

- any specific movable property of the company (not being in the nature of pledge); or

- any specific immovable property wherever situate, or any interest therein.20

20
Prashant Kumar, Debentures under Companies Act, 2013 - Law & Procedure for Issue published on 1/1/2015
available at: https://www.linkedin.com/pulse/debentures-under-companies-act-2013-law-procedure-issue-
kumar(Last visited on 21/10/17)

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2. PROCEDURE TO ISSUE DEBENTURES UNDER
THE COMPANIES ACT, 2013
Applicable Provisions: Section 56, 72, of the Companies Act, 2013 read with Rule 18 and 19
of the Companies (Share Capital and Debentures) Rules, 2014

 Call and hold Board meeting and decide which types of the debenture will be issued

by the Company.

 If the Company decides to issue secured debenture the company has to comply with

the condition prescribed in the Rule 18 of the Companies (Share Capital &

Debentures) Rules, 2014.


 In case appointment of Debenture Trustee, consent shall be obtained from a SEBI

registered Debenture Trustee, who is proposed to be appointed. If debentures to be

issued are Secured Debentures, a Debenture Trust Deed in Form No. SH – 12 or as

near thereto as possible shall be executed by the Company in favour of Debenture

Trustees within sixty days of allotment of Debentures.

 In the Board meeting pass resolutions for i) Approval of Offer letter for private

placement in Form No. PAS – 4 and Application Forms (In case of private placement

of debentures); ii) Approval of Form No. PAS – 5 (In case of private placement of

debentures); iii) Approval of Debenture Trustee Agreement and appointment of a

Debenture Trustee (In case of Secured Debentures only); iv) Appointment of an

expert for valuation (In case of private placement of debentures); v) Approval of

increase of borrowing powers, if required; vi) To authorize for creation of charge on

the assets of the company; vii) Approve the Debenture Subscription Agreement; viii)

To fix day, date and time for the extraordinary general meeting of shareholders.

 Prepare the draft of i) Debenture Subscription Agreement; ii) Offer Letter for private

placement in Form No. PAS – 4 and Application Forms; iii) Records of a private

placement offer in Form No. PAS – 5; iv) Debenture Trustee Agreement; v) Mortgage
Agreement for creation of charge on assets of the company.

9
 Issue notices of extraordinary general meeting along with the explanatory statement.

 Hold extraordinary general meeting and pass special resolution to issue convertible

secured debentures and increase borrowing powers of the company and to authorize

the Board to create charge on the assets of the company.

 File Form No. PAS – 4 and PAS – 5 in Form No. GNL – 2 with the Registrar of

Companies.

 File Offer Letter in Form No. MGT – 14 with the Registrar of the Companies.

 File copy of Board resolutions, Special Resolution, Debenture Subscription

Agreement, Debenture Trustee Agreement etc in Form No. MGT – 14 with the

Registrar of Companies.

 File Form No. PAS – 3 (Return of allotment) with the Registrar of Companies after

making allotment of debentures.


 File Form No CHG – 9 for creation of charge on assets of the Company.21

21
Ibid

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4. KINDS OF DEBENTURES
1. CONVERTIBILITY OF THE INSTRUMENT

Under the convertibility of instruments there are four types of debentures-

a) Non Convertible Debentures: These are the type of debentures which cannot
be converted into equity shares

b) Partly Convertible Debentures: Under these types of debentures a part of


this can be converted into equity shares. This type of debentures is decided by
issue that under what ratio it will be converted.

c) Fully Convertible Debentures: These are the debentures which can be fully
converted into equity shares at issuer’s notice. Under these the ratio of
conversion is decided by the issuer. When these are converted the investors
enjoy the same status as they used to enjoy as ordinary shareholders of the
company.

d) Optionally Convertible Debentures: Under this investor is the option


whether they want to convert these debentures into the shares or not.22
Optionally convertible debentures are debt securities which allow an issuer to
raise capital and in return the issuer pays interest to the investor till the
maturity.23

THE DEBENTURES CAN ALSO BE CLASSIFIED ON THE BASIS OF SECURITY

1. Secured Debentures:
The debentures can also be secured by a charge on the fixed assets. If the payment by
the issuer is fail then his assets can be sold to repay the liability to the investors.
Under Section 71 (3) of the Companies Act, 2013, Security Debentures can be issued
by a company under such terms and condition that may be prescribed by the central
government through the rules.

22
Debentures under companies act 2013 published on 7/11/2016 available at:
http://lawtimesjournal.in/debentures-companies-act-2013/ (Last seen on 21/10/17)
23
Definition of optionally convertible debentures available at:
https://economictimes.indiatimes.com/definition/optionally-convertible-debentures (Last seen on 21/10/17)

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2. Unsecured Debentures:
Under unsecured debentures, the issuer should have the default on the payment of the
interest or principal amount. The unsecured debentures are also known as naked
debentures.24
REGISTRATION
1. Registered Debentures: Registered debentures are those debentures in respect of
which all details including names, addresses and particulars of holding of the
debenture holders are entered in a register kept by the company. Such debentures can
be transferred only by executing a regular transfer deed.25

2. Bearer Debentures: Bearer debentures are the debentures which can be transferred
by way of delivery and the company does not keep any record of the debenture
holders Interest on debentures is paid to a person who produces the interest coupon
attached to such debentures.26
TENURE

1. Redeemable Debentures: Redeemable debentures are those which are payable on the
expiry of the specific period (Maximum period 10 years from the date of issue) either
in lump sum or in Installments during the life time of the company. Debentures can be
redeemed either at par or at premium.
2. Irredeemable Debentures: Irredeemable debentures are also known as Perpetual
Debentures because the company does not give any undertaking for the repayment of
money borrowed by issuing such debentures. These debentures are repayable on the
winding-up of acompany or on the expiry of a long period.27
3. Debentures may be for fixed terms or payable on demand:
 Debentures may be for fixed term of years or repayable on notice.28
 They can legally be framed as payable to bearer

24
Supra 3
25
Dr. G.K Kapoor, Sanjay Dhamija, Taxmann’s Company law (20th Edition.) pg no 297

26
Ibid
27
Divyesh Goyal, Debentures under companies act, 2013- a legal analysis, published on 22/6/2017 available at:
https://taxguru.in/company-law/debentures-under-companies-act-2013-legal-analysis.html, last seen on 20/10/17
28
Wiley v Stocks (1909) 26 TLR 41]

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5. REDEMPTION OF DEBENTURES
Under Section 71 (2) of the Companies Act, 2013 it has been stated that no company can
issue debentures which can carry any voting rights. Under the rule (1) of Companies (Share
Capital and Debentures) Rules, 2014, it has been stated that the company cannot issue
secured debentures unless following conditions are fulfilled. The rate of redemption cannot
exceed 10 years from the date of issue. The company which has been engaged in setting up of
infrastructure projects can issue security debentures crossing 10 years but cannot exceed 30
years. The issue of debentures should be secured by creation of a charged. The security of
debentures by the way of charge should be treated in the favour of debenture trustee.29

CREATION OF DEBENTURE REDEMPTION RESERVE ACCOUNT


For the purpose of redemption of debentures the company has the right to create debenture
redemption reserve account. The debenture redemption reserve should be created out of the
profits of the company available for the payment of dividend. For creating the debenture
redemption reserve account there must be at least 50% of amount which should be raised to
the debenture issue before the debenture Redemption commences.
Debenture redemption reserve should be created by every company on or before 30th April
every year so that there should be investment. If there is a case of convertible debentures then
the debenture redemption reserve shall be created in respect of non convertible portion of
debentures. The amount which is credited to the debenture redemption reserve must not be
utilised by the company itself except for the purpose of redemption of debentures. Company
has to pay the interest to return the debentures in accordance under the terms and conditions
of the issue.30

Sub rule 7 of the Rule 18, the provision for creation of Debenture Redemption Reserve
(DRR) is required to be created for the purpose of redemption of debentures in accordance
with the conditions provided under the said rule itself. The conditions inter alia provided that
the adequacy of the DRR should be 25% of the value of debentures issued. The amendment
Rules, 2016 provide clarification that the adequacy of DRR should be 25% of the value of the
outstanding debentures rather than the value of debentures issued.Further, the Amendment
Rules vide insertion of proviso in clause (b) after sub-clause (iii) of Rule 18(7) provide that, a
29
Redemption of debentures available at: http://lawtimesjournal.in/redemption-of-debentures/(Last seen on
21/10/17)
30
Ibid

13
company intending to redeem debentures prematurely i.e. before time may transfer such
amount in DRR as is necessary for redemption of such debentures even if it exceeds the limit
specified in this rule.31

31
Provisions relating to creation of debenture redemption reserve stand changed, published on 15/5/2017
available at: http://www.companiesact.in/Companies-Act-2013/News-
Details/472/Provisions%20relating%20to%20creation%20of%20%20Debenture%20Redemption%20Reserve%
20stand%20changed (Last seen on 21/10/17)

14
CONCLUSION
Debenture is like a certificate of a loan which acts as the evidence of the fact that the
company is liable to pay the specific amount with the interest and that person becomes the
part of a company’s capital structure. Debentures contains a contract of you payment of
principal after a specific period of time.

Debenture is a financial instrument of any company as the benefit of raising loan capital
through debentures lies in the fact that it does not disturb equity structure of the company and
consequently the existing management. However, the success of a debenture issue, be it
private or public issue depends, to a large extent, on the goodwill and rapport built up by the
company with the investing public. Another aspect of the matter is the protection of interest
of debenture holders. This is sought to be achieved by an independent Debenture Trustee who
is required to be appointed by listed companies in regard to public issue or further issue of
capital as the number of debenture holders are considerably large Creation of DRR which is
statutory obligation is intended to provide liquid resource built out of profits of a company
for redemption of debentures.

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BIBLIOGRAPHY
BOOKS:

1. Avatar Singh, Company Law, Eastern Book Company 16th edition.


2. Dr. G.K Kapoor, Sanjay Dhamija, Taxmann’s Company law 20th Edition.
3. Lexis Nexis Corporate Laws 16th Edition 2017.

Websites:

 Redemption of debentures Published on 7/11/2014 available at:


http://lawtimesjournal.in/redemption-of-debentures/
 Subhransu, Debentures (financial instrument) Published on 4/10/2013 available:
https://subhransu89.wordpress.com/2013/10/04/debenture-financial-instrument/
 Provisions relating to creation of debenture redemption reserve stand changed
published on 15/5/2017 available at: http://www.companiesact.in/Companies-Act-
2013/News-
Details/472/Provisions%20relating%20to%20creation%20of%20%20Debenture%20
Redemption%20Reserve%20stand%20changed
 Debentures under companies act 2013 published on 7/11/2016 available at
http://lawtimesjournal.in/debentures-companies-act-2013/
 Definition of optionally convertible debentures available
https://economictimes.indiatimes.com/definition/optionally-convertible-debentures
 Debenture available at:
http://www.oxfordreference.com/view/10.1093/oi/authority.20110803095704967
 Prashant Kumar, Debentures under Companies Act, 2013 - Law & Procedure for
Issue published on 1/1/2015 available at:
https://www.linkedin.com/pulse/debentures-under-companies-act-2013-law-
procedure-issue-kumar

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