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This article was written by Rachit Sharma, a student of Delhi Metropolitan Education, Greater Noida.
What is a ‘Debenture’?
A Debenture is a type of debt instrument that is not secured by physical assets or collateral. Debentures are backed only by the general creditworthiness and reputation of the issuer. Both corporations and governments frequently issue this type of bond to secure capital.
Debentures are the most common form of long-term loans that can be taken out by a corporation. These loans are normally repayable on a fixed date and pay a fixed rate of interest. A company normally makes these interest payments prior to paying out dividends to its shareholders. They carry a lower interest rate and have a repayment date that is far in the future.
It is different from Share as share represents part of ownership of a company; debenture acknowledges loan or debt to the company.
Section 2 (30) of the Companies Act, 2013 also states that ‘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.
Types of Debentures
There are two types of Debentures according to The Companies Act, 2013:
- Convertible Debentures
- Non-Convertible Debentures
A Convertible Debenture means a debenture which gives the holder the right to exchange debenture either wholly or in part with fully paid shares
Issue of Convertible Debenture
According to Section 71 of The Companies Act, 2013 – The company can issue partly or fully convertible debentures. However, convertible debentures can be issued only after the approval of the members by means of special resolution (by a majority of not less than two thirds of the votes) passed at a general meeting (meeting of the shareholders).
Non-Convertible Debentures are unsecured bonds that cannot be converted to company equity or stock. These generally have higher rate of interest than Convertible Shares.
Issuance of Non-Convertible Debentures
- A Debenture Trustee shall be appointed for each issuance of the NCDs.
- The Company shall disclose its financial position as per the standard market practice.
- The requirements of all the provisions of The Companies Act, SEBI (Issue and Listing of Debt Securities) regulations, 2008 or any other law shall be complied with.
- The Debenture Certificate shall also be issued within the prescribed period.
Issuance of Debenture with Voting Rights
Section 71(2) of The Companies Act, 2013 bars issuance of debentures carrying any voting rights. Same was also barred under section 117 of The Companies Act, 1956.
Issue of Debentures at a Discount
Debentures can be issued at a Discount by a Company. Debenture is said to have been issued at discount when the amount collected is less than the nominal value, for e.g., issue of debentures of Rs. 100/- for Rs. 95/-. The difference of Rs. 5/- is the discount and is called discount on issue of Debentures. This discount on issue of debentures is a capital loss.
Debenture Trust Deed
Debenture Trust Deed is the document created by the company, whereby trustees are appointed to protect the interest of debenture-holders before they are offered for public subscription. The Companies Act, 2013 delegates the power to prescribe rules with regard to the formation of debenture trust deed to the central government along with the procedure to inspect the trust deed. Sub-Rule (5) of Rule 18 of the Companies (share capital and debentures), 2014 provides that the trust deed must be executed within 60 days of allotment of debentures. However, such requirement is not applicable in case of public offer of debentures.
According to SEBI Rules, 1993- “Debenture Trustee” means a Trustee of a Trust Deed for securing any issue of debentures of a body corporate. A debenture trustee shall take steps to protect the interests of the debenture holders and redress their grievances in accordance with such rules as may be prescribed.
According to Section-71(5) of the Companies Act, 2013, Company cannot issue a prospectus or make an offer or invitation to the public or to its members exceeding five hundred for the subscription of its debentures, unless it has, before such issue or offer, appointed one or more debenture trustees.
To act as debenture trustee, the entity should either be a scheduled bank carrying on commercial activity, a public financial institution, an insurance company or a body corporate, the entity should be registered with SEBI to act as a debenture trustee.
Debenture Redemption Reserve (DRR)
Section-71(4) of the Companies Act, 2013 states that the company shall create a DRR account out of the profits of the company available for payment of dividend and the amount credited to such account shall not be utilised by the company except for the redemption of debentures.
The requirement for creation for the DRR in case of convertible debentures is not applicable. However, if the debentures are partly convertible, the requirement relates only to the part which is not convertible.
Rule 18 of Companies (Share Capital and Debentures) Rules, 2014
Rule 18(7) prescribes conditions for creation of DRR, as follows:
- DRR shall be created out of the profits of the company available for the payment of dividend.
- Company shall create DRR equivalent to 50% of the amount raised through the debenture issue before debenture redemption commences.
- Every company required to create a DRR shall before 30th April each year, shall invest or deposit, a sum of at least 15% of the amount of its debentures.
- The amount credited to the DRR shall not be utilised by the company except for the purpose of redemption of debentures.
Quantum of DRR
Section-71(13) of The Companies Act, 2013 empowers the Central Government to prescribe the quantum of the DRR to be created.
Default in Redemption
In case of default in redemption of debentures on the date of maturity, an application may be made by debenture-holders before the Company Law Board (CLB) together with a fee of Rs 50. After hearing the company and debenture holder, the CLB shall direct the company to redeem the debentures by payment of the principal amount and interest due thereon.
Procedure to Issue Debentures under The Companies Act, 2013
- 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 i.e. debentures secured by a charge on the fixed assets of the company, it must 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 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:
- Approval of Offer letter for private placement in Form No. PAS – 4 and Application Forms (In case of private placement of debentures)
- Approval of Form No. PAS – 5 (In case of private placement of debentures)
- Approval of Debenture Trustee Agreement and appointment of a Debenture Trustee (In case of Secured Debentures only)
- Appointment of an expert for valuation (In case of private placement of debentures)
- Approval of increase of borrowing powers, if required
- To authorize for creation of charge on the assets of the company
- Approve the Debenture Subscription Agreement
- To fix day, date and time for the extraordinary general meeting of shareholders.
- Debenture Subscription Agreement
- Offer Letter for private placement in Form No. PAS – 4 and Application Forms
- Records of a private placement offer in Form No. PAS – 5
- Debenture Trustee Agreement
- Mortgage Agreement for creation of charge on assets of the company.
- Issue notices of extraordinary general meeting (Meeting of members, shareholders or employees of the company which is called on short notice and for urgent matter) under Section 101 along with the explanatory statement.
- Call for extraordinary general meeting under Section 100 of The Companies Act, 2013 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.