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Concept of Debentures In India

Introduction To Concept of Debentures
In every corporate organization, enormous or not, engaged in doing business or involved in manufacturing activity or industry providing services, there is always requirement of finances and funds. In order to run a business effectively and successfully, adequate amount of capital is necessary. In some cases it is capital is arranged through internal resources i.e. by way of issuing equity share capital or using accumulated profit . Equity funds are raised by taking money from the shareholders by way of their initial contribution in fixed income securities such as treasury bills and bonds. The share holders are the owners of the company. Equity funds most of the times is not adequate and the organization is resorted to external resources for arranging capital i.e. External Commercial Borrowing(ECB), Debentures, Bank Loan, Public Fixed Deposits etc. There is a provision of powers to borrow for the company in the memorandum of association of a company. The loans are raised by the corporate sector by the way of issuance of debentures. As the funds raised by the issue of shares are are not adequate to meet the financial demand of the company for long run. Hence, the companies choose to raise long- term funds through debentures. A Debenture is basically some of the loan amount the company was interested to raise from the public , that is why it issues debentures. A person who has bought a debenture and holding it is called a debenture holder. A debenture holder is the creditor of the company. Under the seal of the company . Debenture is document issued under the seal of the company. Debenture is an acknowledgment of the funds received by the company equal to the nominal value of the debenture. It includes the payment of interest at a fixed rate till the times the principal sum becomes repayable. There may or may not be a charge put on the sets of the company as security. The date of redemption along with the rate and mode of payment of interest are mentioned in it. The last few years has seen the capital market of India to evolve at a much faster rate, the reasons are launch of new instruments and the modifications in the old technology. In the present situation debentures prove to be a great contributor to support the financial needs of the corporate sector. The issue of debentures is a means significant for raising capital from the market as contrasted with the other modes like , preference shares, bonus as shares, equity shares, rights issues. The provisions of the Companies Act identifying with plan additionally apply to debentures where they are issued to the general population. The Companies act does not provide for a exhaustive definition of debentures but an inclusive definition. As per the definition of debenture[1]given in Section 2(30) of the Companies Act 2013 "Debenture includes debenture stocks, bonds or any other instruments of a Company evidencing a debt, whether constituting a charge on the assets of the Company or not". This sections proves that the company has right to issue bonds or debenture which are instruments as an debt, which can be both secured or unsecured by the way of creating charge on the way of creating charge on the assets of the company. A company may issue debentures as a type of long-term unsecured bond on agreeing to repay it at a predetermined future date. The company usually pays interest to the debenture holders at the end of every year till the time of maturity , but if it is not able to pay either the interest or the principal amount of the loan the creditors of the company has right to ask company into liquidation to recover their money by the way of selling the assets of the company.

Characteristics of Debentures

·Debenture is a movable property. It is in the form of a certificate of indebtedness of the company and issued by the company itself. It generally creates a charge on the undertaking or undertakings of the company. There is usually a specific date of redemption.
·The debenture holders are creditors to the company and they donot have any claim of ownership of the company unlike share holders. The company is only under debt of the debenture holders.
·As the debenture holders are not the owner of the company so they are not entitled with the administration and management of the company.
·The debenture holder need not be concerned with the profits or loss of the company, they have a fixed rate of interest on the principal amount which they get every year irrespective of the financial condition of the company.
·Debentures usually have a charge on the assets of the company, which means that if the company on liquidation is not able to repay the amount the debenture holders can sell of property of the company to recover money.
·There is an undertaking given by the company to repay debenture holders the principal amount along with the interest at the state time.
·The debenture holders cannot claim the privilege to vote in any meeting of the company.
·When the company is winding up, the first priority of the company is to repay to the debenture holders of the company hence , there is no risk involved of loss of money of the debenture holders.
·There is a series with pari passu clause which is usually a part of the debentures being issued and it would be equal as security and if the security is being enforced, the amount shall be discharged relate ably. If there is deficiency of assets, the division will be proportionately.

Kinds of Debenture

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

1.on the basis of convertibility, Debentures are classified into following categories:
(A) Non Convertible Debentures– This type of debentures cannot be converted either into preference shares or equity shares. Non-convertible debentures can either be unsecured or secured. These type of debentures are usually redeemed only on the maturity of a predetermined period which may be 10 or 20 years. These instruments retain the debt character and can not be converted into shares.

(B) Partly Convertible Debentures - Apart of these instruments are converted into equity shares in future at the notice of issuer. The issuer decides the ratio for conversion. The ratio is usually decided at the time of subscribing the debentures. If a debenture converts some of his debentures into share, he a member as other shareholders for those shares, amending the rights accordingly. Thus convertible debentures may be called as debentures which can be converted by he debenture holder after a specific time.

(C) Fully Convertible Debentures -These are those debentures which can be converted into equity or preference shares after a certain period at predetermined rate of exchange. If a debenture converts his debentures into share, he cease to be the creditor of the company and become a member as other shareholder, amending the rights accordingly. Thus convertible debentures may be called as debentures which can be converted by he debenture holder after a specific time. At the time of issue of debenture the rate at which the exchange takes place is decided . Till the time of conversion only the interest is paid to the debenture holder and after that the rights exercised would same as shareholder. In order to issue convertible debentures prior approval of the shareholders is mandatory. The sanction of central government also required for issuing convertible debentures.

(D) Optionally Convertible Debentures- It is a t the option of the debenture holder to convert these debentures into share. The price for such conversion is decided by the issuer and was consented upon by both parties at the time of issue of debenture.

2. on the basis of security, Debentures are classified into following categories:
(A) Secured Debentures –The instruments which are secured as there is a charge on the fixed assets of the company. This is to secure the debenture holder as and when the issuer makes a defaults in the payment of either the principal or interest amount, the assets of the issuer can be sold of in order to do away with the liability to the debenture holders by repayment. In Companies Act, 2013 there is a provision in Section 71(3) which says that a company has right to issue secured debenture subjected to the conditions of the government of India.

(B) Unsecured Debentures– These type of debentures are unsecured in the way that if there is a default in payment of the principal amount or interest amount the debenture holder will have be along with other unsecured lenders and hence could not sell any property or anything for repayment hence they are also called naked debentures.

3. on the basis of Redeemability, Debentures are classified into following categories:
(A)Redeemable Debentures -The debentures which are issued with the option of redemption on demand or after serving notice or at a fixed date or through a system of periodical drawing. Usually debentures are of redeemable nature and after redemption they can either be cancelled or can be reissued. The priorities and rights of the person who is reissued the debentures shall be same as the debentures were never redeemed.
(B)Perpetual or Irredeemable Debentures –an irredeemable debenture is a type of debenture in which there is not fixed time for the issuer to repay the amount. The debenture holder does not have right to demand for the payment of principal amount until and unless the company does not default in making payment of the interest regularly. If a company is going into liquidation it has to pay for all the debenture whether redeemable or irredeemable.

4.on the basis of Registration, Debentures are classified into following categories:
(A) A Registered Debentures- The debentures which are made in the name of a particular individual who is registered by the company as the debenture holder on there register of debenture holders and also his name appears on the debenture certificate. These debentures can be transferred in the similar way as shares are transferred by due means of proper instrument which includes stamped duly, executed and satisfying the demands under Section 56 of the Companies Act, 2013.

(B) Bearer Debentures- These shares on the other hand are negotiable instrument are made out to bearer and so are transferrable by only delivery like share warrants. The person to whom a beared debenture is transferred becomes a "holder in due course" and he has a right to recover and receive the principal amount along with interest on it.

Rules And Guidelines on Debentures

SEBI (ICDR) Regulations 2009[2]
Under the SEBI Regulation 2009, "specified securities" means equity shares and convertible securities. The "convertible securities" is defined as a security which is exchangeable with or converted in equity shares of the company after date of maturity with or without the option of the debenture holder and it also includes convertible preference share or convertible debt instrument. Thus the conditions to be discussed below are specified for equity shares but are also applicable to public issue of convertible debt instruments also. The issuer of such convertible debt instruments shall comply with the following:
·To obtain rating from 1 or more rating agencies.
·Appointment of 1 or more trustee as provided by Section 71(5) of Companies Act, 2013 and some other rules[3].
·Creation of Debenture Redemption Reserve as provided by by Section 71(4) of Companies Act, 2013.
·If the company offers to create a security or charge on its assets with respect to the secured convertible debt instruments, it shall ensure that:
a) Those assets are substantial to discharge the total principal amount at any point of time
b) Those assets shall be free from any interference.
c) The assets or security should come after subtraction of liabilities constituting prior charge, in case the convertible debt instruments are secured by a second or subsequent charge.
d) The redemption of the convertible debt instruments shall be done by the issuer as per the terms and conditions of the offer document. These regulations are also for partly convertible debt instruments.

Provisions of Companies Act 2013 and Companies (Share Capital and Debentures) Rules, 2014

· As provided in Section 71(2) , no company is entitled to issue debentures which carry voting rights. Secured debentures shall adhere to the conditions prescribed.
· Section 71(3) says that subject to certain prescribed terms and conditions secured debentures can be issued by a company.

·Rule 18(1)[4] prescribes following conditions
(1) The company shall issue secured debentures , provided that the date of redemption does not exceed 10 years from the date of issue. The exception to this are companies involved in setting up infrastructure projects can exceed up to 30 years but not beyond that.

(2) The issue of debenture shall be secured by creation a charge on the assets and properties of the company, value of which shall be substantial enough for the due repayment of the principal amount of the debentures along with the interest on it.

(3) It is mandatory for the company to appoint a debenture trustee[5]prior to issue of letter of offer or prospectus for subscription of its debentures. The company shall within 60 days of allotment of debenture, execute a trust deed in to prevent injustice and protect the interest of the debenture holders.

(4) In the case where any issue of debenture by a company which is fully secured by guarantee given by Central government or state government or both then there is no requirement for creating charge on the assets of the company.

Issue of Debentures

The manner of issuing of debentures is usually similar to that of issuing share, it is through prospectus inviting applications for debentures, the money is to be paid in installments on application, allotment and on specific dates. Debentures can, be issued in three ways.

At par: When the amount collected for it is equal to the nominal value of debentures ,it is said to have been issued at par. e.g. the issue of debentures of Rs. 300/- for Rs. 300/-

At Discount: When the amount collected is less than the nominal value, debenture is said to have been issued at discount. For e.g., issue of debentures of Rs. 300/- for Rs. 270/-. The difference of Rs. 30/- is the discount and is called discount on issue of Debentures. This discount on issue of debentures is a capital loss.

At Premium: A debentures is said to be issued at a premium , when the price charged is more than its nominal value. e.g., issue of debentures of Rs. 300 each for Rs. 320, the excess amount over the nominal value i.e., Rs. 20 is the premium on issue of debentures. Premium received on issue of debentures is a capital gain. This Premium on issue of debentures could not be used for distribution of dividend. Premium on debentures reflected under Surplus and the head Reserves on the liability side of the Balance Sheet.

Time limit for issue of debenture certificate
The allotee is entitles to be issued with the debenture certificate within a period of 6 months from the date of allotment. It is provided for in Section 56(4) of the Companies Act, 2013. The Section 56(6) of the Companies Act, 2013 provides that if a company fails to issue the debenture certificate within the time limit, it shall be made liable to pay a fine minimum of 25,000 rupees which may extend to 5,00,000 rupees. The officer who who is in default shall by punished with a fine which is 10,000 rupees minimum and extending to 1,00,000 rupees.

Further in Section 71 of the Companies Act, 2013 there are provisions with respect to issue of debenture which is as follows –
(a) With an approval by a special resolution passed at a general meeting, the company can issue debentures which can be converted into shares either partly or wholly at the time of redemption of debentures.
(b) There shall not be any debenture with any voting rights.
(c) There are certain terms and conditions prescribed subject to which the company can issue secured debentures As per rule 18 of Companies (Share conditions and Debentures) Rules[6], 2014 subject to some conditions only secured debentures of redeemable nature can be issued, the conditions are as follows-
·The redemptions date for secured debenture shall not exceed 10 years from the time of issue of debentures. However , there are a few classes of company which can issue secured debentures exceeding the period of 10 years but not more than 30 years
(i) The companied which are involved in setting of infrastructural projects
(ii) Infrastructure Finance Companies[7]
(iii) Infrastructure Debt Fund Non- Banking Financial Companies[8]

·The issue of debenture shall be secured by creation a charge on the assets and properties of the company, value of which shall be substantial enough for the due repayment of the principal amount of the debentures along with the interest on it.

·It is mandatory for the company to appoint a debenture trustee[9]prior to issue of letter of offer or prospectus for subscription of its debentures. The company shall within 60 days of allotment of debenture, execute a trust deed in to prevent injustice and protect the interest of the debenture holders

·In the favor of debenture trustee a mortgage or charge shall be created as the security for debentures, which can be-
(i) Any specific movable property of the company which is not in the nature of pledge or
(ii) Any specific immovable property situated anywhere or any interest therein.

(d) For the purpose of securing the form of debentures trust deed, issue of debentures, the procedure for the debenture holder to probe into the trust deed and to get copies thereof, quantum of debenture redemption reserve needed to be created. The rules framed includes that the trust deed has to be executed by the company issuing debentures within 3 months of the closure of the offer or issue.

Debenture Trust Deed
At the of issue of debentures for public subscription, it involves a large number of debenture- holder , it is not practicable to create a individual charges in favor of thousands of debenture – holders. Hence , the most convenient and common for securing all the debenture holders is to execute a trust deed conveying the property belonging to the company to the trustees and announcing a trust in favor of debenture-holders. A trust deed usually gives the trustees a free charge on the property of the company except for the freeholds and leaseholds on which it has fixed charge. A trust deed is the documents containing the conditions put on the debentures and the entitlements of the debenture – holders and the company. Following powers are given to the trustees through the trust deed:-
(i) To get a mortgage over that property of the company’s property in which case the title deeds are transferred to them and the company can not further create charge ranking in the priority of debentures.
(ii) To renew leases and to lease or sell the property.
(iii) To trade of the mortgaged property for any other suitable property.
(iv) To adjust claims.
(v) To defend actions and also to commence them.
(vi) To amend the current contracts applicable on any part of the property.
(vii) To appoint a receiver on the security becoming enforceable.

(a) The benefit of a trust deed is that it is the duty of the trustees to look after the well being and interest of the debenture holders, also the trustees are bound it act in an honest manner with due diligence and care. In fact, any provision or clause in the trust deed which indemnifies trustees against liability or exempting them from their duty as trustees is void.

(b) The trustees have a legal mortgage over property of the company so any person who lends money money subsequently can not be given priority over the debenture holders.

(c) At the time of default made by the company, the trustees have authority of enforcement of security on the part of the debenture – holders.

(d) It is the duty of the trustees to insure that the property is properly maintained and insured. It is not practicable for a large body of debenture holders to do that.

(e) No company is entitled to make an invitation or offer or issue a prospectus to the public or its members more than 500 for subscription of its debenture, unless the company has prior to such offer or issue, the company has appointed one or more debenture trustees[10].

(f) The debenture trustee has a duty to address the grievances of the debenture holder and to take steps to protect their interests complying to the prescribed laws.

Rights/Remedies of Debenture Holder

·According to the rule 18[11]it is the duty of the debenture trustee to communicate debenture holders defaults, if occurs, with respect to redemption of debentures or payment of interest and any either action taken by the trustee himself. Besides , the debenture trustee appoints a nominee director on the board of the company if there are 2 consecutive defaults by the company in payment of interest to the debenture holder or failure in redemption of debentures.

·As per the section 71(8) of the Companies Act, 2013 the debenture holder is entitled to interest and redemption of debentures in accordance with the conditions of their issue.

·In section 71(10) of the Companies Act, 2013 there is a provision if the company makes a default either in payment of interest due or in redemption of debentures on date of maturity of debentures, the Tribunal may , on application wither of debenture trustee or of any or all of the debentures and, after hearing the parties involved , direct, through order , the company to redeem the debenture with payment of principal amount as well as the interest overdue.

·Further if the companies make a default in complying with the order of the tribunal, the section 71(11) of the Companies Act, 2013 provides that the tribunal shall punish the officers in default with an imprisonment which may extend to 3 years or with fine shall minimum be of 2,00,000 rupees and can extend to 5,00,000 rupees or both. This section is applicable to both secured and unsecured debenture holder. The debenture holder can give an application to the Tribunal to pass an order of payment for the company which has defaulted. The Tribunal before passing an order takes into account the circumstances under which the company defaulted in making payment.

·Section 164(2)(b) imposes for disqualification of the directors of the company who has defaulted in redemption of debentures on the date of maturity and if such default has continued for 1 year or more. Such a person will not be able to be director of that company ever again or of any other company for 5 years from the date on which the company has failed to redeem the debentures.

·Section 186(8) of the Companies Act, 2013 provides that any company who has failed to repay any deposits or payment of interest shall not give any loan or guarantee or make any acquisition or provide any security till such default subsists.

Redemption of Debenture

Redemption of debentures stands for repayment of the total amount of the debentures by the company in accordance with the terms and conditions of the issue. once a debenture is redeemed by the company, it is discharged or absolved of the liability on account of those debentures. There are four ways by which the debentures can be redeemed.

These are:
1) Payment in lump sum– At the end of stipulated time period the company redeems debenture by the payment of lump sum amount as per the terms of issue.

2) Payment in installments –The payment for redemption of debentures in this case is made in installments on specific dates during the tenure of the debenture. The total liability of the company is divided into number of years.

3) Purchase in the open market –Redemption of debentures by purchase in the open market is when a company purchases its own debenture to for the purpose of cancellation of such debentures.

4) By conversion into shares or new debentures-In this type the companies redeems its debenture by converting them either into share or creating a new class of debentures. It is at the option of the debenture holder to exercise their right of converting the debentures if he finds the offer beneficial.

Debenture Redemption Reserve Account

As under Section 71(4) of the Companies Act, 2013 at the time of issuing of debentures by the company, it is mandatory for the company to create a debenture redemption reserve account with the profits of the company which are available for dividend and the amount added to such account can be utilized for no purpose other than redemption of debentures.

There are certain conditions prescribed under Rule 18(7) of Companies (Share Capital and Debentures) Rules, 2014. Under it it is obligatory for the company to a Debenture Redemption Reserve for the purpose of redemption of debentures, as per the conditions given below :-
(a) Creation of the Debenture Redemption Reserve shall be out of the profits of the company available for payment of dividend.

(b) The company shall create Debenture Redemption Reserve equal to at least 50% of the money gathers through the debenture issue before debenture redemption starts.

(c) The creation of Debenture Redemption Reserve shall not be latter than 30thof April in each year, deposit or invest an amount which is not below 15% of the amount of debentures maturing during the year till 31stMarch of the next year, in one or more of the below mentioned ways:-
(i) in deposits with any scheduled bank, free from any charge or lien
(ii) in unencumbered securities of the Central Government or of any State Government
(iii) in unencumbered securities[12]
(iv) in unencumbered bonds issued by any other company[13]

(v) the amount deposited or invested as mentioned earlier is not supposed to be used for any purpose other than for redemption of debentures maturing during the year referred above, Provided that the amount remaining invested or deposited, as the case may be, shall not at any time be less than 15% of the amount of the debentures maturing during the year ending on the 31st day of March of that year.

(d) in case of partly convertible debentures, Debenture Redemption Reserve shall be created in respect of non-convertible portion of debenture issue in accordance with this sub-rule.

(e) The amount added to such account can be utilized for no purpose other than redemption of debentures.

A debenture is one of the capital market instruments which is utilized to raise medium or long haul stores from open. A debenture is basically an obligation instrument that recognizes a credit to the organization and is executed under the normal seal of the organization. The debenture record, called Debenture deed contains arrangements as to installment, of intrigue and the reimbursement of important sum and giving a charge on the advantages of a such an organization, which may give security for the installment over the a few or every one of the benefits of the organization. Issue of Debentures is a standout amongst the most widely recognized techniques for raising the assets accessible to the organization. It is an imperative wellspring of back.All organizations are offered energy to obtain by their articles which settle the greatest furthest reaches of borrowings. The ability to obtain monies and to issue debentures (regardless of whether in or outside India) must be practiced by the Chiefs at an appropriately gathered meeting. Where the organization obtains without the expert presented on it by the Articles or past the sum set out in the Articles, it is a ultra vires acquiring and henceforth void. Ultra vires borrowings can't be sanctioned by a determination gone by the organization as a rule meeting. If there should arise an occurrence of ultra vires borrowings the moneylender has the accompanying cures: (an) Injunction and Recovery, (b) Subrogation, (c) Suit against Directors. A debenture is a record given by an organization under its seal as a confirmation of an obligation to the holder generally emerging out of a credit and most generally secured by a charge. Debentures might be of various types, viz. redeemable debentures, enlisted and conveyor debentures, secured and unsecured or stripped debentures, convertible debentures. A debenture stock is an obtained capital combined into one mass for comfort. An advance makes a privilege in the loan boss to request reimbursement, and the substance of an obligation is a risk upon the indebted person to reimburse the cash. A debenture trust deed is one of the few instruments required to be executed to secure recovery of debentures what's more, installment of enthusiasm on due dates. Section 71(4) of the Act required each organization to make a debenture reclamation save record to which sufficient sum should be credited out of its benefits accessible for installment of profit until the point that such debentures are recovered and might use the same only for recovery of a specific set or arrangement of debentures as it were. Certificate of store is an archive of title to a period store. Commercial paper alludes to unsecured promissory notes issued by credit commendable organizations to get supports on a here and now premise.

[1]Section 2(30) of Companies Act, 2013
[2]SEBI ( Issue of Capital and Disclosure Requirements) Regulations , 2009
[3]Securities and Exchange Board of India ( Debenture Trustees) Regulations , 1993
[4]Companies ( Share Capital and Debentures) Rules, 2014
[5]Rule 18, The Companies ( Share Capital and Debenture ) Rules, 2014
[6]Amended vide notification no. G.S.R. 413(E), 18thjune, 2014
[7]Non- Banking Financial ( Non- Deposit Accepting or Holding ) Companies Prudential Norms ( Reserve Bank) Directions , 2007
[8]Infrastructure Debt Fund Non- Banking Financial Companies ( Reserve Bank) Directions , 2011
[9]Rule 18, The Companies ( Share Capital and Debenture ) Rules, 2014
[10]Rule 18, The Companies ( Share Capital and Debenture ) Rules, 2014
[11]The Companies ( Share Capital and Debenture ) Rules, 2014
[12]section 20 of the Indian Trusts Act, 1882
[13]sub-clause (f) of section 20 of the Indian Trusts Act, 1882

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