LEGAL CONCEPT AND PROVISION OF DEBENTURE

By: Kanishka Vashistha

Roll no.: A-14
Class: BA LLB 4th Year Sem VII

ABSTRACT
As we all know share capital is the main source of finance of a company. Such capital
is raised by issuing shares. Those who hold the shares of the company are called the
shareholders and are owners of the company. The company may need an additional
amount of money for a long period. It cannot issue shares every time. It can raise
loans from the public. The amount of loan can be divided into units of small
denominations and the company can sell them to the public. Each unit is called a
‘debenture’ and the holder of such units is called a Debenture holder. The amount so
raised is a loan for the company.
A debenture is the most important instrument and method of raising the loan capital by
the company. A debenture is like a certificate of loan or a loan bond evidencing the
fact that the company is liable to pay a specified amount with interest and although the
money raised by the debentures becomes a part of the company’s capital structure, it
does not become share capital.

INTRODUCTION
In every organization, whether it operates on any scale, there is a need for funds, for
conducting various business activities. There has to be sufficient capital, based on the
appetite of the company, in order to ensure smooth functioning. There are various
methods adopted by companies to raise funds and capital, but some companies might
opt for issuing debentures, especially when there is a need for raising funds for the
long term.
The shareholders are the company’s investors/owners. As the company’s equity assets
are depleted, it must seek financing help from outside sources such as External
Commercial Borrowing (ECB), Debentures, Bank Loans, and Public Fixed Deposits.
A provision for borrowing powers for the company is included in the memorandum of
association of a company. . As the funds raised by the issuance of shares would not be
enough to satisfy the company’s long-term financial needs. As a result, companies
choose to raise long-term capital through debentures.
A debenture is an amount of a loan that a company has to raise from the public that’s
why a company issues debenture. A person who purchased and holds a debenture is
called a debenture holder who becomes the creditor/ charge holder of the company a
debenture is a document that bears the company’s seal and is issued by it. A debenture
is a document that acknowledges the fact that the company has earned funds in the
sum of the debenture’s nominal value. It entails paying a fixed rate of interest before
the principal is repaid.
It specifies the redemption date as well as the interest rate and method of payment.
The Indian capital market has evolved at a much faster pace in recent years, owing to
the introduction of new instruments and changes to existing technology. Debentures
are proving to be a valuable contributor to the corporate sector’s financial needs in the
current situation. In comparison to other ways of raising capital from the market, such
as preferred shares, bonus shares, equity shares, and rights issues, the issuance of
debentures is a major means of raising capital from the market.
The Companies Act provides an expansive definition of debentures rather than an
exhaustive definition. According to Section 2(30) of the Companies Act 2013, the
company has the authority to issue bonds or debentures, which are debt instruments
that can be both secured and unsecured by establishing a fee on the company’s assets.
Debentures are a form of long-term unsecured bond that a company may issue if it
agrees to repay it at a specified future date. The company normally pays interest to
debenture holders at the end of each year before maturity, but if it is unable to pay
either the interest or the principal amount of the loan, the creditors of the company
have the right to request the competent authority that the company be liquidated to
recover their money by selling the company’s properties.

MEANING OF DEBENTURE
The word ‘debenture’ has been derived from the Latin word ‘debere’ which means to
borrow. A debenture is a written instrument acknowledging a debt under the common
seal of the company. It contains a contract for repayment of principal after a specified
period or at intervals or the option of the company and for payment of interest at a
fixed rate payable usually either half-yearly or yearly on fixed dates.
According to section 2(12) of The Companies Act,1956 ‘Debenture’ includes
Debenture Inventory, Bonds, and any other securities of a company whether
constituting a charge on the assets of the company or not.
Another term used in companies in the same perspective is ‘Bond’. Bond is an
instrument of acknowledgment of debt. Traditionally, the Government issued bonds,
but these days, bonds are also being issued by semi-government and non-
governmental organizations. The terms ‘debentures’ and ‘Bonds’ are now being used
interchangeably.

CHARACTERISTICS OF DEBENTURES
1. 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 assets/ undertaking of the
company. There is usually a specific date of redemption. \
2. The debenture holders are creditors to the company and they do not have any claim
of ownership of the company, unlike shareholders.
3. As the debenture holders are not the owner of the company so they are not entitled
to the administration and management of the company.
4. 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.
5. Debentures usually have a charge on the assets of the company, which means that if
the company goes into liquidation and is not able to repay the amount, the debenture
holders can also sell the property of the company through the legal process under the
applicable law to recover the money of the debenture holders.
6. There is an undertaking given by the company to repay debenture holders the
principal amount along with the interest at the stated time.
7. The debenture holders cannot claim the privilege to vote in any meeting of the
company.
8. When the company is in winding up, the priority of the company is to repay the
debenture holders of the company as per the applicable law hence, there is no risk
involved of loss of money of the debenture holders.

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 the following
categories:
(A) Non-Convertible Debentures- This form of debenture can’t be converted into
equity or preference shares. These debentures are typically repaid only after they reach
their maturity date, which is normally 10 or 20 years. These instruments keep their
debt status and can’t be converted into stock of the company.
(B) Partly Convertible Debentures – These partly convertible debentures will be
converted into equity shares at the issuer’s discretion in the future. The conversion
ratio is set by the issuer. The ratio is normally determined when the debentures are
subscribed. If a debenture holder converts any of his debentures into equity, he
becomes a shareholder for those converted shares and his rights are amended
accordingly. Thus, convertible debentures are debentures that can be converted by the
debenture holder as agreed upon after a set period of time.
 (C) Fully Convertible Debentures – These are debentures that can be exchanged
into equity or preference shares at a fixed rate of exchange after a set period of time. If
a debenture holder converts his debentures into shares, he ceases to be the company’s
creditor and becomes a member as an additional shareholder. Thus, convertible
debentures are debentures that can be converted by the debenture holder after a set
period of time. The rate at which the debenture is exchanged is determined at the time
of issue of such debentures. Only interest is paid to the debenture holder before the
conversion, after which the rights exercised are the same as those of a shareholder.
The approval of the shareholders of the company is required prior to the issuance of
convertible debentures.
(D) Optionally Convertible Debentures- The debenture holder has the option/ability
to convert his or her debentures into stock. The issuer determines the price of
conversion, which was agreed upon by all parties at the time of the issue of such
debentures
2. On the basis of security, Debentures are classified into the following categories:
(A) Secured Debentures- The instruments of secured debentures are secured with the
charge on the company’s fixed assets. This is to protect the debenture holder in the
event that the issuer company defaults on either the principal or interest payment, the
issuer’s assets can be sold off to satisfy the debenture holders’ obligation as per the
due process of law. Section 71(3) of the Companies Act of 2013 states that a company
has the right to issue secured debentures subject to the government of India’s
conditions.
(B) Unsecured Debentures- These debentures are unsecured in the sense that if the
principal or interest is not paid, the debenture holder will be forced to join other
unsecured lenders and will be unable to sell any property or other assets to repay the
debt, thus the name “unsecured debentures.”
3. On the basis of Redeem ability, Debentures are classified into the following
categories:
(A) Redeemable Debentures – Redeemable debentures are those which are payable
on the expiry of the specific period either in a lump sum or in Installments during the
lifetime of the company. Debentures can be redeemed either at par or at a premium.
(B) Perpetual or Irredeemable Debentures - “An irredeemable debenture is one in
which the borrower does not have a set period to repay the principal. The debenture
holder has no right to claim payment of the principal unless the company defaults in
making regular interest payments. If a company goes bankrupt, it must pay off all of
its debentures, whether redeemable or irredeemable.
4. On the basis of Registration, Debentures are classified into the following categories:
(A) Registered Debentures- The debentures issued in the name of a specific person
who is listed as a debenture holder on the company’s register of debenture holders and
whose name appears on the debenture certificate. These debentures may be transferred
in the same manner as shares are transferred, by the use of a proper instrument that is
stamped, executed, and meets the demands set forth in Section 56 of the Companies
Act, 2013.
(B) Bearer Debentures- These debentures, on the other hand, are a negotiable
instrument that is made payable to the bearer and can only be transferred by delivery,
similar to share warrants. An individual who receives a bearer debenture bond
becomes a “holder in due course,” with the right to recover and collect the principal
sum as well as interest.

LEGAL PROVISIONS OF DEBENTURE

A debenture is the most important instrument and method of raising the loan capital by
the company. A debenture is like a certificate of loan or a loan bond evidencing the
fact that the company is liable to pay a specified amount with interest and although the
money raised by the debentures becomes a part of the company’s capital structure, it
does not become share capital.
Rules and Guidelines on Debentures
SEBI issue of capital and disclosure requirement (ICDR) Regulations 2009
“Specified securities” are defined as equity shares and convertible securities under the
SEBI Regulation 2009. The term “convertible securities” refers to a bond that can be
exchanged for or converted into equity shares of a company after its maturity date,
with or without the debenture holder’s consent, which also includes convertible
preference shares and convertible debt instruments. As a result, the conditions to be
addressed below apply not only to equity securities but also to public issues of
convertible debt instruments. The issuer of such convertible debt instruments must
meet the following requirements:
i. To get a ranking from one or more credit agencies.
ii. Appointment of one or more trustees in accordance with Section 71(5) of
the Companies Act, 2013 and certain other laws.
iii. Establishment of a Debenture Redemption Reserve in accordance with
Section 71(4) of the Companies Act of 2013. iv. If the company offers to
establish a guarantee or fee on its assets in connection with the secured
convertible debt instruments, it must ensure the following:
a) Those assets are sufficient to pay off the entire principal sum at any time.
b) Such properties must be protected from all forms of interruption.
c) If the convertible debt instruments are backed by a second or subsequent payment,
the assets or security should come after the liabilities constituting the prior charge.
d) The issuer is responsible for redeeming the convertible debt securities in
accordance with the terms and conditions of the offer contract. These rules apply to
partially convertible debt instruments as well

ISSUE OF DEBENTURES
Debentures are normally issued in the same way as they issue shares like, through a
prospectus accepting applications for debentures, with the money to be charged in
installments on application, allotment, and particular dates. There are three ways to
issue a debenture.
At par: It is said to have been issued at par when the sum received for it is equal to
the nominal value of the debentures. For example, the issue of debentures worth Rs.
300/- for Rs. 300/- is said to have been issued at par.
At Discount: A debenture is said to have been given a discount when the amount
received is less than the nominal value. Consider the issue of Rs. 300/- debentures for
Rs. 270/-. The difference of Rs. 30/- is the discount, which is referred to as discount
on Debenture.
At Premium: If the price paid for a debenture is higher than the nominal value, it is
said to be issued at a premium. For example, if you issue 300 rupee debentures for 320
rupees, the excess sum over the nominal value, i.e. Rs. 20, is the premium on
debentures. A capital gain is a premium gained on the issuance of debentures. This
premium on debenture issuance could not be used for dividend distribution. Premium
on debentures is expressed on the liability side of the Balance Sheet under Surplus and
Reserves.

CONCLUSION
In business, issuing debentures is one way to raise money for the working of the
company. It is very different from equity shares or other kinds of shares (both
preference and equity). The basic distinction being, when one buys the shares of the
company he becomes the part-owner of the company, but when one buys debentures
issued by the company he becomes a creditor to the company. We can conclude that
debenture is a kind of formal loan given to the company by another individual. The
company is under obligation to repay the loan within a specified period of time with
interest.