Debentures

Mrs. Shruti Reddy,

CoLS, UPES
 Meaning and Definition
• S. 2(30): “Debenture includes debenture stock,
bonds, or any other instrument of a company
evidencing a debt, whether constituting a charge on
the company’s assets or not”.
• Levy v. Abercorris Co. [1888] Ch.D. 260-4:
“debenture means a document which either creates
a debt or acknowledges it and document which
fulfils either of those conditions in a debenture”
• Gower, L C B: “debenture is a name applied to
certain types of documents evidencing an
indebtedness which is normally but not necessarily
secured by a charge over property”
 Meaning and Definition
• Every document creating or acknowledging an
indebtedness of the company, until redeemed-
debenture
Characteristic features of Debenture
1. Movable property [S. 44]
2. Issued by the company and in the form of a
certificate of indebtedness
3. Usually specifies the date of redemption
4. Provides for repayment of principal and
interest at specified date/s
5. Generally creates a charge on the undertakings
of the company
• Significance of the term “pari passu”
 Debenture stock
• Creation of one loan fund
• Instead of individual debentures, debenture
stock may be created divisible among class of
lenders
• Instead of separate debts, debenture certificate
reflects part of the whole loan to which lender is
entitled
• Debenture includes debenture stock
Debenture Debenture Stock
Legally transferrable as one entity Can be sub divided and transferred
in any fractions that the holder
wishes
May or may not be fully paid Fully paid
 Distinction between shareholder and
debenture holder
Shareholder Debenture holder
• Member of the company • Lender of the company
• Right to vote • No such right [S. 71 (2)]
• Dividend driven by profits • Entitled to fixed rate of
interest independent of profits
• Winding up: not prioritized • Winding up: prioritized
• Dividend isn’t treated as • Interest on debentures is
charge on profits charge against profits,
deducted from revenue for
calculating tax liability
 Kinds of Debentures
1. Registered debentures:
• Debentures payable to registered holders
• Names appear in the register of debenture holders
• Transferable in the same way as shares or in
accordance with conditions endorsed on their back
• Consists of 2 parts:
a. Covenants by the company to pay principal and
interest
b. Endorsed conditions (term of loan)
• Pari passu or in order of issue if pari passu clause
missing
 Kinds of Debentures
2. Bearer debentures:
• Transferable by delivery (similar to share
warrants); acquires characteristic of a
negotiable instrument
• Regn may be avoided by issuing debentures
payable to bearer - register need not be
maintained of such holders
• Such holder may apply for winding up if not
paid
• Cannot be questioned on acquisition of
debenture
• Interest paid by means of attached coupons
 Kinds of Debentures
3. Perpetual or Irredeemable debentures:
• Contains no clause as to payment
• Contains clause that it shall not be paid back
• “Once a mortgage, always a mortgage”- Oliver, M C
• Rule: Once principal or interest is paid, property
may be redeemed
• Section 120, Companies Act, 1956: Exception to
the rule: debentures can be made perpetual, loan
may be paid on winding up or a long period of time
• No corresponding provision under Companies Act,
2013, thus, fresh irredeemable debentures can’t be
issued
 Kinds of Debentures
4. Redeemable debentures:
• Issued for a specified period of time u/S. 71 and
corresponding rules
• Right to pay back as stipulated and redeem
property
• Re-issue of redeemed debentures (Section 121,
Companies Act, 1956): AoA should permit it; no
other conditions contrary to it; no intention to
cancel redeemed debentures- debentures may
be kept alive for re-issue; no corresponding
provision in Companies Act, 2013
 Kinds of Debentures
5. Naked/ unsecured debentures:
- debentures may be issued without any charge on
company’s assets
- mere acknowledgement of debt
- creates no rights beyond those of ordinary unsecured
creditors
- Unsecured debentures treated as deposits; thus to
confirm with provisions applicable to public deposits
6. Convertible debentures: option given to debenture
holders to convert it into equity or preference shares at
stated rates of exchange, after a certain period;
requirement of special resolution for issue- S. 71
Cannot be reconverted into debentures.
 Kinds of Debentures
• Classification on basis of convertibility:
1. Fully convertible debentures (FCDs):
- Debentures convertible into equity shares of co. on
expiry of certain specified period/s
- Conversion after 18 but before 36 months of
allotment: optional on part of debenture holders in
terms of SEBI guidelines
- After 36 months: put and call option to be exercised
2. Non- convertible debentures (NCDs):
- Right to convert debentures into equity shares not
conferred on holder
- Debentures redeemed at expiry of specified period
 Kinds of Debentures
3. Partly convertible debentures (PCDs)
- Two parts- convertible and non convertible
- Convertible: debentures converted into equity
shares at expiry of certain period
- Non convertible: debentures redeemed at
expiry of certain period
 Features of Convertible Debentures
1. Conversion into specified or unspecified no. of equity
shares at the end of specified period
2. Conversion Price/ Conversion Ratio: ratio at which
debentures are exchanged for shares
3. Calculation of Conversion price/ratio and Conversion
premium: dividing face value of debenture by its
conversion price
4. Fully or partly convertible
5. May be converted in one or more stages
6. Credit rating of debentures- if conversion after 18
months
7. Interest paid as per market forces; interest rates
deregulated after 1991
8. Listed on stock exchange
 Floating Charge
• S. 2(30):A charge may or may not be created on co.’s
assets while issuing debentures [S. 2(16)- charge
includes mortgage]
• 2 kinds of charges may be created:
a.Fixed charge
b.Floating charge
• Fixed charge: mortgage created on definite or specific
assets of co.- permanent- land, building, heavy
machinery; co. loses right to transfer property
unencumbered without sanction of charge holder;
possession continues with co. though
• Floating charge: created on property which is of liquid
nature, assets keep changing, need to create fresh charge
every time the property turns in course of business;
sanction of lender not required to dispose the property;
floating charge does not get attached to any specific
property till it crystallizes
 Floating Charge
• Characteristics of floating charge:
 Yorkshire Woolcombers’ Assn Ltd., Re ([1903] 2 Ch 284)
1. It should be a charge upon a class of assets both present and
future
2. Class of assets charged must be one which in ordinary course
of business of co. would change from time to time
3. It should be obvious that unless action is taken by mortgagee,
the co. shall have right to use assets comprised in charge in
ordinary course of its business

 Government Stock Co. v. Manila Railway [1897] A.C. 81

“A floating charge is an equitable charge on the assets for the
time being of a going concern. It attaches to the subject charged
in the varying conditions in which it happens from time to time.
It is the essence of such a charge that it remains dormant until
the undertaking ceases to be a going concern or until the person
in whose favour the charge is created, intervenes. This right to
intervene may of course, be suspended by agreement. But, if
there is no agreement of suspension, he may exercise his right
whenever he pleases after default”.
 Floating Charge
• Difference between fixed charge and floating charge-
degree of control over the property which charge
holder exercises
• Construction of instrument of charge: intention of
parties should be focused on
• Before crystallization of floating charge co. can
deal/dispose assets of co. in ordinary course of
business
• Further floating charge cannot be created (Re
Benjamin Cpe & Sons, [1914] 1 Ch. 800)
• Can be created only by incorporated co.- created by
deed- must be regd with RoC
 Crystallization of floating charge
• Debentures with undertaking to pay principal
sum at specified date with interest in meantime
• When assets seized in this manner- called as
crystallization of charge
• Government Stock Investment Co. Ltd. v.
Manila Railway Co. Ltd., [1897] A.C. 81:
mortgage having priority over floating charge
• Floating charge may be created only by an
incorporated body; must be created by a deed
and registered with RoC
 Crystallization of floating charge
• Instances of crystallization of floating charge:
1. When co. goes into liquidation
2. When co. ceases to carry on business
3. When creditors/debenture holders enforce the
security
4. On the happening of specified event in the
deed
 Effect of winding up on
Floating Charge (S. 332)
• Validity of floating charge
-floating charge created 12 months immediately
before commencement of winding- invalid
-Exceptions:
a. If co. was solvent after creation of charge; and
b.Charge valid to the extent to which any cash
was paid to co. under the charge
-Objective: to prohibit insolvent co.s to create
charge
 Registration of Charges (S. 77)
• Co. authorised to borrow may create charge (even on
uncalled capital) subject to MoA and AoA
• Co. to register charge created on any property within 3o
days of its creation in prescribed form, manner with
prescribed fee
• Extension of time up to 300 days on completion of 30
days- addl fee if co. satisfies RoC it had sufficient reasons
for the delay
• Further extension of time: failure to register on expiry of
300 days, appln to CG u/S. 87
• Charge created by decree of court of law- beyond ambit
of S. 125
• On additional fee & on sufficient grounds for delay- 30
days extension may be given by RoC
 Particulars with the Registrar
• Every instrument/ deed creating charge to be
verified
- Property wholly situated outside India:
verification as true copy by co./ co. offr./ person
interested in mortgage
- Property wholly/ partly situated in India: co. offr./
pub. offr.
• Failure to deliver particulars of charge- validity of
charge not affected (T R Thayagarajan v. Official
Liquidator [1960] 30 Comp. Cas. 481 (Mad)
 Particulars to be filed with the
Registrar
1. Date and description of the instrument creating charge
2. Amount secured by charge
3. Short particulars of property charged; if property
charged subject to charge- date of acquisition of
property
4. Gist of terms, conditions, extent & operation of charge
5. Names, addresses and description of persons entitled
to charge
6. Date and description of instrument modifying charge
7. All details of modification
 Issue of Debentures
• Prospectus/ letter of offer
• Issue of debenture certificates [S. 56(4)]: within 06 months from date
of allotment; default [S. 56(6)]- co. (25,000/- upto 05 lakh); officer
(10,000/- upto 01 lakh)
• Issue of Debentures [S. 71]:
 Convertible debentures- special resolution at GM
 No voting rights
 Secured redeemable debentures
a. Date of redemption- not to exceed 10 yrs from date of issue
b. Companies with date of redemption not exceeding 30 yrs:
i. Companies engaged in setting up Infrastructure Projects;
ii. Infrastructure Finance Companies
iii.Infrastructure Debt Fund Non Banking Financial Companies
c. Debenture to be secured by creation of charge on property
sufficient for repayment
d. Appointment of debenture trustee: before issue of prospectus/
letter of offer and not later than 60 days after allotment
e. Creation of security on specific movable/ immovable property of
the company
Contd.
 Debenture Redemption Reserve Account: out of
profits, available for payment of dividends; amount to be
utilized only for redemption of debentures:
a. DRR not required- All India Financial Institutions, both
pub and pvt placed debentures
b. Other Financial Institutions- DRR same as NBFC regd
with RBI
c. NBFC & Housing Finance Companies (regd with National
Housing Bank): 25% of value of debentures issued
through pub issue and no DRR for pvt placed issue
d. Other companies (including infra and manufacture
companies): 25% of value of debentures issued through
pub issue and pvt placed issue
e. Unlisted companies: 25% of value of debentures issued
through pvt placed issue
Contd.
 Minimum amount to be maintained in DRR: on or
before April 30 every year: create/ invest/ deposit- sum not
less than 15% of amount maturing during the current
financial year- following methods
a. Deposits with Scheduled Banks, free form charge or lien;
b. Unencumbered Securities of CG/SG;
c. Unencumbered Securities under Indian Trusts Act, 1882;
d. Unencumbered Bonds issued by any other company under
Indian Trusts Act, 1882;
e. Amount invested not to be used for any purpose other
than redemption of debentures maturing as above; at no
time DRR to fall below 15%
f. Partly convertible debentures- DRR to be created for non
convertible portion of debentures
Contd.
 Public Offer: if to more than 500, appointment of
debenture trustee- mandatory
 Debenture trust deed- void, if clause of exemption of
liability of trustee or clause of indemnification present;
3/4th in value of debenture holders may subject liability
to exemptions agreed by them in a meeting held for that
purpose
 Payment of interest & Redemption of debentures: acc to
T&C of issue
 Insufficiency of assets: debenture trustee to file a
petition to NCLT; NCLT may impose restrictions on
incurring further liabilities by company on its assets
Contd.
 Failure of redemption and payment of
interest: application by any/ all debenture
holders/ debenture trustee to NCLT; NCLT may
pass orders to pay forthwith
Default in complying with NCLT order: offr.
responsible- imprisonment upto 03 years OR fine
not less than 02 lakh INR, upto 05 lakh OR both
Contract with company- payment of debentures-
may be enforced by decree for specific performance
Procedure for security in secured debentures, form
of debenture trust deed, process of inspection of
trust deed by debenture holders+ copies, quantum
of debenture redemption reserve, etc- CG