Module 2

Debentures
Debentures

• To raise funds company offers public to buy shares of the company. The other way to raise fund is by way of
debenture- means to take loan. So there are two ways of getting funs- Equity and debt
• When company doesn't wants to dilute its Share Capital it can go for borrowing from Banks and Public
• Definition: Section 2(30)Debentures includes Debentures Stocks, Bonds or any other instrument of a
company evidencing a debt, whether constituting a charge on the assets of the Company or not provided.
However as per Companies (Amendment) Act,2017 (a) The instrument referred to in chapter III-D of RBI act.
1934; and (b) Such other instrument as may be prescribed by the Central Government in consultation with
the RBI, issues by a Company, shall not be treated as debentures.
• A debenture may be defined as an instrument acknowledging a debt by a Company to some person or
persons.
Characteristics of Debenture

• Debenture is a movable property.

• A debenture is in a form of Certificate (like a share certificate) issued under the common seal (if any) of the
Company
• A debenture usually provides for the payment of a specified sum at a specified date.
• A debenture usually provides for the payment of interest until the principal sum is paid back.
• A company shall not issue any debentures carrying voting rights
• The certificate is the acknowledgement by the Company of the indebtedness.
• It generally creates a charge on the undertaking or undertakings of the company.
 Pari-passu clause:
• Means ranking equally amongst themselves. With Pari Passu every Debenture Holder is entitled to share the
proceeds of the security realised equally even though issued at different times.
• Without Pari Passu- As per dates of issue and if on the same date then as per serial number of debentures
issued.
• Usually the words pari passu appear in the terms and conditions of debentures. This means that all the
debentures of a particular class will receive the money proportionately in case the company is unable to
discharge the whole obligation.
• In the absence of this clause the debenture-holders would rank in accordance with the rank of the issue and
if issued on the same date then in the order of time when they were issued (which is known by the serial
number of the debenture).
 Debenture Stock
• A company, instead of issuing individual debentures, evidencing separate and distinct debts, may create one
loan fund known as “debenture-stock” divisible among a class of lenders each of whom is given a debenture-
stock certificate evidencing the parts of the whole loan to which he is entitled.
• Debenture is a single thing which can be legally transferred only as one entity whereas debenture-stock can
be sub-divided and transferred in any fractions which the holder wishes. One more difference between the
two is that while debenture stock must be fully paid, debenture may or may not be fully paid.
Distinction between shareholder and debenture
holder
Shareholder Debenture holder
1. A shareholder is a member of the company A debenture holder is a lender to the company.
2. A shareholder has a right to vote A debenture holder does not enjoy such a right. Sub-
section (2) of section 71 of the Companies Act, 2013
declares that no company shall issue any debentures
carrying voting rights
3. Income on shares depends on the profits. Debenture holders are entitled to a fixed rate of
Shareholders are entitled to get dividend only interest which the company must pay irrespective of
out of profits. profits, i.e., profits or no profits.
4. In the event of winding-up, shareholders Debenture holders, normally being secured lenders,
cannot claim payment unless all outside have prior claim for repayment.
creditors have been paid in full
5. Dividend on shares is not a charge against profit Interest on debentures, on the other hand, is a
charge against the profits and is deducted from
revenues for the purpose of calculating tax liability
Types of Debentures
 Registered Debentures: These debentures are such debentures within which all details comprising
addresses, names and particulars of holding of the debenture holders are filed in a register kept by the
company. Such debentures can be moved only by performing a normal transfer deed.
 Bearer Debentures: These debentures are 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.
 Irredeemable Debentures: Irredeemable debentures continue for perpetuity and unlike redeemable
debentures, there is no fixed date on which the company needs to pay the debenture holders. It becomes
redeemable only when the company goes into liquidation. Though irredeemable debentures were allowed
under section 120 of the Companies Act, 1956, no corresponding provision has been made under the Act of
2013. Thus, no fresh irredeemable debentures may be issued by the companies.
 Redeemable Debentures: Redeemable debentures are the debentures where the date of redemption of the
debentures are specifically mentioned in the debenture certificate issued, where on such date, the company
is legally bound to return the principal amount to the debenture holder. Section 71 and the rules framed
thereunder regulate issue of such debentures.
 Unsecured Debentures: Unlike secured debentures, unsecured debentures are issued by the company
without creation of charge over the assets of the company. In other words, these debentures do not offer
any protection to the debenture holder in case the company is unable to pay the principal amount on the
due date. They are mere acknowledgements of a debt due from the company, creating no rights beyond
those of ordinary unsecured creditors. Such debentures are called 'Naked or unsecured debentures'.
Unsecured debentures are treated as deposits and should, therefore, conform to requirements applicable to
public deposits accepted by a company.
 Secured Debentures: When the debentures are issued by way of creation of charge over the assets of the
company, then such debentures are called as secured debentures. The charge created over the debentures
may be fixed or maybe floating
• Secured debentures may be issued by a company subject to such terms and conditions as may be prescribed
by Companies (Share Capital and Debentures) Rules 2014 and amendment thereof.
• CONDITION FOR ISSUE OF SECURED DEBENTURE: Before issue of the secured debentures by the company
they have to comply with the following conditions, namely:
1. Redemption of Secured Debenture shall not exceed ten years from the date of issue. Provided following
classes of companies may issue secured debentures for a period exceeding ten years but not exceeding
thirty years,
i. Companies engaged in setting up of infrastructure projects;
ii. Infrastructure Finance Companies;
iii. Infrastructure Debt Fund Non-Banking Financial Companies
iv. Companies permitted by a Ministry or Department of the Central Government or by Reserve Bank of India
or by the National Housing Bank or by any other statutory authority to issue debentures for a period
exceeding ten years.
2. Issue of debentures shall be secured by the creation of a charge on the properties/assets of the company/
its subsidiaries/ its holding company/ its associates companies, having a value which is sufficient for the due
repayment of the amount of debentures and interest thereon
3. company shall appoint a debenture trustee before issue prospectus or make an offer or invitation to the
public or to its members exceeding five hundred for the subscription of its debentures and execute trust
deed within sixty days from the allotment of the debentures to protect the interest debenture holder
4. The company shall comply with the requirements with regard to Debenture Redemption Reserve (DRR).
 Convertible debentures - A company may also issue convertible debentures, in which case an option is given to the
debenture-holders to convert them into equity or preference shares at stated rates of exchange, after a certain period.
Section 71 requires the company to pass a special resolution for issue of convertible debentures whether wholly or
partly. Such debentures once converted into shares cannot be reconverted into debentures.
According to convertibility, debentures are further classified into three categories:
1. Fully Convertible Debentures (FCDs)

2. Non-Convertible Debentures (NCDs)

3. Partly Convertible Debentures (PCDs).

Fully convertible debentures: Debentures that are converted into equity shares of the company on the expiry of specified
period or periods. Where the conversion is to be made at or after 18 months from the date of allotment but before 36
months, the conversion is optional on the part of the debenture holders in terms of SEBI guidelines.

Non-convertible debentures: Debentures that do not confer any option on the holder to convert the debentures into
equity shares and are redeemed at the expiry of a specified period.

Partly convertible debentures : Partly convertible debenture consists of two parts: convertible and non-convertible. The
convertible portion is convertible into equity shares at the expiry of specified period. Non-convertible portion, on the
other hand, is redeemed at the expiry of a certain period. Where the conversion takes place at or after 18 months, as per
SEBI's guidelines, the conversion is optional at the discretion of the debenture-holder.
Issue of Debentures- Section 71
1. A company can issue debentures with an option to convert such debentures into shares, either wholly or
partly at the time of redemption. Provided that it shall be approved by a special resolution passed by the
shareholders in a duly convened general meeting of the company.
2. No company shall issue any debentures carrying any voting rights.
3. Secured debentures may be issued by a company subject to such terms and conditions as may be
prescribed.
4. Where debentures are issued by a company, the company shall create a debenture redemption reserve
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.
5. No company shall 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 the company has, before such issue or
offer, appointed one or more debenture trustees.
6. A debenture trustee shall take steps to protect the interests of the debenture holders and redress their
grievances.
7. The trustees to watch the interest of the debenture-holders who are bound to act honestly and with due
care and diligence. In fact, any clause in the trust deed exempting them from liability for breach of their
duty as trustees or which indemnifies them against liability is void.
However, the liability of the debenture trustee shall be subject to such exemptions as may be agreed upon
by a majority of debenture-holders holding not less than three-fourths in value of the total debentures at a
meeting held for the purpose.
8. A company shall pay interest and redeem debentures as per the terms and conditions of issue.
9. Tribunal may impose restrictions on incurring further liabilities-Where at any time the debenture trustee
comes to a conclusion that the assets of the company are insufficient or are likely to become insufficient to
discharge the principal amount as and when it becomes due, the debenture trustee may file a petition
before the Tribunal and the Tribunal may, after hearing the company and any other person interested in the
matter, by order, impose such restrictions on the incurring of any further liabilities by the company as the
Tribunal may consider necessary in the interests of the debenture-holders.
10. Tribunal may order for redemption-Where a company fails to redeem the debentures on the date of their
maturity or fails to pay interest on the debentures when it is due, the Tribunal may, on the application of
any or all of the debenture-holders, or debenture trustee and, after hearing the parties concerned, direct,
by order, the company to redeem the debentures forthwith on payment of principal and interest due
thereon.
11. Penalty- Any default is made in complying with the order of the Tribunal- every officer in default shall be
punishable with imprisonment for a term which may extend to three years or with fine which shall not be
less than two lakh rupees but which may extend to five lakh rupees, or with both.
12. A contract with the company to take up and pay for debentures of the any company may be enforced by a
decree for specific performance.
13. Rules by Central Government- The Central Government may prescribe the procedure, for securing the
issue of debentures, the form of debenture trust deed, the procedure for the debenture-holders to inspect
the trust deed and to obtain copies thereof, quantum of debenture redemption reserve required to be
created and such other matters.
 Time within which Debenture certificate to be Issued
• Section 56(4) of the Companies Act, 2013 provides that the debenture certificate must be issued to the
allottee within a period of six months from the date of allotment.
• Section 56(6)-In case of default, Company punishable with fine- not less than 25,000 but may extend to 5
lakh and every officer in default punishable with fine- not less than 10,000 but may extend to 1 lakh.
Debenture Redemption Reserve (DRR)

• Debenture Redemption Reserve shall be created out of the profits of the company available for payment of
dividend
• Company shall create Debenture Redemption Reserve (DRR) in accordance with following conditions:
i. DRR not required for debentures issued by All India Financial Inst. (AIFIS) and banking companies.
ii. In case of NBFCs registered with RBI DRR will be 25% of the value of outstanding debentures issued
through public issue. In case of privately placed debentures then not required
iii. For other companies including manufacturing and infrastructure companies, the adequacy of DRR will be
25% of the value of outstanding debentures issued through public issue and also 25% DRR is required in
the case of privately placed debentures by listed companies.
• In case of partly convertible debentures, DRR shall be created in respect of non-convertible portion.
• The amount credited to the Debenture Redemption Reserve shall not be utilised by the company except for
the purpose of redemption of debentures.
Debenture Trust Deed
• When debentures are issued for public subscription, involving a considerable number of debenture-holders, it is
not feasible to create a separate charge in favour of thousands of debenture-holders. Therefore, the most
common and convenient form of securing them is to execute a Trust Deed conveying the property of the
company to the trustees and declaring a trust in favour of the debenture-holders.
• The trust deed contains the terms and conditions endorsed on the debentures and defines the rights of the
debenture-holders and the company
• The advantage of trust deed is that it becomes the function of the trustees to watch the interest of the
debenture-holders who are bound to act honestly and with due care and diligence. In fact, any clause in the trust
deed exempting them from liability for breach of their duty as trustees or which indemnifies them against
liability is void.
• Debenture trustee - Responsible for protecting the interest of Debenture holders and redressing the grievances.
• It is Mandatory to appoint Debenture trustee in case of prospectus, public (Offer or invite) and when there are
more than 500 members
• Company shall execute Trust deed with trustees to protect interest of debenture holders
• 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
• 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 or immovable property