Debenture

Debentures
A debenture is a document which creates or
acknowledges a debt.
See the Definition of Securities u/s 2(h) of Securities
Contract Regulations Act.
Debentures - Definition
Debenture includes debenture stock, bonds and any other
securities of a company whether constituting a charge on the
assets of a company or not [Sec 2 (30)].
This is an inclusive definition and amounts to borrowing of
monies from the holders of debentures on such terms and
conditions subject to which the debentures have been issued.
 It is a document or certificate signed by the authorized
officers of a company acknowledging money lent and
guaranteeing repayment with interest and creating security
on the assets of the company for due performance of its
obligation.
Debenture stock
Debenture stock, loan contract issued by a company or
public body specifying an obligation to return borrowed
funds and pay interest, secured by all or part of the
company’s property.
Certificates specifying the amount of stock, with coupons for
interest attached, are usually issued to the lenders.
The interests of the stockholders may be protected by a trust
deed naming a trustee who acts on behalf of the stockholders
and against whom they actually have claim. In case of default
, the debenture holder may appoint a receiver to seize and
realize assets and repay the money secured. 
Issue of Debentures [Section 71 (1)]
A company may issue debentures with an option to
convert such debentures into shares, either wholly or
partly at the time of redemption.
 Issue of Debentures to be approved by special
resolution.
 No debenture shall carry voting rights.
Kinds of Debentures
 Redeemable and Irredeemable Debentures
(Companies Act, 2013, now a company cannot issue
perpetual or irredeemable debentures).
 Secured and Unsecured or Naked Debentures.
 Registered and bearer debentures.
 Fully Convertible Debentures (FCDs).
 Non Convertible Debentures (NCDs).
 Partly Convertible Debentures (PCDs).
Debentures
Redeemable Debentures
They are issued on the terms that the company is
bound to repay the amount of the debenture, either at
a fixed date, or upon demand, or after notice, or under
a system of periodical drawings.
Debentures
Perpetual or Irredeemable Debentures: A Debenture in which no
time is fixed for the company to pay back the money, although it
may pay back at any time it chooses, is an irredeemable
debenture.
 The debenture holder cannot demand payment as long as the
company is a going concern and does not make default in
making payment of the interest.
 Normally irredeemable debentures are not issued.
 Though there is no legal bar on the issue of irredeemable
debentures in 1956 – in 2013 it is a history.
SEBI Guidelines on debentures presumes the redeemability of
debentures.
Debentures
  Secured and Unsecured Debentures: Where
debentures are secured by a mortgage or a charge on
the property of the company, they are called secured
debentures. Where they are not secured by any
mortgage or charge on any property of the company
they are said to be naked or unsecured debentures.
Rules Relating to Issue of Secured
Debentures
 Section 71 (3) read with Rule 18(1) of Companies (Share Capital and
Debentures) Rules, 2014.
 Sec. 71 (3) states that Secured debentures may be issued by a
company subject to such terms and conditions as may be prescribed.
 Conditions precedence under Rule 18(1) of Companies (Share
Capital and Debentures) Rules, 2014 –
 redemption period less than ten years from the date of issue.
 debentures shall be secured by the creation of a charge.
 Appointment of a debenture trustee before the issue of prospectus
for subscription of debentures.
 Security for the debentures by way of a charge or mortgage shall be
treated in favour of the debenture trustee.
Debentures
Registered and Bearer Debentures:
 Registered debentures are made out in the name of a particular
person, whose name appears on the debenture certificate and
who is registered by the company as holder on the Register of
debenture holders.
Such debentures are transferable in the same manner as shares
by means of a proper instrument of transfer duly stamped and
executed and satisfying the other requirements specified in the
Act.
Bearer debentures, on the other hand, are made out to bearer,
and are negotiable instruments, and so transferable by mere
delivery like share warrants.
Debentures Stock
Instead of issuing individual debentures evidencing
separate and distinct debts , the company may raise
consolidated borrowed fund for convenience.
 Each lender of this fund is given a debenture stock
certificate evidencing the part of the consolidated fund to
which he is entitled.
 A debenture may or may not be fully paid whereas the
debenture stock is necessarily fully paid.
 Debenture stock certificate furnishes evidence of the title
or interest of the holder .
 It is generally secured by a trust deed.
Debentures Stock
 Debenture stock is the indebtedness itself, and the
debenture stock certificate furnishes evidence of the
title or interest of the holder in the indebtedness.
 It is generally secured by a trust deed.
 Debenture stock must be fully paid, while debenture
may or may not be fully paid.
Pari Passu Clause in case of Debentures
 The expression ‘pari passu’ implies with equal step,
equally treated, at the same rate, or at par with.
 When it is said that existing debentures shall be
issued pari passu clause, it implies that no difference
will be made between the old and new debentures.
 If the words pari passu clause is not used, the debentures
will be payable according to the date of issue.
 if they are all issued on the same day, then repayment is
done in order of time.
Debenture Trustee - Appointment
 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 [Section 71
(5); Rule 18(2) of Companies (Share Capital and
Debentures) Rules, 2014].
Debenture Trustee – Preconditions for
Appointment [Sec 71(5)]
 The names of the debenture trustees shall be stated
in letter of offer inviting subscription for debentures.
 The above documents should state that the debenture
trustees have consented to be appointed as such
required.
 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 Trustee - Appointment
 A person shall not be appointed as a debenture trustee, if he-
 (i) beneficially holds shares in the company;
 (ii) is a promoter, director or key managerial personnel or any other officer or an
employee of the company or its holding, subsidiary or associate company;
 (iii) is beneficially entitled to moneys which are to be paid by the company
otherwise than as remuneration payable to the debenture trustee;
 (iv) is indebted to the company, or its subsidiary or its holding or associate company
or a subsidiary of such holding company;
 (v) has furnished any guarantee in respect of the principal debts secured by the
debentures or interest thereon;
 (vi) has any pecuniary relationship with the company amounting to two per cent. or
more of its gross turnover or total income or fifty lakh rupees or such higher amount
as may be prescribed.
 (vii) is relative of any promoter or any person who is in the employment of the
company as a director or key managerial personnel.
Duties of the Debenture Trustee Section
71(6)
A debenture trustee shall take steps to protect the interests of the debenture holders [Section
71(6)].
Rule 18(3) of Companies (Share Capital and Debentures) Rules, 2014 –
It shall be the duty of every debenture trustee to-
(a) Ensure letter of offer does not contain any matter which is inconsistent with the
terms of the issue of debentures or with the trust deed;
(b) Ensure covenants in the trust deed are not prejudicial to the interest of the debenture
holders;
(c) call for periodical status or performance reports from the company;
(d) communicate promptly to the debenture holders defaults, if any, with regard to payment of
interest or redemption of debentures and action taken by the trustee therefor;
(e) appoint a nominee director on the Board of the company in the event of-
(i) two consecutive defaults in payment of interest to the debenture holders; or
(ii) default in creation of security for debentures; or
(iii) default in redemption of debentures.
(f ) ensure that the company does not commit any breach of the terms of issue of debentures
Authority of the Debenture Trustee
The functions of the debenture trustees shall generally be to
protect the interest of holders of debentures.
 To ensure that the assets of the company issuing debentures and
various guarantees are sufficient to discharge the principal
amount at all times
 To ensure that letter of offer does not contain any matter which is
inconsistent with the terms of the debentures or with the trust
deed.
 To ensure that the company does not commit any breach of
covenants and provisions of the trust deed.
 To take other reasonable steps which the trustee thinks fit.
REMEDIES OPEN TO DEBENTUREHOLDERS
Debenture Trustee power to file a petition with Central
Government–
 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 Central Government .
 after hearing the company and any other person interested in
the matter, by an order, impose such restrictions on the
incurring of any further liabilities as the Central Government
thinks necessary in the interests of holders of the debentures.
SEBI Guidelines Pertaining to Issue of
Debentures
 SEBI Guidelines Pertaining to Issue of Debentures –
 Chapter X of the SEBI (Disclosure and Investor Protection) Guidelines
2000 states that a company offering a debt instrument through an offer
document, shall comply with the following Guidelines –
1. Requirement of Credit Rating – The ratings should be obtained from
more than 2 qualified credit rating agencies and the same to be
disclosed in the offer document.
2. Requirement in respect of Debenture Trustee.
3. Creation of Debenture Trustee Redemption Reserve
4. Disclosure and creation of charge – The offer document must provide
the details of the charges and its and the risk associated with the
charges.
5. Redemption – as per the terms of the offer document.
Creation of debenture redemption reserve
account [Section 71(4)]
 LIABILITY OF COMPANY TO CREATE SECURITY AND
DEBENTURE REDEMPTION RESERVE –
 1956 Provision - Where a company issues debentures after
the commencement of this Act (Amendment Act, 2000), it
shall create a debenture redemption reserve for the
redemption of such debentures, to which adequate amounts
shall be credited, out of its profits every year until such
debentures are redeemed.
 2013 Provision - Section 71(4) states that when debentures are
issued by a company under this section, the company shall
create a debenture redemption reserve account out of the
profits of the company.
Debenture Redemption Reserve Account
Rule 18(7) of Companies (Share Capital and Debentures) Rules, 2014 prescribes the following
conditions:
(a) the Debenture Redemption Reserve shall be created out of the profits of the company available for
payment of dividend;
 (b) the company shall create Debenture Redemption Reserve equivalent to at least fifty percent of the amount
raised through the debenture issue before debenture redemption commences.
(c) every company required to create Debenture Redemption Reserve shall on or before the 30th day of April in
each year, invest or deposit, as the case may be, a sum which shall not be less than fifteen percent, of the amount
of its debentures maturing during the year ending on the 31st day of March of the next year, in any one or more
of the following methods, namely:-
 (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 mentioned in sub-clauses (a) to (d) and (ee) of section 20 of the Indian Trusts
Act, 1882;
 (iv) in unencumbered bonds issued by any other company which is notified under sub-clause (f) of
section 20 of the Indian Trusts Act, 1882;
 (v) the amount invested or deposited as above shall not 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 fall below fifteen percent of the amount of the debentures
maturing during the year ending on the 31st day of March of that year;
Power to create the charge
 The company having the power to borrow money is
empowered also to create a charge on its assets.
 Limitation may be provided in the memorandum or
article of the company.
 A company may borrow money on uncalled capital if
it is allowed by the memorandum or article of the
company.
Charges
A charge is a security given for securing loans or
debentures by way of a mortgage on the assets of the
company. A company, like a natural person, can offer
security for its borrowings.
Sec 2(16) “charge” means an interest or lien created on
the property or assets of a company or any of its
undertakings or both as security and includes a
mortgage;
Types of Charges
 Fixed Charges – It covers the fixed and ascertained property, such as
land, building, Machinery etc.
In case of fixed charge the company cannot dispose the property which
is encumbered.
 Floating Charges – such kind of charge is made on the class of assets
which changes time to time, such as stock in trade.
 The company shall be entitled to deal with such kind of class of assets.
 The company may sell, mortgage or lease such property in the
ordinary course of its business if it is authorized by its memorandum
of association.
 The company deals with such assets as long as the charge is
crystalized.
Floating Charge – Case Laws
 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 condition in which it happens to be
from time to time” - Lord Macnaghten in Government Stock
Investment Company Ltd. v. Manila Rly. Company Ltd.,
(1897) A.C. 81.
 “A floating charge is ambulatory and shifting in its nature
hovering over and so to speak floating with the property
which it is intended to affect until some event occurs or act is
done which causes it to settle and fasten on the subject of the
charge within its reach and grasp” - Illingworth & Another v.
Holdsworth & Another.
Crystallization of Charges
 When the floating charge is crystalized it becomes
the subject matter of same restriction as the fixed
charge.
 A floating charge is crystallized in the following
circumstance –
1. When the company goes into liquidation.
2. When the company ceases to carry on the business.
3. When the creditors takes the step to enforce the
security.
4. On the happening of any event in the deed.
Charges
The charge may be created on tangible or intangible
property.
 Second charges, third charges …..
Floating Charges and Winding Up
 Where a company is being wound up, a floating charge on
the undertaking or property of the company created within
the twelve months immediately preceding the
commencement of the winding up, unless:
1. it is proved that the company immediately after the
creation of the charge was solvent.
2. The amount of any cash paid to the company at the time
of, or subsequent to the creation of, and in consideration
for, the charge, together with interest on that amount at
the rate of five per cent. per annum or such other rate as
may be notified by the Central Government in this behalf.