Business Law In Bangladesh

Topic – “ A document which either creates a debt or acknowledges it, and any document which fulfills either of the conditions is a debenture “ – explore / explain and illustrate.

Debenture is a is an widely used instrument by the companies to borrow money for the company. It is another instrument like taking loan from bank or issuing shares of the company in joint stock company.

Defination-

A debenture has been defined as a document which either creates a debt or acknowledges it and any document which fulfills either of these conditions is a debenture.1commercial practice the term “debenture” typically refers to the document that evidences a secured debt, although in law the definition may also cover unsecured debts (like any “IOU”).2 The legal definition is relevant for certain tax statutes, so for instance in British India Steam Navigation Co v IRC3 Lindley J held that a simple “acknowledgement of indebtedness” was a debenture, which meant that a paper on which directors promised to pay the holder £100 in 1882 and 5% interest each half year was enough, and as a result subject to pay duty under the Stamp Act 1870.

1.        Levy v abercorris slate and slab co ( 1987 ) ch D. 260.

2.        ^ CA 2006 s 738, and see Levy v Abercorris Slate and Slab Co (1887) 37 Ch D 260, Chitty J, ‘a debenture means a document which either creates a debt or acknowledges it, and any document which fulfils either of these conditions is a “debenture”.’

3. British India Steam Navigation Co v IRC The definition depends on the purpose of the statutory provision for which it is used, as it also matters because debenture holders have the right to company accounts and the director’s report,  because debenture holders must be recorded on a company register which other debenture holders may inspect,and when issued by a company, debentures are not subject to the rule against “clogs on the equity of redemption”. This old equitable rule held that one could not contract lose their right to pay off and be free from debt after the debt had been created, with the consequence that two parties could not convert a mortgage into a sale and that one could not contract for a perpetual period for interest repayments.

However given this rule was designed as a limit on contractual freedom where one party was vulnerable to the bargaining strength of another, it was thought that the rule was inappropriate for companies. In Kreglinger v New Patagonia Meat & Cold Storage Co Ltd[4 the House of Lords held that an agreement by New Patagonia to sell sheepskins exclusively to Kreglinger in return for a £10,000 loan secured by a floating charge would persist for five years even after the principal sum was repaid. The contract to keep buying exclusively was construed to not be a clog on redeeming autonomy from the loan because the rule’s purpose was to preclude unconscionable bargains. For companies the rule as a whole was abolished in what is now section 739 of the Companies Act 2006. In Knightsbridge Estates Trust Ltd v Byrne the House of Lords applied this so that when Knightsbridge took a secured loan of £310,000 from Mr Byrne and contracted to repay interest over 40 years, Knightsbridge could not then argue that the contract should be void, because the deal constituted a debenture under the Act, and so avoided this rule of equity.

4.        Kreglinger v New Patagonia Meat & Cold Storage Co Ltd[http://en.wikipedia.org/wiki/United_Kingdom_insolvency_law

Security in different jurisdictions

v      in the United States, debenture refers specifically to an unsecured corporate bond,5 i.e. a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bond’s maturity. Where security is provided for loan stocks or bonds in the US, they are termed ‘mortgage bonds’.

v      However, in the United Kingdom a debenture is usually secured.6

v      In Asia, if repayment is secured by a charge over land, the loan document is called a mortgage; where repayment is secured by a charge against other assets of the company, the document is called a debenture; and where no security is involved, the document is called a note or ‘unsecured deposit note’.7

Convertibility

There are two types of debentures:

1.     Convertible debentures, which are bonds that can be converted into equity shares of the issuing company after a predetermined period of time. “Convertibility” is a feature that corporations may add to the bonds they issue to make them more attractive to buyers. In other words, it is a special feature that a corporate bond may carry. As a result of the advantage a buyer gets from the ability to convert; convertible bonds typically have lower interest rates than non-convertible corporate bonds.

2.     Non-convertible debentures, which are simply regular debentures, cannot be converted into equity shares of the liable company. They are debentures without the convertibility feature attached to them. As a result, they usually carry higher interest rates than their convertible counterparts.

5.         Glossary: D on the Financial Industry Regulatory Authority (FINRA) website, United State

6.        Company Law Club, referring to United Kingdom usage

7.        Chandra Gopalan (2007); Company Law in Singapore 3rd Edition; McGraw-Hill Education (Asia)

Legal procedure of issuing debenture-

Provisions regulating issue of Debentures
The power to issue debentures can be exercised on behalf of the company at a meeting of the Board of Directors8 . A public company may, however, require the approval of shareholders to borrow money in excess of the aggregate of its paid up capital and free reserves9. Consent of the shareholders would also be required for selling, leasing or disposing of the whole or substantially the whole of the undertaking of the company under section 293 (1) (a). Debentures have been defined under Section 2 (12) of the Act to include debenture stocks, bonds and any other securities of the company whether constituting a charge on the company’s assets or not.

The attributes of a debenture are:
a. A movable property.
b. Issued by the company in the form of a certificate of indebtedness.
c. It generally specifies the date of redemption, repayment of principal and interest on specified dates.
d. May or may not create a charge on the assets of the company.

Section 372 A of the Companies Act also regulates inter-corporate loan and investments and stipulates the ceiling limits on investments and the amount of loan that can be borrowed by a company. The explanation clause of this section states that the loan shall include debentures.

Section 117 to Sections 123 of the Companies Act 1956 regulate the provisions relating to debentures, appointment of debenture trustees, their duties, creation of Debenture Redemption Reserve Account, liability of trustees etc.

8.        Section 292(1)(b) of the Companies Act

9.        Section 293 (1) (d)} of the Companies Act

The debentures issued under the Act shall not carry any voting rights. In the case of public issue of debentures, there would be a large number of debenture holders on the register of the company. As such it shall not be feasible to create charge in favour of each of the debenture holder. A common methodology generally adopted is to create Trust Deed conveying the property of the company. A Trust deed is an arrangement enabling the property to be held by a person or persons for the benefit of some other person known as beneficiary. The Trustees declare the Trust in favour of the debenture holders. The Trust Deed may grant the Trustees fixed charge over the freehold and leasehold property while a floating charge may be created over other assets. The Company shall allow inspection of the Trust Deed and also provide copy of the same to any member or debenture holder of the company on payment of such sum as may be prescribed. Failure to provide the same would invite penalties by way of fine under the Act. Any provision contained in the Trust Deed, which exempts a Trustee from liability for breach of Trust, is void.

As per Section 125 (4)10 of the Companies Act, registration of a charge for purpose of issue of debentures is mandatory. Section 128 stipulates that where a company issues series of debentures which is secured by charge, benefit of which will be available to all debenture holders pari passu, the company shall file the prescribed particulars in Form 10 and 13 with the Registrar of Companies for registration of charge. These forms shall be filed within 30 days after the execution of the deed.

10.     Section 125 ( 4 ) of the Companies Act.

Appointment and Duties of Debenture Trustees
In terms of Section 117 B, it has been made mandatory for any company making a public/rights issue of debentures to appoint one or more debenture trustees before issuing the prospectus or letter of offer and to obtain their consent which shall be mentioned in the offer document. The Debenture Trustees shall not:

a. beneficially hold shares in a company.
b. be beneficially entitled to monies which are to be paid by the company to the debenture trustees.
c. enter into any guarantee in respect of principal debt secured by the debentures or interest thereon.
This section also lists the functions that shall be performed by the Trustees. These include:

i. Protecting the interests of the debenture holders by addressing their grievances.
ii. Ensuring that the assets of the company issuing debentures are sufficient to discharge the principal amount.
iii. To ensure that the offer document does not contain any clause which is inconsistent with the terms of the debentures or the Trust Deed.
iv. To ensure that the company does not commit any breach of the provisions of the Trust Deed.
v. To take reasonable steps as may be necessary to undertake remedy in the event of breach of any covenant in the Trust Deed.
vi. To convene a meeting of the debenture holders as and when required.

If the debenture trustees are of the opinion that the assets of the company are insufficient to discharge the principal amount, they shall file a petition before the Central Government and the latter may after hearing the parties pass such orders as is necessary in the interests of the debenture holders. As per the SEBI (Debenture Trustees) Regulations, 1993, {hereinafter referred to as the ‘Regulations’} a Debenture Trustee can be a scheduled bank, an insurance company, a body corporate or a public financial institution.

Debenture Trust Deed
A Debenture Trust Deed shall, interalia, include the following:

a. An undertaking by the company to pay the Debenture holders, principal and interest.
b. Clauses giving the Trustees the legal mortgages over the company’s freehold and leasehold property.
c. Clauses that may make the security enforceable in the event of default in payment of principal or interest i.e. appointment of receiver, foreclosure, sale of assets etc.
d. A clause giving the Trustees the power to take possession of the property charged when security becomes enforceable.
e. Register of Debenture holders, meeting of all debenture holders and other administrative matters may be included in the Deed.

In addition thereto, the SEBI regulations have laid format of the Trust Deed in Schedule IV to the regulations. Some of the important provisions would include

f. Time limit of creation of security for issue of debentures.
g. Obligations of the body corporate towards the debenture holders.
h. Obligations towards the debenture holders – equity ratio and debt service coverage ratio.
i. Procedure for the inspection of charged assets by the Trustees.

Creation of debenture Redemption Reserve
Section 117 C of the Act casts an obligation on the company to create a Debenture Redemption Reserve. This account will be credited with proceeds from the profits of the company arrived at every year till redemption of the debentures. The Act, however, does not stipulate the time period for creation of security. SEBI regulations provides for creation of security within six months from the date of issue of debentures and if a company fails to create the security within 12 months, it shall be liable to pay 2% penal interest to the debenture holders. If the security is not created even after 18 months, a meeting of the debenture holders will have to be called to explain the reasons thereof. Further, the issue proceeds will be kept in escrow account until the documents for creation of securities are executed between the Trustees and the company.

Compliances under Registration Act and Stamp Duty Act
In the case of English Mortgage, the trust deed will attract ad valorem stamp duty. After execution, such deed will be registered with the sub registrar of Assurances. Registration charges will have to be paid in addition to the stamp duty. While in case of an equitable mortgage, if no document, deed etc. is signed then nothing is required to be registered with the sub registrar of Assurances. If however, a note or letter is made then it will attract stamp duty. It is pertinent to mention that once a mortgage is created by registration then no further stamp duty is payable on registration.

Default
In the event of failure on the part of the company to redeem the debentures on the date of maturity, the Company Law Tribunal may, on the application of any debenture holder, direct redemption of debentures forthwith by payment of principal and interest due thereon. If a default is made in complying with the orders of the Tribunal, every officer of the company who is in default shall be punishable with imprisonment for a term which may extend to three years and shall also be liable to fine of not less than Rs.500/- for every day during which the default continues. (Section 117C) Further this offence is not compoundable under section 621A of the Act.

There are contradictions between the Companies Act and the SEBI regulations on issues relating to:
a. Utilisation of Debenture Redemption Reserves. The Act provides that the Debenture Redemption Reserve will be used towards redemption of debentures only whereas the SEBI regulation states that these will be a part of the General Reserves, which can be utilised for the purpose of bonus issues.Any debentures issued with a maturity period of 18 months or less is exempted from the creation of Debenture Redemption Reserve Account, whereas no such exemption is provided under the Companies Act.

c. No Public Issue/Rights Issue of Debentures shall be made by a company unless it has appointed one or more Debenture Trustees for such debentures whereas under SEBI guidelines, appointment of Debenture Trustees is compulsory only in case of debentures with maturity of 18 months or more.

A listed company though subjected to SEBI regulations must comply with stringent norms between the two legislations / regulations made there under.

Key conditions of a Debenture-

v      Creates a debt- Debenture must create a debt no matter its secured or not. If a new debt is occurring debenture may take place at that time. It may state the conditions under which the debt is taking place.

v      Acknowledges the debt- Debenture may issued under existing debt as well to acknowledge it in a lawful way.

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