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“A document which either creates a debt or acknowledges it and any document which fulfill either of this condition is a debenture”

INTRODUCTION:

Companies have frequently to borrow large sums of money. The loan requirement of a company may not, therefore, be met by single lender. The loan may have to be split into several units. One very convenient method of doing so is to borrow by issuing debentures. Suppose, for a example, the sum to be borrowed is one lakh rupees, It may be divided into one thousand units each of the value of hundred rupees. A lender may purchase as many units as he pleases. The company will certify the number of units he holds and that is the concept of debenture, A debenture is, therefore, a certificate of loan issued by a company. It is a type of security.1

The term debenture has however, been found to be something very difficult to define. The Act in Section 2(12) contains only this definition: “Debenture includes debenture stock, bonds and any other securities of a company whether constituting a charge on the company’s assets or not.”  CHITTY J defines in these words: “Debenture means a document which either creates a debt or acknowledges it and any document which fulfill either of this condition is a debenture.”2 According to Topham: “Debenture is a document given by a company as evidence of a debt to the holder usually arising out of a loan and most commonly secured by charge.”3

As a matter of fact, the term does not have any legal meaning. The term as used in the modern commercial parlance is of extremely elastic character.4 Indeed no definition can help in all cases to know whether a particular document issued by a company is a debenture or not. “We must look at the substance of the instrument itself and without the assistance of any precise legal definition, from the best opinion we can whether the instrument is or is not a debenture.”5

The main business of a private company was to sell what were called “Patron Bonds” and to invest the money realized by the sale of those bonds. The form of the bond bore a serial number. It acknowledges a debt; it was one of the series; it bore the company’s seal; it provided for the payment of interest by determining the lucky number. The court observed: “The main features which in our opinion tend conclusively to show that these “Patron Bonds” are the debenture are the acknowledgement of debt, the promise to return it , the fact that they form a series bearing consecutive number.”

1 A company may issue debentures convertible into share either fully or partly. For rules and regulations to be observed in this connection. See Section F of SEBI.Guidelines for Disclosure and investor protection on issue of convertible and non-convertible debenture.

2 In Levy v Abercorris Slate & Slab Co, (1887) 37 Ch D 260,264 Ref: Company Law, Avtar Singh, (Edn:14),

3 Topham’s Company Law 168 (12 th Edn). See also speech of Viscount MAUGHAM in Knightsbridge Estate Ltd, Re. 1940, AC 613,

4 Chief Controlling Revenue authority v State Bank of Mysore ,AIR 1988 Kant 1:(1989)65 Comp Case 427 FB.A detailed discussion about the nature of the debenture is to be found in Narendra Kumar Maheshwari v UOI,[1989] 2 Comp LJ95  Ref:Company Law, Avtar Singh, (Edn:14),

5 CHITTY J in Levy v Abercorris, supra, fn 2, cited in Laxman Bharmaji v Emperor , AIR 1946 Bom 18:223 IC 110. Ref: Company Law, Avtar Singh, (Edn: 14),

Usual Features

As it appears from the above circumstances the usual features of a debenture are as follows:

In the first place, a debenture is usually in the form of a certificate issued under the seal of the company.6 Secondly, the certificate is generally an acknowledgement of indebtedness. In the striking words of POLLCK MR.7 But whatever be the characteristics which would expect to find in debentures; that it does record indebtedness.

“Further, a debenture usually provides for the payment of a specified principal sum at a specified date.” But that is not essential. A company may issue perpetual debentures with no undertaking to pay. It provides that debentures are not invalid simply because “they are made irredeemable or redeemable only on the happening of a contingency, however remote, or on the expiration of a period, however long.”8 Then again a debenture usually provides for payment of interest until the principal sum is paid back. But this again is not essential. Interest may be made payable subject to contingencies of uncertain nature.9

Thirdly, a debenture is as a rule one of a series, yet a single debenture is not uncommon. “There may be a single debenture issued to one man.”Lastly, a debenture generally creates a charge on the undertaking of the company, or on some class of its assets or on some part of its profit. Again this is not an essential element. A debenture which creates no such charge is perfectly valid.10

Floating Charge:

It is usual, though not essential for debentures to create a charge on the company’s asset. the charge which may company can create are of two types. They are:

1. Fixed Charge

2. Floating Charge 11

6 The case of British India Steam Navigation Co v Commissioners, (18871)7 QBD 165, however, shows that a seal is not necessary. There, a debenture certificate which was merely signed by two directors and did not bear the company’s seal was held valid. Ref: Company Law, Avtar Singh, (Edn: 14),

7 In Lemon v Austin Friars Investment Trust, [1926] Ch 1:133 LT 790

8 See Knightsbridge Estates Ltd v Byrne,1940 AC 613 :109 LJ Ch 200 :162 LT 388:56 TLR 652: [1940] 2 A11ER 401 HL

9 In Lemon v Austin Friars Investment Trust, [1926] Ch 1:133 LT 790

10 S.2 (12) .S. 122 provides that a contract with a company to take up and pay for any debentures in the company may be may be enforced by a degree for specific performance. This provision became necessary because otherwise money lending transactions are not so enforceable.

11 S.124 provides that the word “charge” includes “mortgage”

The normal concept of a mortgage is that it is created on some definite or specific asset. Such a mortgage is suitable for property which is more or less fixed. But it is quite impracticable where the assets to be charged are of circulating or liquid nature. Such assets keep changing and a fresh charge would have to be created every time they were turned over in the course of business. This would hinder business. Hence there was the necessity of a charge which would not paralyses the company’s business and, at same time, give a safe security to the moneylender. In the words of Gower: 12

The ingenuity of equity practitioners led to the evaluation of an unusual but highly beneficial type of security known as the floating charge.

A simple illustration will explain this:

A company borrows money on the security of its stock in trade. The charge created, though present and immediate, will not, however, get fixed on the stock. Rather it will keep floating over the changing stock in trade. And when the time comes for the lender to enforce his security he will do so by seizing whatever stock is then in the company’s hands. When this happens, the floating charge becomes fixed or crystallized.

The validity of such a charge was clearly recognized in Panama New Zealand & Australia Royal Mail Co, Re: 13

A steamship company having power to do so issued mortgage debentures, charging the “undertaking and all sums of money arising therefore”, with repayment at a specified time of the money borrowed with interest in the meantime. Before the debentures became due the company was wound up. The debenture-holders wanted to enforce their security. The unsecured creditors disputed the validity of the charge on a fluid thing like the “undertaking of the company”. But it was held that “the word undertaking” had reference to all the property of the company, not only which existed at the date of the debenture, but which might afterwards become property of the company. Debenture- holders, therefore, have a charge upon all; the property of the company, past and future”.

Thus, floating charge is a charge of ambulatory nature, floating with the property it is intended to cover.”It attaches to the subject charged in the varying conditions in which it happens to be form time to time.”14 It is a charge which floats like a cloud over the whole assets from time to time falling within a generic description…”15

The class of assets charged must be one which in the ordinary course of business of the company would be changing from time to time.16

12 The Principal of Modern Company Law, 78 (3rd Edn, 1969).See also Robert R. Pennington. The Genesis of the Floating Charge, (1960) 23 Mod LR 630

13. (1870) Chapter 5 App 318 22 LT 424

14 Lord MACNAGHTEN in Govt’s Stock Investment Co v Manila Rly Co,[1897] AC 81, at 86:75 LT 553 Ref:Company Law, Avtar Singh, (Edn:14),

15 Gower, THE PRINCIPLES OF MODERN COMPANY LAW, 78(3rd Edn.1969)

16 Where a charge was created on “fixed plant and machinery “ which would have been a fixed charge, but since the company had no firmly fixed machinery, the charge was held to be in the nature of a floating charge. Hi Fi Equipment (Cabinets) Ltd, 1988 BCLC 65 Ch D.A Construction Company’s washing machine which was in use at the site, being one fixed item and not likely to change, a charge on it was held to be fixed asset. Re: Company Law, Avtar Singh, (Edn: 14),

If the assets are withdrawn from the business and transferred to the lender’s possession, there is, indeed, nothing over which the charge is to float. It immediately gets fixed on that assets.17 A charge on book debts was held to be is appropriate where the company had the right to collect the debts and use the proceeds in the country course of its business. The charged book debts were not under the control of chargee to make it a fixed charge.17

Crystallisation:

Debenture generally contains an undertaking to pay the principal sum at a specified date with interest in the meantime. When the company makes a default or when it comes to be wound up, the debenture-holder should take step to enforce their security by seizing the assets over which the charge was until then floating. Then the charge is known as Crystallisation. After an installment of interests had been due more than three months but before the debenture holders had taken any steps to enforce their security, the company mortgaged its asset.

Debenture trust deed [Sec 118-119]:

Where the debenture-holders do not have the time to look after their interest in the properties mortgaged or charged to them, they may appoint some of themselves as trustee for supervision of their common interest. A trust deed is made under which some of them are appointed as trustee. Properties of the company are mortgaged to the trustee in favor of the debenture-holders. Any clause in the trust deed which exempts them from liability for breach of the duty as trustee or which indemnifies them against liability is void.18 A debenture trust deed is not in itself a mortgage or a bond. It is only a document expressing the faith of the shareholder upon their chosen trustee and have, therefore, to be stamped as a deed only. Sec 118 entitles every debenture-holder and member to member to demand from the company a copy of the debenture trust deed.19

17 The case in Tansukhrai M. Karundia v Official Liquidator of Andhra Paper Mills Ltd,(1949) 2 MLJ 66, A creditor was given possession of the movable pledges to him and it was provided that as and when other properties were acquired, they would also stand pledged to him. The security was stated to be continuing one. On default of payment, the lender had the right to sell. Though the debtor company was allowed to run its business, it was only run by the creditor as an agent under an irrevocable power of attorney. This was held to be floating charge. The element of possession made it something wholly inconsistent with the concept of a floating charge. Ref: Company Law, Avtar Singh, (Edn: 14),

18 Sec 119(1).See also sub section (2) and (3) which allows the trustee in certain circumstances to be released from liability.

19 Sec 118(1).The trust deed is also open to the members of debenture; holders in the like manner as the register of members, Sec 118(4). Sub section (2) make denial of this right a punishable offence and sub section (3) empowers the Court to direct copies to be given.

Section 117-A contains three provisions:

Form of trust deed:

The deed has to be in such from and executed within such time as may prescribed.

Supply of copies and inspection:

A copy of the deed should be available for inspection to member and debenture holder

Penalty:

If a copy of the trust deed is not made available for inspection or may not given to any debenture holder or member ,every officer of the company who is in default shall be punishable with fine extending up to Rs 500 for every day of default.

Function:

The functions are to protect the interests of holders of debenture, to bring about the creation of securities within the stipulated time and to redress grievances of debenture- holders, to take care to call meeting of debenture-holder as and when it is required to be held.20

Responsibility of company to create security and debenture redemption reserve [Sec: 117-C] 21

The company issuing debenture has to create a debenture redemption reserve; adequate amounts have to be transferred to the fund every year from the profits of the company till the debentures are redeemed.

The amounts so credited cannot be used for any other purpose. The company is under a duty to go on paying interest and to redeemed debentures in accordance with the terms and condition of the issue.

On failure of the company to do so, the debenture-holder or any of them can apply to the Tribunal. The Tribunal, after hearing the parties, may direct the company to pay off the interest and principal amount and redeem the debenture. If the orders of the Tribunal are not carried out, the defaulting officers are liable to punishment by way of imprisonment extending to three years and a fine extending to Rs500 for every day of default.

Remedies of debenture-holder: 22

The remedies of debenture- holders depend upon the terms of their agreement with the company. A debenture holder who wishes to realizes his security and get back his money may exercise remedies given by the debenture trust deed or resort to legal proceeding to enforce his rights.23If money due on a debenture is payable on demand the debtor company is entitled, once demand is made, to reasonable time to implement the mechanics of payment, but it is not entitled to any time to raise the money if it was not at hand. A demand under a debenture need not specify the amount due.24 It is not necessary to allow time

20 A provisions introduced by the second amendment act of 2002 says that in the case of revival and rehabilitation of a sick industrial company under vi-A, the provisions of this section shall have effects as if for the word Central government ,the word tribunal had been substitute.

21 Company Law, Avtar Singh, (Edn: 14), pg453, ppt: 3

22 Company Law, Avtar Singh, (Edn: 14), pg453, ppt: 4

23 Lloyds Bank Plc v Lampert, [1999] BCC 507 Ref: Company Law, Avtar Singh, (Edn: 14)

24 Bank of Baroda v Panessar, [1986] 3 AII ER 751 Ch D Ref: Company Law, Avtar Singh, (Edn: 14)

to the borrowing company to enable it to engage in a commercial transaction for the purpose of raising funds for redemption of debentures.25But one of the remedies which is always open to them as mortgage under the Transfer of Property Act is to bring the property charged to

sale. 26

Receiver

Secondly they may appoint a receiver to take charge of the assets subjected to the charge. If they don’t have the power under the terms of their debentures they may have a receiver appointed by the court. The appointment must be brought to the notice of the Registrar within 30 days, whose duty is to enter the same in the register of charges.27 A similar notice has to be given by the receiver when he ceases to act.28 When the receiver take possession of the assets comprised in the charge, he has to maintain proper accounts of his receipts and payments and to submit an abstract with the Registrar once every half year.29 The fact of the receiver’s appointment should also be mentioned on every invoice, order for goods, or business letter issued on behalf of the company.30

Manager

When the receiver has taken possession of the company’s assets, obviously they cannot be used by the company for business. Yet sometimes it may be necessary to carry on for beneficial winding up. In such case the debenture holder may appoint a manager also have him appointed under of an order of the court. The above provisions relating to a receiver also apply to a manager.31

It has been held that a receiver or manager is not an “officer” of the company for the purposes of Companies Act, nor a “manager” of the company and consequently he cannot be subjected to public examination.32There is a clear authority for the proposition that where a receiver or manager is appointed by the court his function as manager confers duty on him to preserve the goodwill and property of the company, both in the interests of the mortgage and of the mortgagor.”33

25 Lloyds Bank Plc v Lampert, [1999] BCC 507 Ref: Company Law, Avtar Singh, (Edn: 14)

26 Company Law, Avtar Singh, (Edn: 14) pg 454 ppt: 1

27 Sec: 137(1) .This he does on payment of the prescribed fee. The notice has to be given by the person who appoints or obtains appointment.

28 Sec: 137(2) .Sub-sections (3) impose penalty up to Rs 500 for every day of default.

29 Sec: 421

30 Sec 422, See also Sec: 423 which contains penalty provisons.This section says that if default is made in complying with the requirement of Sec: 421(Filing of accounts of receiver) and Sec: 422 (Invoices etc, to refer to receiver if there is one) the company and the defaulting officer are punishable with fine extending up to Rs 2000.For the purpose of this section the receiver is deemed to be officer of the company

31 Sec 424, Also see Company Law Avtar Singh, (Edn: 14) pg: 455

32 Company Law Avtar Singh, (Edn: 14) pg: 455 ppt: 2, A receiver was held to be not personally liable to the employees whose service he continued,

33 The same duty is cast upon a mortgagee of shares. Bishop v Bonhama, 1988 BCLC 656 CA Westminster Corpn v Haste, 1950 Ch 442, dealing with company property in an unwanted manner. American Express International Bkg Corpn v Hurley, [1985] 3 All ER 564, the bankers as debenture holders control the actions of the receiver, held liable for the receiver’s negligence.

Redeemable debenture:

A debenture is generally redeemable. This means that on expiry of the term of the loan the company has the right to pay back the debenture-holders and have its properties released from the mortgage or charge. Redeemed debenture can be re-issued. This power is expressly given by Section 121The company may re issue the same debenture or other debentures in their place. Upon such re-issue the person entitled to the debentures has the same rights and priorities as if the debenture had never been redeemed.34

Perpetual debenture:

A debenture which contains no clause as to payment or which contains a clause that it shall not be paid back is known as a perpetual or irredeemable debenture.35 Section 120 provides that a“condition contained in any debenture….shall not be invalid by reason only that thereby, the debentures are made irredeemable or redeemable only on the happening of the contingency, however, remote or on the expiration of the period, however, long.”

Debenture to Registered Holder and Bearer Debenture:

A company which has issued debentures will obviously maintain a register of its debenture-holders, as Section 152 provides that every company shall keep a register of the holders of its debentures. The name of the holder is placed both on the debenture certificate and on the company’s debenture. Such a holder is known as the register holder. He can transfer his debentures in the open market in just the same way as shares are transferred.36 Transfer will have to be registered with the company. The transferee’s title will subject to all equities between the transferor and the company.37Registration of transfer can be avoided only by issuing debenture payable to bearer, as the company has not to maintain a register of such debenture-holder38 Such debenture are transferable, like negotiable instruments, by simple delivery and are called debenture payable to bearer.

Register of debenture-holders [Sec: 152]

A company issuing debentures has to maintain a register of debenture-holders showing the following particulars:

1.      The name, address and occupation of each debenture holder;

2.      The debenture held by each hoder,showing numbers and the amount actually pais or deemed to be paid;

3.      The date at which each person was entered as a debenture holder and

4.      The date at which any person ceased to be a debenture-holder

34 See section 121 (2)

35 Company Law Avtar Singh, (Edn: 14) pg: 457 ppt: 4

36 Sec: 108

37 Natal Investment Co, Re, (1868) 3 Ch App 355: 18 LT 171

38 Sec: 152 (4)

Index:

Where the number of the debenture holder exceeds fifty, an index should be maintained which should enables the entries relating to a debenture holder to be readily found. Any change in the particulars of register should be reflected by the index within fourteen days.

Conclusion:

The issue of debenture is a particular made of borrowing money by companies. It is a document which shows on the face of it, that the company has borrowed certain sum of money from the holder upon certain terms and conditions where the rate of interest, the time of payment of interest, the security against which the debenture is issued, steps the debenture holder can take in case of non-payment of his dues, floating charge that is enforceable upon non-payment of interest or principal on the due dates, trust deed are included. The debentures are perpetual; company can pay back the debenture-holders39. Debenture holder being secured creditors, paid in priority.40 The term is used in corporate finance for a medium to long-term debt instrument used by large companies to borrow money. In some countries the term is used interchangeably with bond, loan stock or note.

39 A company may, however, pay back the debenture holder share first. Company Law, Avtar Singh, (Edn: 14) pg: 458, ppt: 4

40 Sec: 108,111

Bibliography

1 Avtar Singh, Company Law (Edn: 14)

2  Gower, The Principal Of Modern Company Law, 78 (3rd Edn, 1969).

3 In Lemon v Austin Friars Investment Trust,[1926]

4  Topham’s Company Law 168 (12 th Edn)

5 Sen Mitra, Business Law [27th Edn]

6 Md Samsul Haq, The Companies Act

7 en.wikipedia.org/wiki/debenture

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