“A document which either creates a debt or acknowledges it and any document which fulfils either of these conditions is a debenture”- explain and illustrate.
Introduction:
A Debenture is a debt security issued by a company (called the Issuer), which offers to pay interest in lieu of the money borrowed for a certain period. In essence it represents a loan taken by the issuer who pays an agreed rate of interest during the lifetime of the instrument and repays the principal normally, unless otherwise agreed, on maturity. A debenture is evidence of the borrower’s debt to the lender. The word derives from the Latin ‘Debeo’, meaning ‘I owe’. Debentures are issued to the general public through a prospectus and are secured by a trust deed which spells out the terms and conditions of the fundraising and the rights of the debenture-holders. Debenture is a type of debt instrument that is not secured by physical asset or collateral. Typical issuers of debentures are finance companies and large industrial companies. Debenture-holders’ funds are invested with the borrowing company as secured loans, with the security usually in the form of a fixed or floating charge over the assets of the borrowing company. As secured lenders, debenture-holders’ claims to the company’s assets rank ahead of those of ordinary shareholders, should the company be wound up; also, interest is payable on debentures whether the company makes a profit or not. Debentures are issued for fixed periods but if a debenture-holder wants to get his or her money back, the securities can be sold.[1]
So we can say that, a debenture is a document that either creates a debt or acknowledges it. In corporate finance, the term is used 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.
Debentures are generally freely transferable by the debenture holder. Debenture holders have no rights to vote in the company’s general meetings of shareholders, but they may have separate meetings or votes e.g. on changes to the rights attached to the debentures. The interest paid to them is a charge against profit in the company’s financial statements.
Types of debenture:
There are many types of debentures[2]. Those are explained below:
1. Simple naked or unsecured debentures: – These debentures are not given any security on assets. They have no priority as compared to other creditors.
2. Secured or mortgage debentures: – these debentures are given a security on assets of the debentures company. In case of default in the payment of interest or principle amount, debenture holders can sell the assets in order to satisfy their claims.
3. Bearer debentures: – These debentures are easily transferable. They are just like negotiable instruments. The debenture is handed over to the purchaser without any registration deed.
4. Registered debentures: – as compared to bearer debenture which is transferred by mere delivery, registered debenture require a procedure to be followed for the transfer.
5. Redeemable debenture: – these debentures are to be redeemed on the expiry of ascertain period. The interest on the debenture is paid periodically but the principle amount is returned after a fixed period.
6. Irredeemable debentures:- such debentures are not redeemable during the life time of the company. There are payable either on the winding up of the company or at the time of any default on the part of the company.
7. Convertible debenture: – sometimes convertible debenture is issued by a company and the debenture holders are given an option to exchange the debenture into enquiry shared after the lapse of a specified periods.
Debentures can also be classified on the basis of convertibility[3] into:
Non Convertible Debentures (NCD): These instruments retain the debt character and cannot be converted in to equity shares·
Partly Convertible Debentures (PCD): A part of these instruments are converted into Equity shares in the future at notice of the issuer. The issuer decides the ratio for conversion. This is normally decided at the time of subscription.
Fully convertible Debentures (FCD): These are fully convertible into Equity shares at the issuer’s notice. The ratio of conversion is decided by the issuer. Upon conversion the investors enjoy the same status as ordinary shareholders of the company.
Optionally Convertible Debentures (OCD): The investor has the option to either convert these debentures into shares at price decided by the issuer/agreed upon at the time of issue.
Characteristics of debenture:
The characteristics[4] of debentures are written below:
- A movable property.
- Issued by the company in the form of a certificate of indebtedness.
- It generally specifies the date of redemption, repayment of principal and interest on specified dates.
- May or may not create a charge on the assets of the company.
- No voting rights
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 Directors[5] (Section 141of the Companies Act). 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 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.
Debenture trust deed
The trust deed contains the terms and conditions endorsed in the debentures and define the rights of debenture-holders and the company. It usually empowers the trustees to appoint a
receiver to protect their interest. I t also contains other provisions concerning meeting of the debenture-holders supervision of the assets charged, and the keeping of a register of a debenture holders. Whenever there is a default by the company, the security is enforced or action is taken by the trustees on behalf of all the debenture-holder
A Debenture Trust Deed shall, interlaid, 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.
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.
Right of a debenture holder
- To receive interest punctually
- To receive a copy of the trust deed (on request)
- To approach the Debenture trustee with your grievances
Conclusion:
According to the discussion, it can be said that a document which either creates a debt or acknowledges it and any document which fulfils either of these conditions is not a debenture because Debenture is just long term loan which is taken by company. A debenture is a debt instrument evidencing the holder’s right to receive interest and principal installments from the named obligor. The term applies to all forms of unsecured, long-term debt evidenced by a certificate of debt. When investors loan funds to a business, the company may issue a debenture so that repayment of the debt is guaranteed by the overall capital value of the company under certain specific terms.
A debenture generally is considered more secure than shares of stock or general bonds. A denture is a bond backed by the general credit of the issuer rather than any specific collateral. The issuer is required to pay a fixed sum annually until maturity and then a fixed sum to repay the principal.
So any document which fulfills the conditions to create a debt or acknowledges it is not a debenture. It has to be issued by the company in the form of a certificate of indebtedness and It generally specifies the date of redemption, repayment of principal and interest on specified dates.
BIBLIOGRAPHY
1. http://law.jrank.org/pages/5992/Debenture.html
2. Accounting for Shares . and Debentures” module 5
3. Fundamentals of Financial Management 10th ed.
5. Securities Law www.allbusiness.com
6. Corporate Finance 7th ed.
[1] See’ the language of money’ by Edna Carew.
[2] See “Accounting for Shares and Debentures”
[3] See “Accounting for Shares and Debentures” module 5
[4] See “Accounting for Shares and Debentures”( module 5) and also
“Fundamentals of Financial Management,”
[5] Section 141of the Companies Act
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