A document which either creates a debt or acknowledges it, and any document which fulfills either of these conditions is a debenture.- explain and illustrate.
Debenture is a long term debt instrument that is not secured by a specific asset. In the event of default, the holder does not have a claim against any specific asset(s) of the issuing firm.
In law 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.
A debenture has been said to be a promissory note1 but with more elaborate conditions and generally in anticipation of a longer-term loan and, optionally, with some form of security2.
1. A promissory note, referred to as a note payable in accounting, or commonly as just a “note”, is a negotiable instrument, wherein one party (the maker or issuer) makes an unconditional promise in writing to pay a sum of money to the other (the payee), either at a fixed or determinable future time or on demand of the payee, under specific terms.
2. Security is the degree of protection against danger, damage, loss, and criminal activity. Security as a form of protection are structures and processes that provide or improve security as a condition.
In English Scottish Trust, Justice Bowen wrote that a debenture could be:
"(1) A simple acknowledgment under seal of the debt; (2) an instrument acknowledging the debt and charging the property of the company with repayment; (3) an instrument acknowledging the debt, charging the property of the company with repayment, and further restricting the company from giving any prior charge." 3
A debenture is a debt instrument evidencing the holder’s right to receive interest4 and principal installments from the named obligor. It gives 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 capital5 value of the company under certain specific terms.
3. Edmonds v Blaina Furnaces (1887) 36 Chancery Division 215
English Scottish Trust v Brunton (1892) 2 QB 700.
4Chapter I – Small Business Administration; Part 108 – New Markets Venture Capital _“NMVC”_ Program;
5.Cash or goods used to generate income either by investing in a business or a different income property. The net worth of a business, that is, the amount by which its assets exceed its liabilities.
The money, property, and other valuables which collectively represent the wealth of an individual or business.
A company is a form of business organization. It is a collection of individuals and physical assets with a common focus and an aim of gaining profits. This collection exists in Law and therefore a company is considered a “Legal Person”.
Companies are legal entities separated from its owner or manager, directors or employees. The people of the company come together for a common goal.
In general there are two types of companies:
- Public limited companies6
- Private limited companies7
Debentures are issued in both the organizations but in large scale in public limited companies. As in debenture there are no collateral assets as security so the investor has to trust the organization.
6. The standard legal designation of a company which has offered shares to the general public and has limited liability. A Public Limited Company’s stock can be acquired by anyone and holders are only limited to potentially lose the amount paid for the shares. It is a legal form more commonly used in the U.K. Two or more people are required to form such a company, assuming it has a lawful purpose.
7. A private company limited by shares, usually called a private limited company (Ltd) (though this can theoretically also refer to a private company limited by guarantee), is a type of company incorporated under the laws of England and Wales, Scotland, that of certain Commonwealth countries and the Republic of Ireland. It has shareholders with limited liability and its shares may not be offered to the general public, unlike those of a public limited company (plc)
3.Types of debenture:
There are a few types of debenture that are discussed below;
1. compulsory convertible debenture
2. convertible debenture
3. non-convertible debenture
4. fixed debenture
1. Compulsory convertible debenture:
A type of debenture in which the whole value of the debenture must be converted into equity8 by a specified time. The compulsory convertible debenture’s ratio of conversion is decided by the issuer when the debenture is issued. Upon conversion, the investors become shareholders of the company. The main difference between convertible debentures and other convertible securities is that owners of the debentures must convert their debentures into equity, whereas in other types of convertible securities, the owner of the debenture has an option.
Some CCDs, which are usually considered equity, are structured in a manner that makes them more like debt. Often, the investor has a put option which requires the issuing companies to buy back shares at a fixed price.
8. 1. A stock or any other security representing an ownership interest.
2. On a company’s balance sheet, the amount of the funds contributed by the owners (the stockholders) plus the retained earnings (or losses). Also referred to as “shareholders’ equity”.
3. In the context of margin trading, the value of securities in a margin account minus what has been borrowed from the brokerage.
4. In the context of real estate, the difference between the current market value of the property and the amount the owner still owes on the mortgage. It is the amount that the owner would receive after selling a property and paying off the mortgage.
5. In terms of investment strategies, equity (stocks) is one of the principal asset classes. The other two are fixed-income (bonds) and cash/cash-equivalents. These are used in asset allocation planning to structure a desired risk and return profile for an investor’s portfolio.
A type of loan issued by a company that can be converted into stock9 by the holder and, under certain circumstances, the issuer of the bond. By adding the convertibility option the issuer pays a lower interest rate on the loan compared to if there was no option to convert. These instruments are used by companies to obtain the capital they need to grow or maintain the business. Convertible debentures are different from convertible bonds10 because debentures are unsecured; in the event of bankruptcy11 the debentures would be paid after other fixed income holders. The convertible feature is factored into the calculation of the diluted per-share metrics as if the debentures had been converted. Therefore, a higher share count reduces metrics such as earnings per share, which is referred to as dilution.
3. Non-convertible debenture:
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.
9. The capital stock (or just stock) of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors. Stock is distinct from the property and the assets of a business which may fluctuate in quantity and value.
10. A debt investment in which an investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period of time at a fixed interest rate. Bonds are used by companies, municipalities, states and U.S. and foreign governments to finance a variety of projects and activities. Bonds are commonly referred to as fixed-income securities and are one of the three main asset classes, along with stocks and cash equivalents..
11. Bankruptcy or insolvency is a legal status of a person or an organisation that cannot repay the debts it owes to its creditors. Creditors may file a bankruptcy petition against a business or corporate debtor (“involuntary bankruptcy”) in an effort to recoup a portion of what they are owed or initiate a restructuring.
A note that carries a fixed (as opposed to floating) charge against the issuer’s property or assets for repayment. The charge will remain on the company’s records until the debenture is repaid. Corporations can issue fixed debentures to finance operations in the same way they issue stock. Fixed debentures can be issued singly or in a series. They pay out a fixed rate of interest at regular interval.
Fixed charge debentures require restrictions on the underlying property or asset backing the loan to ensure the lenders’ security. For example, a company may issue a fixed debenture to obtain a mortgage; the mortgage would most likely preclude the borrower (company) from subletting the mortgaged property to a third party.
4Legal areas of Debenture:
Company law initiates with Act 43 of 1850,which was based on the English Companies Act of 1844, making it possible, for the first time, to incorporate and register a company without obtaining a royal charter. Under the Indian Act, the supreme courts in the presidency towns of Calcutta , Bombay and Madras were authorized to order the registration of unincorporated companies of partners associated under a deed containing a provision that the shares were transferable. The privilege of limited liability was not conferred upon by this Act, although a company was permitted to sue and be sued in its registered name.
The act was amended several times after that12.
Security and Exchange Commission Act 1993 is entrusted with the task of ensuring proper issuance of shares and debentures to protect the interests of investors in securities and to promote the development of, and to regulate, the capital and securities market.
The company has to be wounded or liquidated under this act to pay off the debts. 13
The Companies Act, 1956: Sec73 – Allotment of shares and debentures to be dealt in on stock exchange
“Every company, intending to offer shares or debentures to the public for subscription by the issue of a prospectus shall, before such issue, make an application to one or more recognised stock exchanges for permission for the shares or debentures intending to be so offered to be dealt with in the stock exchange or each such stock exchange.”
“If default is made in complying with the provisions of sub-section (2A), the company and every officer of the company who is in default shall be punishable with fine which may extend to fifty thousand rupees, and where repayment is not made within six months from the expiry of the eighth day, also with imprisonment for a term which may extend to one year.” 14
12. www.investopedia .com, www.banglapedia .org.
14. www.investopedia .com, www.banglapedia .org.
Companies Act 1994 (Act XVIII of 1994):
In the companies act 1994 there is provisions for debenture and penalty for debenture.
Sec 140 part iv states that debentures should be dealt in stock markets.
Debenture Redemption Reserve
A provision that was added to the Indian Companies Act of 1956 during an amendment in the year 2000. The provision states that any Indian company that issues debentures must create a debenture redemption service to protect investors against the possibility of default by the company.
Under the provision, debenture redemption reserves will be funded by company profits every year until debentures are to be redeemed. If a company does not create a reserve within 12 months of issuing the debentures, they will be required to pay 2% interest in penalty to the debenture holders. Only debentures that were issued after the amendment in 2000 are subject to the. 15
15. www.investopedia .com, www.banglapedia .org.
From the discussion above we have seen that any investor who wants to buy a debenture gets a certificate or promissory note or written document. Then the investor gets an interest until the amount of debenture is repaid. Debenture is or creates a debt because it has to be repaid within specific period of time. If a company becomes unable to pay of the debt the company goes for winding up or liquidation.
Debenture is acknowledged by a debt. Because investor at any time protected by law but as debentures are not backed by any collateral asset it so investor can not claim any particular asset.
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