“A document which either creates a debt or acknowledges it and any document which fulfills either of these conditions is a debenture” Explain.
Debentures:
The word ‘Debenture’ is derived from the Latin term debere (to owe debt) which means “to borrow”. (1) Share capital is the main source of finance of a joint stock company. Such capital is raised by issuing shares. Those who hold the shares of the company are called the shareholders and are owners of the company. Company may need additional amount of money for a long period. It cannot issue shares every time. It can raise loan from the public. The amount of loan can be divided into units of small denominations and the company can sell them to the public. Each unit is called a ‘debenture’ and holder of such units is called Debenture holder. The amount so raised is loan for the company. A Debenture is a unit of loan amount. When a company intends to raise the loan amount from the public it issues debentures. A debenture is a document issued under the seal of the company. It is an acknowledgment of the loan received by the company equal to the nominal value of the debenture. It bears the date of redemption and rate and mode of payment of interest. A debenture is therefore, a certificate of loan issued by a company. It is a type of security and a debenture holder is the creditor of the company. As per section 2(12) of Companies Act 1956, “Debenture includes debenture stock, bond and any other securities of the company whether constituting a charge on the company’s assets or not”. A 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 a charge.
In Laxman Bharamji v. Emperor, the Bombay High Court observed that debentures normally indicate the security against the loan taken by the company and contain the conditions of repayment, date, rate of interest payable to the holder. They may even create a charge on the company’s property, but it is not always necessarily so. Briefly speaking, the debentures are the acknowledgement of debt, the promise to return it.
In United Dominion Trust Ltd. v. Kirkwood, receipt or a certificate for a deposit made with a company when the deposit was repayable at a fixed period after it was made, was held to be debenture.
Thomas Evelyn, “a debenture is a document under company’s seal, which provides for the payment of a principal sums and interest there on at regular intervals, which is usually secured by a fixed or floating charge on the company’s property or undertaking and which acknowledges a loan to the company.
(1) In law, a debenture is a document that either creates a debt or acknowledges it. 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. (enwikipedia.org/wiki/Debenture)
In the ordinary business sense a ‘debenture’ is generally understood to be a document acknowledging a debt and securing repayment thereof by mortgage or charge on the
company’s property or undertaking , and providing that until repayment ,interest will be paid there on at a fixed rate payable usually half yearly or yearly on fixed dates.
Debenture includes stock, bonds and any other company’s securities. It may or may not constitute charge on the assets. A document given by the company which describes the debt and is a proof of debt is known as Debenture. It secures the repayment of loan by creating charge on the assets. It may or may not be under seal.
Debentures are tools used by large companies to raise capital for their projects and operations. This is known as a debt offering since the company literally goes into debt to the investors until the price of the debenture is paid back, plus interest, or until it is converted into stock. The company must record this debt in their balance sheet. If bankruptcy occurs, the debenture holders are considered creditors and must be paid back by the companies remaining assets. Debentures are a way for companies to raise capital without having to use their assets or give up ownership in their company. This leaves their assets free to do other things to generate capital for the business.
Major types of debentures:
- Convertible debentures, which are convertible bonds or 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.
- 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.
§ In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest (the coupon) and/or to repay the principal at a later date, termed maturity. A bond is a formal contract to repay borrowed money with interest at fixed intervals.(2)
(2) A bond is debt instrument which guarantees to repay the principal of the loan plus interest to the bondholder. Bonds are considered to be long-term debt and have to be paid back on their maturity date. Usually bonds have fixed interest rate, which is paid to the bondholder during the term of the bond. Bonds can be issued by both governments and corporations. When you buy bonds you are in effect lending money to the bond issuer, who agrees to repay the loan in the future and to pay interest during the life of the bond.-(Transfers & Transformation of Share & Debenture, 4th ed. By Dr. K.R Chandratre)
§ Thus a bond is like a loan: the issuer is the borrower (debtor), the holder is the lender (creditor), and the coupon is the interest. Bonds provide the borrower with external funds to finance long-term investments, or, in the case of government bonds, to finance current expenditure. Certificates of deposit (CDs) or commercial paper are
considered to be money market instruments and not bonds. Bonds must be repaid at fixed intervals over a period of time.
Bonds and stocks are both securities, but the major difference between the two is that (capital) stockholders have an equity stake in the company (i.e., they are owners), whereas bondholders have a creditor stake in the company (i.e., they are lenders). Another difference is that bonds usually have a defined term, or maturity, after which the bond is redeemed, whereas stocks may be outstanding indefinitely. An exception is a consol bond, which is a perpetuity (i.e., bond with no maturity).
The attributes of a debenture are:
§ 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.
§ It may be irredeemable, or redeemable on the happening of a contingency.
§ 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.
§ 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 favor 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) 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.
Provisions regulating issue of Debentures:
Issuing debentures means issue of a certificate by the company under its seal which is an acknowledgment of debt taken by the company. The procedure of issue of debentures by a company is similar to that of the issue of shares. A Prospectus is issued, applications are invited, and letters of allotment are issued. On rejection of applications, application money is refunded. In case of partial allotment, excess application money may be adjusted towards subsequent calls.
The power to issue debentures can be exercised on behalf of the company at a meeting of the Board of Directors {Section 292(1)(b) of the Companies Act}. 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 reserves.{Section 293 (1) (d)}. 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.(3)
Concluding Remarks:
A debenture is an instrument of debt executed by the company acknowledging its obligation to repay the sum at a specified rate and also carrying an interest. It is only one of the methods of raising the loan capital of the company. A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the company’s capital structure, it does not become share capital. Finally it can be said that, all the features and classifications of debentures has proved the statement “A document which either creates a debt or acknowledges it and any document which fulfills either of these conditions is a debenture”
(3) The Law of Banking and Financial Institutions, Fourth Edition (Casebook).By Jonathan R. Macey; Geoffrey P. Miller; Richard S. Carnell,Publisher: Aspen Publishers (2008)
Correspondence
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