A document which either creates a debt or acknowledges it and any document which fulfills either of these conditions is a debenture.
INTRODUCTION:
A document includes summons, notice, requisition, order, other legal process, and registers, whether issued, sent or kept in pursuance of the Company Act 1956 of India or any other Act or otherwise.[1]
A debenture is defined as any acknowledgment of debt which, of course, implies a promise to repay the debt. In financial practice, however, the word has gradually become restricted until it now means only an unsecured promise to repay a debt.[2] The issue of debenture is a particular mode of borrowing money by companies. A debenture is a document which shows on the face of it, that the company has borrowed a certain amount sum of money from the holder whereof upon certain terms and conditions. [3]
Palmer defines a debenture as—
“Any instrument under seal evidencing a deed, the essence of it being the admission of indebtedness.”[4]
Section 2(12) of the Company Act states that—
“A debenture includes debenture stock, bonds and any other securities of a company, whether constituting a charge on the assets of a company or not.”[5]
BORROWING POWERS OF A COMPANY:
The powers of a company are determined by the memorandum and articles of association. Therefore, a company can borrow depending upon the interpretation of these two documents. Sometimes the power to borrow is given, subject to certain limitations.[6] When the power to borrow is given, loans may be taken in many different ways. One of these many different ways is debentures and debenture stock.
In the Company Act 1956 of India it is mentioned:-
Article 50
“The Board may from time to time subject to the provision of Section 292[7] of the Act raise or borrow or secure the payment of any sum or sums of money for the purposes of the Company.”
Conditions on which money can be borrowed is mentioned in the following article of the Company Act 1956:-
Article 51
“The Board may raise or secure the payment or repayment of such sum or sums in such manner and upon such terms and conditions in all respects as they think fit and in particular, by the issue of debentures or debenture stock of the Company charged upon all or any part of the property of the company, both present and future, including its uncalled capital for the time being.”
Borrowing from venture capital and, sometimes, from other financial institutions, is often part of a larger finance package involving shares and loans. In most cases of borrowing a debenture is issues. A debenture is the traditional name given to a loan agreement where the borrower is the company.[8] In finance, borrow or borrowing means, monetary debt.
DEBT:
Debt is that which is owed usually referencing assets owed, but the term can also cover moral obligations and other interactions not requiring money. In the case of assets, debt is a means of using future purchasing power in the present before a summation has been earned. Some companies and corporations use debt as a part of their overall corporate finance strategy.[9]
Debt means all book debts, other debts, receivables and liabilities of any kind whatsoever now or at any time hereafter (and from time to time) due, owing or payable to the Charger, including the benefit of any judgment or order to pay a sum of money, and the benefit of all rights, securities and guarantees of any nature enjoyed or held by it in relation to any of the same and all bills of exchange, promissory notes and other negotiable instruments for the time being owned or held by the Charger.
Debt is also defined by the international economic glossary as the amount that is owed, as a result of previous borrowing. [10]
A debt is created when a creditor agrees to lend a sum of assets to a debtor. In modern society, debt is usually granted with expected repayment; in most cases, plus interest.[11]
There are mainly two categories of debt instruments – bond and loan. Under the loan category falls usury, consumer lending, predatory lending, loan shark and payday loan and under the bond category falls debenture, corporate bond, government bond and municipal bond. All of these are the legal liability of the company which is the legal bound obligations of the company to pay debts.[12]
Debt may include bank loans, overdrafts, and lease financing and may be long or short term, secured or unsecured. The lender receives interest at an agreed rate and in the event that this is not paid may be entitled to take control of and sell certain assets owned by the company. A lender does not, however, generally have a share in the ownership of the business.[13]
Debt securities are a type of financial platform in which an issuer, also known as a creditor, provides assets to a borrower with the intention of receiving a repayment of the funds. Basically, it is some form of contract that represents money owed to another party. Examples of this include different types of bonds and documents such as debentures. The concept of a debt security is important to the continued function of most of the worldwide economy. Those institutions with capital provide individuals and companies in need of funding with the ability to purchase goods and services on credit. The creditor then issues some sort of binding document designed to symbolize the debt accrued. These documents are considered to be worth a certain value, requiring the individual or group to repay the debt according to the terms of the agreement.[14]
BOND:
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.[15]
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.[16]
A bond entitles the holder to repayment of the principal sum, plus interest. Bonds are issued to investors in a marketplace when an institution wishes to borrow money. Bonds have a fixed lifetime, usually a number of years; with long-term bonds, lasting over 30 years, being less common. At the end of the bond’s life the money should be repaid in full.[17]
Bondholders have a creditor stake in the company which means they are the lenders for the company. Bonds usually have a defined term, or maturity, after which the bond is redeemed.[18] Thus, bond is a legal liability of a company.
DEBENTURES:
So far we have discussed debentures in brief and its related significant areas. Now let us get into full details of it and take a complete look into debentures and how they are the debts. An attempt has been made here to assess all these.
a. Characteristics of a Debenture:
There are mainly six broad characteristics of a debenture which are as follows:
1. Each debenture is numbered.
2. Each contains a printed statement of the terms and conditions, the rate of interest, the time of payment of interest, the security against which the debenture is issued and what steps the debenture holder can take in case of non-payment of his dues.
3. A debenture usually creates a floating charge[19] on the assets of the companies.
4. A debenture may create a fixed charge[20] instead of a floating charge.
5. Sometimes debenture holders are given the right to appoint a receiver in case of non-fulfillment of the terms of the debentures by the company.
6. Sometimes a series of debentures are issued with a trust deed by which trustees are appointed to whom some or all the properties of the company are transferred by way of security for the debenture holders.[21]
Apart from these, there are some more characteristics. These are as follows:
1. A debenture holder is only a creditor of the company.
2. Debenture is loan to the company.
3. A debenture holder cannot have voting rights.
4. Debenture holders get priority over shareholders when assets are distributed upon winding up.[22]
b. Rights and Remedies of Debenture Holders
If the company fails to pay the interest or principal on the due date or fails to comply with any of the terms and conditions under which the debenture was issued, the debenture holder can adopt any of the following remedial measure:
1. He may file a suit for the recovery of money by sale of the assets which were charged for the payment of the money.
2. He may file an application for the appointment of a receiver by the court.
3. He may himself appoint a receiver if the terms of the debenture entitled him to do so.
4. The trustees may sell the properties charged, if such a power is given to them under the terms of the debenture.
5. He may apply to the court for the foreclosure of the company’s right to redeem the properties charged for the payment of the money.
6. He may present petition for the winding up of the company.[23]
c. Classification of Debentures:
Debentures may be classified in many different ways. Some of which are mentioned below:
1. Redeemable Debentures and Perpetual Debentures
2. Registered Debentures and unregistered or Bearer Debentures
3. Debenture and Debenture Stock
4. Mortgage Debenture and Naked Debenture[24]
Debentures can also be classified as:
1. Unsecured Debentures
2. Secured Debentures
There are three types of debentures available:
1. Subordinated Debentures
2. Government Debentures
3. Corporation Debentures
d. Security in Different Jurisdictions:
In the United States, debenture refers specifically to an unsecured corporate bond, that is 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’.
However, in the United Kingdom a debenture is usually secured.
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’.[25]
DEBENTURE AS A DEBT:
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.[26]
In deposit terminology, the term Debentures refers to a certificate issued by a person or corporation with the purpose of acknowledging or creating a debt. Debentures are generally unsecured by assets and are interest bearing securities.
For example, most Debentures are essentially unsecured bonds issued by corporations relying on the credit worthiness of the issuer for their distribution, although a Debenture in the United Kingdom is usually a secured debt. The interest income that holders of Debentures receive is generally derived from a company’s corporate profits. Some Debentures feature a convertibility option, whereby the Debenture can be converted into shares of the corporation’s common stock. These securities are known as convertible Debentures. Because of the convertibility feature of these securities, they typically carry lower interest rates than Debentures without the convertibility feature. In the case that the corporation goes into bankruptcy, the Debenture holders get treated as general creditors.[27]
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.[28]
Debenture is a general term that loosely refers to debt, but can also refer to more specific things such as the debt itself, the document that details the debt, or a type of bond or security issue provided by a company for a debt.[29]
A debenture may also be commonly referred to as an agreement of debt between 2 parties. It is considered a contract between 2 parties that provides information with regards to the parties involved and the terms of the loan.[30]
The term debenture is used in slightly different ways around the world. Roughly, a debenture is a debt and the term may refer to the debt itself, the document which states the terms of the debt, or a type of security issue made by a company in the form of debt, such as a bond. In the finance world, a debenture is a financing instrument. Governments and large corporations issue debentures as a way of raising capital.[31]
A debenture can also be related to a debt which is not associated with government or corporate attempts to raise capital. When people enter into a debt, they are usually required to sign a contract which sets out the terms of the loan agreement and establishes a repayment plan. The resulting contract is a form of debenture because it acknowledges the debt and provides information about the terms and the parties involved in the loan.[32]
Section 205C of the Indian Company Act 1956 states the following about debenture being an instrument to borrow capital—
“Debentures are instruments to obtain loan capital. The debenture certificate is a certificate issued to acknowledge loan obtained and various commitments made to the debenture holders as to rate, periodicity and manner of payment of interest, redemption of debentures etc.”[33]
A debenture is a certificate that shows the debt of a company. It is a debt instruments in which an average investor gives a loan to an institution and receives return of the principal plus interest payments. Debenture includes debenture stock, bonds and any other securities of a company, whether constituting a charge on the assets of the company or not.
Convertible debentures are debt instruments which can be converted into another type of security, classically stock in a company. Companies may use convertible debentures as a financing tool which allows them to raise capital without having to sell stock.
For example, of a convertible debenture, a company might issue bonds, using the capital from the bond sales to fund a project. The bondholders could opt to convert their bonds into stock at an agreed-upon price, or to accept repayment of the bond funds. For the seller, this convertible debenture carries a lower interest rate, and for buyers, it carries a potentially higher return, as the value of the stock may grow, allowing the buyer to take advantage of the agreed-upon sale price to make a significant profit.
Debenture refers to a long-term debt instrument. The governments and corporations issue debentures in the market in order to collect fund. The concept of debenture is similar to bonds and the person who buys debenture actually becomes the creditor to the issuing company. The securitization conditions of the debentures and bonds are different. As the debenture does not require pledging of any assets, it is generally considered unsecured. The debenture holders are treated as general creditors in the cases of bankruptcy. In other words, a debenture may be defined as the promissory note that is backed by a company’s general credit and is not secured by the lien on any specific property.[34]
The advantage that the issuers enjoy over the debentures is that they leave the assets free of burden hence leaving them open for further financing. The debentures are often freely transferable by the holders of debenture. Typically, the debenture is a type of debt instrument, which is not secured by collateral or physical asset. It is the reputation and general creditworthiness of the issuer that backs the debentures. The debentures are certificated in the indentures. Debentures are very frequently issued by the governments and corporations to collect funds.[35]
When the charge crystallizes it fixes on the assets then owned by the company, catching any assets acquired up to that date, but missing any which have already been disposed of. If the charge was created before 15th September 2003 the debenture-holder is then entitled to appoint an administrative receiver, whose job is to collect the assets charged to pay off the loan. This is what is usually meant when a company goes into receivership. If the charge was created after that date, the debenture-holder may appoint an administrator.[36]
Secured debentures allow investors to be involved in business investment with some degree of safety. It is important to distinguish secured debentures from other unsecured types of debentures. In an average debenture, the debt holder has no real recompense should the issuer of the debenture default on its agreement to pay back the loan. The company that is the issuer of the debenture usually agrees to pay back the investor interest until the completion of the debenture agreement, at which point the principal is also repaid.[37]
CONCLUSION
Debenture is an instrument of debt and a vital source of raising the capital of a company. It is falls under the category of bond which itself is a debt instrument. It is the company’s legal liability and a document which either creates a debt or acknowledges it and any document that fulfills either of these conditions is a debenture.
BIBLIOGRAPHY
Arun Kumar Sen, Jitendra Kumar Mitra .Commercial Law and Industrial Law
http://www.vakilno1.com/bareacts/companiesact/s2.htm
http://chestofbooks.com/finance/private/Business/Debenture-Bonds.html
http://www.companylawclub.co.uk/topics/company_borrowing.shtml
http://en.wikipedia.org/wiki/Debts
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http://www.nottingham.ac.uk/business/cmbor/Glossary.html
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http://en.wikipedia.org/wiki/Debenture
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[1] http://www.vakilno1.com/bareacts/companiesact/s2.htm
[2] http://chestofbooks.com/finance/private/Business/Debenture-Bonds.html
[3] Arun Kumar Sen, Jitendra Kumar Mitra .Commercial Law and Industrial Law, , pg-733, paragraph-2
[4] Arun Kumar Sen, Jitendra Kumar Mitra .Commercial Law and Industrial Law, , pg-733, paragraph-3
[5] Arun Kumar Sen, Jitendra Kumar Mitra .Commercial Law and Industrial Law, , pg-733, paragraph-3
[6] Arun Kumar Sen, Jitendra Kumar Mitra .Commercial Law and Industrial Law, , pg-732, paragraph-1,2
[7] Section 292 refers to Certain powers to be exercised by Board only at meeting.
[8] http://www.companylawclub.co.uk/topics/company_borrowing.shtml
[9] http://en.wikipedia.org/wiki/Debts
[10] http://www-personal.umich.edu/~alandear/glossary/d.html
[11] http://en.wikipedia.org/wiki/Debts
[12] http://en.wikipedia.org/wiki/Legal_liability
[13] http://www.nottingham.ac.uk/business/cmbor/Glossary.html
[14] http://www.wisegeek.com/what-are-debt-securities.htm
[15] http://en.wikipedia.org/wiki/Bond
[16] http://en.wikipedia.org/wiki/Bond
[17] http://en.wikipedia.org/wiki/Debts
[18] http://en.wikipedia.org/wiki/Bond
[19] A floating charge is a particular type of security, available only to companies. It is an equitable charge on (usually) all the company’s assets both present and future, on terms that the company may deal with the assets in the ordinary course of business. Very occasionally the charge is over just a class of the company’s assets, such as its stock.
[20] A fixed charge is a charge or mortgage secured on particular property, e.g. land and buildings, a ship, piece of machinery, shares, intellectual property such as copyrights, patents, trade marks, etc.
[21] Arun Kumar Sen, Jitendra Kumar Mitra .Commercial Law and Industrial Law, , pg-732, paragraph-4
[22] Arun Kumar Sen, Jitendra Kumar Mitra .Commercial Law and Industrial Law, , pg-738, paragraph-2
[23] Arun Kumar Sen, Jitendra Kumar Mitra .Commercial Law and Industrial Law, , pg-738, paragraph-1
[24] Arun Kumar Sen, Jitendra Kumar Mitra .Commercial Law and Industrial Law, , pg-735, paragraph-2
[25] http://en.wikipedia.org/wiki/Debenture
[26] http://en.wikipedia.org/wiki/Debenture
[27] http://www.deposits.org/dictionary/term/debentures/
[28] http://definitions.uslegal.com/d/debenture/
[29] http://brainz.org/law-what-debenture/
[30] http://brainz.org/law-what-debenture/
[31] http://www.wisegeek.com/in-law-what-is-debenture.htm
[32] http://www.wisegeek.com/in-law-what-is-debenture.htm
[33] http://www.taxmanagementindia.com/visitor/detail_article.asp?ArticleID=321
[34] http://finance.mapsofworld.com/finance-theory/term-financing/debentures.html
[35] http://finance.mapsofworld.com/finance-theory/term-financing/debentures.html
[36] http://www.companylawclub.co.uk/topics/fixed_and_floating_charges.shtml
[37] http://www.wisegeek.com/topics/debenture
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