“A document which either creates a debt or acknowledges it, and any document which fulfills either of these considers is a debenture.”
Introduction
Debenture includes debenture stock, bonds and any other securities of a company whether constituting a charge on the assets of a company or not as defined in section 2(12) of the Companies Act 1956 (“the Act“).[1]This is a comprehensive definition and amounts to borrowing of monies from the holders of debentures on such terms and conditions subject to which the debentures have been issued. Mainly the debenture is represented by a document or certificate signed by the authorized officers of a company acknowledging money lent and guaranteeing repayment with interest and with or without security on the assets of the company for due performance of its obligation. This is a debt instrument and is the commonest method of raising loan capital at a lower cost, as part of project financing or for any other purposes.
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.[2]
Types of Debenture
There are two types of debentures. These are describe shortly in the below-
As we all know, 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.
Another one I found that, 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.
Issue of Debentures & concern of Security
A company which issues debentures is under an obligation to create security thereof pursuant to section 117A of the Act by executing a trust deed. The need for executing a trust deed will arise when a company wants to issue a prospectus or letter of offer to the public for securing subscription to its debentures and for this purpose appoint one or more Debenture Trustees. The trust deed should state that the Debenture Trustees have consented to be appointed as such as required by section 117B of the Act. Thus a Debenture Trustee enjoys a unique position of being an independent entity unconnected with the issuer of security but none- the- less appointed to protect the interest of holders of debentures.[3]
Qualification for Appointment of Debenture Trustee
I found that, all and sundry cannot be appointed as Debenture Trustees. A person holding beneficially shares in the issuer company or beneficially entitled to receive moneys from that company and has provided any guarantee in respect of principal debts secured by the debentures or interest thereon as specified in section 117B of the Act. SEBI (Debenture Trustee) Regulations, 1993 additionally prescribe that no person shall be entitled to act as Debenture Trustee unless he is either a scheduled bank carrying on commercial activity or a public financial institution within the meaning in section 4A of the Act or an insurance company or a body corporate.[4] It is also necessary that such an entity should have capital sufficiency of net worth of one core of rupees and have been licensed by SEBI to act as a Debenture Trustee.
The Functional Role of Debenture Trustee
As we all know, the Debenture Trustee is an intermediary between the issuer of debentures and the holders of debentures. Accordingly the main responsibility of debenture trustee is to protect the interest of holders of debentures including creation of adequate security by the company issuing the debentures and to redress their grievances. He may also take such steps as he deems fit to:
Under the Act
I found some rules and regulation under the act. These are given to the below:
a) Ensure that company does not commit any breach of covenants and provisions of the trust deed.
b) Take such reasonable steps to remedy any breach of the covenants of the trust deed or the terms of issue of the debentures.
c) Take steps to call a meeting of holders of debentures as and when such meeting is required to be held.
d) Ensure on a continuous basis that the assets o f the company issuing debentures.
e) Each of the guarantors is sufficient to discharge the principal amount and the interest at all time.
f) Satisfy him that the prospectus or the letter of offer does not contain any matter which is inconsistent with the terms of debentures or with the trust deed.
Under aforesaid Regulation
Regulation 15 of aforesaid Regulation prescribes the duties of the Debenture Trustee, inter alia, as under:
a) Exercise due diligence to ensure compliance by the body corporate with the provisions of the Act, the listing agreement of the stock exchange or the trust deed;
b) Take appropriate measures for protecting the interest of the debenture holders as soon as any breach of the trust deed or law comes to his notice;
c) Ascertain that the debentures have been converted or redeemed in accordance with the provisions and conditions under which they are offered to the debenture holders.
d) Inform the Board immediately of any breach of trust deed or provision of any law;
e) Appoint a nominee director on the board of the body corporate in the event of:-
f) i) two consecutive defaults in payment of interest to the debenture holders; or
ii) default in creation of security for debentures, or
iii) default in redemption of debentures.
g) No debenture trustee shall relinquish its assignments as debenture trustee in respect of the debenture issue of anybody corporate, unless and until another debenture trustee is appointed in its place by the body corporate.
h) Call for periodical reports from the body corporate i.e. issuer of debentures.
i) Take possession of trust property in accordance with the provisions of the trust deed.
j) Enforce security in the interest of the debenture holders.
k) Ascertain and satisfy on a continuous basis that the property charged to the debentures is available and adequate at all times to discharge the interest and principal amount payable in respect of the debentures and that such property is free from any other encumbrances save and except those which are specifically agreed to by the debenture trustee.
l) Exercise due diligence to ensure compliance by the body corporate with the provisions of the Act, the listing agreement of the stock exchange or the trust deed.
Under the sec 17A, every debenture trustee shall appoint a compliance officer who shall be responsible for monitoring the compliance of the Act, rules and regulations, notifications, guidelines, instructions, etc., issued by the Board or the Central Government and for redressal of investors’ grievances.[5]Thus, a Debenture Trustee occupies a pivotal position of trust and confidence between the company which issues debentures and the debenture holders who subscribe to the debentures. He shall be responsible for monitoring under which they are offered.
Contents of the Debenture Trustee Agreement
Debenture Trustee Agreement should include the following:
a) Preamble
b) Description of the Instrument
c) Details of charged securities i.e.
d)
i.nature of charge
ii.examination of title
iii.rank of the charge i.e. whether first, second, or pari passu charge etc
iv.charging of future assets
v. time limit for creation of charge
vi. minimum security cover required
vii. valuation of security
viii.circumstances in which security becomes enforceable
ix. method and preservation of secured property etc
e) Events of default
f) Rights of Debenture Trustee
g)Obligations of the body corporate (i.e. Issuer of debentures)
Apart from the above, the Debenture Trustee Agreement will have to include the following provisions:
i. Definition and Interpretation
ii. Appointment of Debenture trustee and its powers
iii. Remuneration of Debenture Trustee
iv. Appointment of debenture Trustee as Attorney
v. Negative pledge i.e. not to creation additional encumbrances on the secured asset,
vi. Description of Events of Default, this may arise due to non-payment to debenture holders, breach of any undertaking, avoidance or repudiation
vii. Notice of exercise of trustee powers
viii. Indemnity of trustee
ix. Retirement of trustee & appointment of new trustee
x. Reimbursement of expenses incurred by the trustee
xi. General covenants etc.[6]
Who be capable of appoint Debenture Trustee?
Here, Creation of security means mortgaging or charging the property in favor of Debenture Trustee for the benefit of debenture holders. This is an incidence of ownership of property and creation of security has to be done by the owner of the property.
However, the debenture holders are beneficiaries and they have no access to mortgaged property. The Debenture Trustee holds the secured property on behalf of issuer of security and for benefit of debenture holders. In the event of default by the issuer of security, the Debenture Trustee will have the power and authority to bring the secured property to sale following the procedure in the Transfer of property Act, 1882 and the proceeds of sale will have to be applied to redeem the debentures.
Should Debentures be completely secured?
This is one of the vexed issues regarding the issue of debentures. There is divergence of views in this regard. Debenture is defined in Sec 2(12) of the Act as including debenture stock, bonds and any other securities of a company whether constituting a charge on the assets of the company or not. This is an inclusive definition .and does not define what is debenture. Of course in commercial parlance it is generally understood as borrowing of funds under certain terms and conditions represented by the debenture certificate.
The definition of “debenture” enacted in the year 1956 when the present Act came on the statute book creates an impression that a debenture may or may not be secured. It follows from this if it is secured, the provisions of section 125 of the Act will apply requiring registration of charge with the ROC. If it is not secured, then it will not get the benefit as an exempt deposit. Under Rule 2(b)(x) of the Companies (Acceptance of Deposits) Act 1975 and Part 3 of the Return of Deposits (which lists out particulars of exempt borrowings etc not considered as deposits) item 9 thereof describes “money received by issue of debentures secured by mortgage of immovable properties or convertible debentures is shown as exempt deposit”.
Accomplish of conception of Charge
A charge for securing any issue of debentures is considered as a charge within the meaning of section 125 of the Act. It envisaged various types of charges. The nature of charge created differs from company to company and every company has a choice as what it would like to offer as security to the debenture holders.
However the security offered should be adequate to meet the financial obligation to the debenture holders. Registration of charge will make the debenture holders secured creditors of the company and as such they have priority claim on the secured property. A charge on immovable property requires registration not only under the Act but also under the Registration Act. This may also include a charge created by way of conditional sale of any immovable property.
The creation of charge may be by way of fixed charge or a floating charge or both. A charge becomes fixed with reference to the specific property on which charge is created and the company which creates such a charge has to deal with the property subject to charge. On the other hand, a floating charge is a charge over all the assets, properties and the company may deal with such property in the ordinary course of business in any manner until the charge attaches.
However, whether a charge is “fixed” or “floating” has to be determined by the substance of the transaction and not by the description used by the parties in the agreement creating the charge. A floating charge becomes a fixed charge when the debtor company ceases to carry on its operations or goes into liquidation.
Can a private company issue debentures & appoint debenture trustee?
A private company is prohibited from inviting public to subscribe to its shares or debentures. However, nothing prohibits the company from issuing debentures on private placement basis, if the Articles of the company empowers the Board to borrow by issuing debentures and creation of security. All other provisions of the Act as applicable to a public company will apply except that it may not be required to appoint Debenture Trustee.
The company may execute a deed of charge on its assets and register it with the ROC and this is permissible under section 117B of the Act. The requirement of having to create Debenture Redemption Reserve (DRR) will have to be followed as section 117C is a special provision applicable to all companies. This is however subject to relaxations provided in respect to certain categories of companies by the DCA vide its circular No9\2002 dated 18-4-2002.
Stamping Requirements
I found that, In the matter of issue of debentures, Mortgage Deed (Article 40) and Debenture (Article 27) has been dealt with in the Stamp Act. While the former document sets out the terms and conditions subject to which debentures have been issued security, the latter document provides for transfer of debentures as a marketable security.
There are various forms for creation of security by way of mortgage. It may be with possession or without possession of Property with reference to which mortgage has been created or proposed to be created.
Article 27 deals with stamp duty payable on the transfer of debentures as a marketable security by way of endorsement or by separate instrument of transfer. Rates of stamp duty are given in the Article.
However, in the matter of issue of debenture certificate, there is an exemption. This exemption is applicable if the debenture certificate is issued by an incorporated company in terms of registered mortgage deed, duly stamped in respect of full amount of debentures and the debenture certificate is issued pursuant to the said mortgage deed.
Payment of stamp duty is incidental to acquisition or transfer of property. Sometimes companies get the Instruments stamped in the State where the stamp duty is comparatively low to save on cost, though the property may situate in another state. This may not work out in a beneficial manner.
Debenture Certificate
The debenture certificate stands on a different footing. Before issue of certificate, the company will have to create a charge on the assets of the company by filing the required forms with the ROC. The certificate of charge will have to be reproduced on the back of the certificate as also major terms and conditions subject to which debentures have been issued. Section 113 of the Act provides for issue of debenture certificate within three months from the date of allotment of debentures.
However, the Company Law Board (this power is being shifted to Central Govt) may extend the period to a further period not exceeding nine months if it is satisfied that the company is not in a position to deliver the certificate within the aforesaid period of three months. Delay in creation of security may be one of the reasons for seeking extension of time.
Debenture Redemption Reserve (DRR)
According to Shri S.Srinivasan, Practicing Company Secretary and Authorized Representative of the Companies, Section 117C has been inserted by the Companies (Amendment) Act, 2000 with effect from 13.12.2000. Prior to the Amendment Act, 2000 there has been no such provision for creating debenture redemption reserve to safeguard the interests of debenture holders. He pointed out that sub-section (1) of section 117 C stipulates the following: –
I. Create a debenture redemption reserve for the redemption of debentures issued by the Company after the commencement of the provisions of section 117C.
II. Redemption reserve should be created from out of the Company’s profits of every year.
III. The reserve so created should be credited with adequate amount.
IV.The reserve so created should remain until such debentures are redeemed.[7]
Section 117C of the Act requires that every company issuing debentures should create DRR for the purpose of redemption of debentures to which adequate amounts should be credited from the profits of the company until debentures are redeemed. This is a mandatory provision. SEBI regulations also require companies issuing debentures to provide for DRR as required under the Act. Even where debentures are compulsorily convertible into the equity shares of the debenture issuing company, as in the case FEMA, creation of DRR is unavoidable till the date of conversion.
However, after conversion of debentures, the amount in the DRR may be transferred to general reserve or in such other manner as the Board thinks fit and proper. The amount credited to DRR cannot be utilized except for the redemption of debentures. DCA Circular NO 9 \2002 dated 18-4-2002 provides some relief as under in the matter of DRR in the case of banking Institutions, All India Financial Institutions, NBFC’s and others keeping in view the genuine problems likely to be caused to these institutions:
a) For manufacturing and infrastructure companies, the adequacy of DRR will be 50% of the value of debentures issued through public issue and 25% for privately placed debentures.
b) Section 117C will apply to debentures issued and pending to be redeemed and such DRR is required to be created for debentures issued prior to 13-12-2000 and pending redemption subject to clarification issued herein.
c) Section 117C will apply to non-convertible portion of debentures issued whether they are fully or partly convertible.
d) No DRR is required for debentures issued by All India Financial institutions (AIFI’s) regulated by RBI and banking companies for both public as well as privately placed debentures.. For other FI’s within the meaning of section 4A, DRR will be as applicable to NBFC’s registered with RBI.
e) For NBFC’s registered with RBI under section 45-1A of the RBI(Amendment) Act 1997 the adequacy of DRR will be 50% o f the value of debentures issued through public issue and no DRR is required in the case of privately placed debentures.
Unsecured Debentures
Unsecured debentures are debentures that are not supported by a collateral security. No specific assets will be set aside against unsecured debentures. It is basically a loan without any protection. They are backed only by the general credit worthiness of the issuer.[8]Companies may also issue unsecured\subordinated debt instruments\obligations. However, such instruments have to be subscribed by qualified institutional investors or others who have given positive consent for subscribing to such unsecured\subordinated debt instruments. In the case of companies issuing debt instruments like debentures having maturity of less than 18 months, there is a facility of creating a charge on the assets of the company, instead of having to create mortgage and appoint Debenture Trustee for its assets.
However, where no charge is created as aforesaid, the issuer company is required to ensure compliance with the provisions of companies (Acceptance of Deposits) Rules as such unsecured debentures\bonds are treated as “deposits”.
Conclusion
Finally we can say that, Issue of Debentures, whether redeemable or convertible involves compliance with the substantive and procedural aspects of law. Documentation is equally important. The benefit of raising loan capital lies in the fact that it does not disturb equity structure of the company and consequently the existing management. However, the success of a debenture issue is it private or public issue depends, to a large extent, on the goodwill and rapport built up by the company with the investing public. Another aspect o f the matter is the protection of interest of debenture holders. This is sought to be achieved by an independent Debenture Trustee who is required to be appointed by listed companies in regard to public issue or further issue of capital as the number of debenture holders are considerably large Creation of DRR which is statutory obligation is intended to provide liquid resource built out of profits of a company for redemption of debentures.
Correspondence
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