What Are Debentures?
When the ownership capital of the company is not sufficient enough to carry out the business activities the company needs to borrow capital in the form of creditorship securities to supplement its owned capital.
Debentures are one of the primary and principal sources of raising borrowed capital to meet its short term, long term and medium term financial requirements.
Debentures are also known as creditorship securities. It is a financial instrument issued in order to raise long-term finance.
They are one of the primary sources of raising borrowed capital. Debentures have acquired a significant position in the financial structure of the organisations.
The term debenture has come from the latin word ‘debere’ which means to ‘owe’.
Under the existing definition, debenture includes debenture stock, debenture means a document which either creates or acknowledges debt. Generally, debenture constitutes a lien on some property of company but there may be a debenture without such lien.
Sec 2(30) of the Companies Act 2013, only states that, ‘the word debenture includes debenture stock, bonds and other instruments of the company evidencing a debt, whether constituting a charge on the assets of the company or not’.
Palmer defines: “ A debenture is an instrument under seal evidencing debt, the essence of it being admission of indebtedness”.
Topham defines: “ A debenture is a document given by a company as evidence of debt to the holder, usually arising out of loan and most commonly secured by charge”.
It is a debt tool, finance raised through debentures is considered as a loan. Is an acknowledgement from the company that it has taken a loan from the public. Debentures are issued by analysing the creditworthiness of the company.
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 a fixed rate of interest.
Debentures are the borrowed capital of the company. The people holding debentures are known as debenture holders. A Trust Deed is executed when debentures are issued to protect the interest of the debenture holders.
Features:
Debenture is an evidence of debt by company that it owes specified sum of money to the holder of the debenture.
The face value of debenture normally carries high denomination.
The principal amount of debenture is repaired on maturity date.
Debenture holders have a priority in repayment over the other claimants of company.
A fixed rate of interest is paid to debenture holders, whether, the company makes profit or not.
Debenture holder is a creditor of the company.
Generally, secured by a fixed or floating charge on assets of the company.
Debentures can be easily transferred through the instrument of transfer.
Types:
Secured Debentures:
These are the debentures are secured by creating a fixed or floating charge on the assets of the company.
Unsecured Debentures:
Such debentures have no security. No assets is charged as a collateral security. These are also known as ‘naked’ debentures. The interest paid is generally higher than the secured debentures because of the risk elemant. A floating charge may be established by default, regardless, the issue of unsecured debentures is not circulated.
Convertible Debentures:
Convertible debentures can be converted into equity shares after the maturity period of the debenture. These debentures confer a right to the holder to convert them into equity shares after its maturity. The issue of such debentures must be approved by the special resolution in the General meeting before their issue to the public. These debentures prove to be advantageous to the holder as after the maturity period, they are entitled to equity shares and receive further capital appreciation.
Non-convertible Debentures:
These debentures cannot be converted into equity shares after they mature. The redemption process is done on its maturity and they get no capital appreciation as in the case of convertible debentures.
Registered Debentures:
As the name suggests, the names of the holders are recorded in the registered debentures. The issuing company has to maintain a register of debenture holders, wherein, the name, address and important documentations of debenture holders are recorded. For the transfer of registerd debentures there is a requirement of transfer deed.
Bearer Debentures:
The names of the holders are not recorded in the bearer debentures hence, their names do not appear in the register of debenture holders. For the transfer of bearer debentures there is no requirement of transfer deed. The company attaches coupons to the debenture certificate for the payment of interest.
Redeemable Debenture:
The debentures which are redeemed at the maturity period as mentioned in the debenture certificate are known as redeemable debentures. The repayment can be made either in installments or in lump sum. The provision pertaining to the repayment is mentioned in the Trust Deed.
Irredeemable Dentures:
These type of debentures serve as a permanent borrowed capital, they are redeemed only at the time of winding up of the company and not repayable during the lifetime of the company. Also known as the ‘Perpetual Debentures’. Generally, irredemable type of debentures are not issued.
A Company Can Raise Finance From The Public, Only If:
The company or its promoters or its directors have not been prohibited from accessing the securities market by SEBI (The Securities Exchange Board of India).
The company or its promoters or its directors have not been declared as a willful defaulter or has not defaulted in repaying any principle or interest on any debt securities for a period of more than 6 months.
Provisions For Issue of Debentures As Per The Companies Act 2013:
Voting Rights: Debentures issued will not have any voting rights.
Types: A company can issue secured or unsecured debentures and fully or partly convertible or non-convertible debentures. For the issue of convertible debentures a special resolution has to be passed in the Annual General meeting (AGM).
Debenture Certificate: A debenture certificate has to be issued by the company to the debenture holders within 6 months of allotment of debentures.
Payment of Interest and Redemption: Company has to make the payment of interest and redemption of debentures as stated in the debenture certificate.
Debenture Redemption Reserve (DRR): On the issue of debentures, the company has to create a Debenture Redemption Reserve account out of the profits of the company. This money shall be used only for The redemption of debentures. As per the companies (Share Capital and Debentures) Amendment Rules 2019, MCA has removed Debenture Redemption Reserve requirement for listed companies, NBFCs and Housing Finance Companies.
Appointment of Debenture Trustees: If the company issues prospectus or invites more than 500 people company has to appoint Debenture Trustees.
Can Approach the NCLT: If the company make defaults on the repayment of the principal amount or defaults in paying the interest. The debenture trustees are in a position to approach the National Company Law Tribunal (NCLT) for redressal of grievances.
Impose Norms: The debenture trustees have the power to check the solvency of the company. When they are of this opinion that the assets of the company are insufficient to redeem the principal amount of debentures, with the help of the NCLT (The National Company Law Tribunal) they can order a company to restrict incurring further liabilities so as to protect and promote the interests of the debenture holders.
Punishment: Provided that the company fails to comply with any provisions of the ACT, then the company and its promoters shall be liable to pay fine or imprisonment as prescribed in the Act.
Provisions As Per Companies (Share Capital and Debenture) Rules 2014:
Tenure: All secure debentures issued must be redeemed within 10 years from the date of such issue. Companies involved in Infrastructure projects or companies granted permission by the Central Government, MCA or RBI have the power to issue debentures beyond a period of 10 years but not exceeding 30 years.
Security: Company has to create a charge on the assets. The value of charge should be adequate enough to cover the entire value of debenture issued and interest payable on it. Debentures issued by any Government company need not create any charge on its assets.
Appointment of Debenture trustees: Companies issuing secured debentures must appoint Debenture Trustees. It has to execute a Debenture Trust Deed either before the issue of the prospectus or within 60 days from the allotment of debentures.
Debenture Redemption Reserve Account: On such issue, the company has to create a Debenture Redemption Reserve account out of the profits of the company which will only be used for the redemption of debentures.
Requirements As Per SEBI For Issue of Debentures:
Debt-Equity Ratio: The debt to equity ratio for the issue of debentures shall not exceed 2:1.
Complete Disclosure: The company shall clearly disclose the purpose of the issue of debentures.
Appointment of Debenture trustees: The company issuing debentures, shall appoint the debenture trustees and get into the agreement by creating a Trust Deed. Company has to execute the Deed within 3 months of the closure of issue.
Debenture Redemption Reserve: Companies issuing debentures must create a Debenture Redemption Reserve (DRR) to protect the interests of investors against the risk of default.
Obtain Credit Rating: SEBI ( Issue of Capital and Disclosure Requirements) Regulation 2018 states that the company should get a credit rating for issuing debentures, “it states that, companies making a public issue or right issue of convertible debentures has to obtain credit rating which has to be mentioned in the offer letter or prospectus”.
Credit rating is the rating given to the debt securities by the credit rating agencies which indicates the creditworthiness of the company. For example, CRISIL, CARE.
Minimum subscription: SEBI (Issue and Listing of Debt Securities) Regulation, 2008-12 States the minimum subscription requirement. As per SEBI guidelines the minimum subscription is to be to be collected. Under any circumstances, if the minimum requirement is not fulfilled the entire money received on allotment should be refunded.
Procedure For Issue of Debentures:
Pass resolution in the Board Meeting: Amount and type of debentures to be issued:
- Approval of prospectus.
- Appointment of Debenture Trustees.
- Authorize the Board of create a fixed or floating charge on the assets.
- Hold extra ordinary general meeting if the boards borrowing capacity is to be increased.
- Board has to open a separate bank account for receiving application money.
Borrowing Powers: Call Extra-Ordinary General Meeting (EGM) if the Board’s borrowing powers need to be increased.
Filing with the Registrar of Companies: The company secretary has to file the special resolution along with the company’s prospectus with registrar of companies within 30 days of board meeting.
Acquire Credit Rating: Rating given to the debt security by a credit rating agency indicates the credit worthiness of the company. The company has to get its debentures rated by the credit rating agency, which must be mentioned in the prospectus.
Entering Into Underwriting Agreement: For the successful issue of debentures the company enters into an underwriting agreement.
Issue of Prospectus: The company has to inform and invite the public to buy its debentures. Prospectus is a document which gives all the details relating to the issue of debentures.
Opening of Separate Bank Account: The issuing company has to open a separate bank account for receiving the application money.
Actual Reception of Money: Once the issue is open subscribers will submit their application money along with the money required to the specific bank account as mentioned in the prospectus.
Call Board Meeting: After receiving the application money the Board takes the decisions for the approval and allotment of debentures.
Prima Facie Evidence: The company is under an obligation to complete the allotment procedure within 60 days from the reception of application money. It has to issue the debenture certificate within 6 months of allotment of debentures.
Maintain Register of Debenture Holders: Company secretary has to make relevant entries in the register of debenture holders for the physical issue of Debentures. Section 88 of the Companies Act, 2013 requires companies to maintain a register for each member within seven (7) days after the approval of Board for the allotment, including equity holders, preference shareholders, and debenture holders.
