Debentures :

Section 2(30) of the Companies Act, 2013 defines the term “debenture” which includes debenture stock, bonds or any other instrument of a company evidencing a debt, whether constituting a charge on the assets of the company or not. Debentures are bonds issued in acknowledgement of any indebtedness. Generally, however, they are issued under the company’s seal and contain a provision for the repayment of principal sum at the appointed date and the payment of interest at fixed rate. Debentures are usually secured upon the company’s property or undertaking.

Thus, a debenture is an instrument which is drawn under the seal of the company; it binds the company to pay a sum of money at a fixed time with interest but the debenture stock is a debt which carries interest at a fixed rate; it is constituted generally by a deed of covenant with trustees and the stockholder obtains a certificate of title. A stock is called perpetual if the principal amount of debt is not payable at any fixed time but only in the case of winding up or in case of default in paying interest.

Section 71 of the Companies Act, 2013 provides the manner in which a company may issue debentures.

(1) Issue of debentures with an option to convert: A company may issue debentures with an option to convert such debentures into shares, either wholly or partly at the time of redemption. Provided that the issue of debentures with an option to convert such debentures into shares, wholly or partly, shall be approved by a special resolution passed at a general meeting.

(2) No company shall issue any debentures carrying any voting rights.

(3) Secured debentures may be issued by a company subject to such terms and conditions prescribed under the Companies (Share Capital and Debentures) Rules, 2014.

(a) An issue of secured debentures may be made, provided the date of its redemption shall not exceed ten years from the date of issue.

As per the ‘the Companies (Share Capital and Debentures) Amendment Rules, 2014 following proviso has been amended-

“Provided that the following classes of companies may issue secured debentures for a period exceeding ten years but not exceeding thirty years,

(i) Companies engaged in setting up of infrastructure projects;

(ii) ‘Infrastructure Finance Companies’ as defined in clause (viia) of sub-direction (1) of direction 2 of Non-Banking Financial (Non-deposit accepting or holding) Companies Prudential Norms (Reserve Bank) Directions, 2007;

(iii) ‘Infrastructure Debt Fund Non-Banking Financial companies’ as defined in clause

(b) of direction 3 of Infrastructure Debt Fund Non-Banking Financial Companies (Reserve Bank) Directions, 2011”.

(b) such an issue of debentures shall be secured by the creation of a charge, on the properties or assets of the company, having a value which is sufficient for the due repayment of the amount of debentures and interest thereon;

(c) the company shall appoint a debenture trustee before the issue of prospectus or letter of offer for subscription of its debentures and not later than sixty days after the allotment of the debentures, execute a debenture trust deed to protect the interest of the debenture holders ; and

(d) the security for the debentures by way of a charge or mortgage shall be created in favour of the debenture trustee on-

(i) any specific movable property of the company (not being in the nature of pledge); or

(ii) any specific immovable property wherever situate, or any interest therein.

(4) Creation of debenture redemption reserve (DRR) account: Where debentures are issued by a company under this section, the company shall create a debenture redemption reserve account out of the profits of the company available for payment of dividend and the amount credited to such account shall not be utilised by the company except for the redemption of debentures.

As per the Companies (Share Capital and Debentures) Rules, 2014, the company shall create a Debenture Redemption Reserve for the purpose of redemption of debentures, in accordance with the conditions given below-

(a) the Debenture Redemption Reserve shall be created out of the profits of the company available for payment of dividend;

(b) the company shall create Debenture Redemption Reserve (DRR) in accordance with following conditions:-

(i) No DRR is required for debentures issued by All India Financial Institutions (AIFIs) regulated by Reserve Bank of India and Banking Companies for both public as well as privately placed debentures. For other Financial Institutions (FIs) within the meaning of clause (72) of section 2 of the Companies Act, 2013, DRR will be as applicable to NBFCs registered with RBI.

(ii) For NBFCs registered with the RBI under Section 45-IA of the RBI (Amendment) Act, 1997, and for Housing Finance Companies registered with the National Housing Bank[The Companies (Share Capital and Debentures) Amendment Rules, 2014]‘the adequacy’ of DRR will be 25% of the value of debentures issued through public issue as per present SEBI (Issue and Listing of Debt Securities) Regulations, 2008, and no DRR is required in the case of privately placed debentures.

(iii) For other companies including manufacturing and infrastructure companies, the adequacy of DRR will be 25% of the value of debentures issued through public issue as per present SEBI (Issue and Listing of Debt Securities), Regulations 2008 and also 25% DRR is required in the case of privately placed debentures by listed companies. For unlisted companies issuing debentures on private placement basis, the DRR will be 25% of the value of debentures.

The Companies (Share Capital and Debentures) Rules, 2014 issued by the Ministry of Corporate Affairs (MCA) on 27 March 2014, required companies to create debenture redemption reserve (DRR) equivalent to at least fifty per cent of the amount raised through the debenture issue. Subsequently, the Rules published in the Official Gazette on 3 April 2014 (effective from 1 April 2014), changed the above requirement for creation of DRR.

The Gazetted Rules exempt certain companies from creation of the DRR and in case of other companies, reduce the percentage of DRR from 50 per cent to 25 per cent of the value of debentures.

(c) every company required to create Debenture Redemption Reserve shall on or before the 30th day of April in each year, invest or deposit, as the case may be, a sum which shall not be less than fifteen percent, of the amount of its debentures maturing during the year ending on the 31st day of March of the next year, in any one or more of the following methods, namely:-

(i) in deposits with any scheduled bank, free from any charge or lien;

(ii) in unencumbered securities of the Central Government or of any State Government;

(iii) in unencumbered securities mentioned in sub-clauses (a) to (d) and (ee) of section 20 of the Indian Trusts Act, 1882;

(iv) in unencumbered bonds issued by any other company which is notified under sub-clause

(f) of section 20 of the Indian Trusts Act, 1882;

(v) the amount invested or deposited as above shall not be used for any purpose other than for redemption of debentures maturing during the year referred above: Provided that the amount remaining invested or deposited, as the case may be, shall not at any time fall below fifteen percent of the amount of the debentures maturing during the year ending on the 31st day of March of that year;

(d) in case of partly convertible debentures, Debenture Redemption Reserve shall be created in respect of non-convertible portion of debenture issue in accordance with this subrule.

(e) the amount credited to the Debenture Redemption Reserve shall not be utilised by the company except for the purpose of redemption of debentures.

(5) Limitation on the issue of prospectus/ offer / invitation to the public: No company shall issue a prospectus or make an offer or invitation to the public or to its members exceeding five hundred for the subscription of its debentures, unless the company has, before such issue or offer, appointed one or more debenture trustees and the conditions governing the appointment of such trustees shall be such as may be prescribed.

(6) Debenture trustee to protect the interest of debenture holders: A debenture trustee shall take steps to protect the interests of the debenture- holders and redress their grievances in accordance with such rules as may be prescribed.

(7) Liability of debenture trustee: Any provision contained in a trust deed for securing the issue of debentures, or in any contract with the debenture-holders secured by a trust deed, shall be void in so far as it would have the effect of exempting a trustee thereof from, or indemnifying him against, any liability for breach of trust, where he fails to show the degree of care and due diligence required of him as a trustee, having regard to the provisions of the trust deed conferring on him any power, authority or discretion.

Exemption from the liability: Provided that the liability of the debenture trustee shall be subject to such exemptions as may be agreed upon by a majority of debenture-holders holding not less than three fourths in value of the total debentures at a meeting held for the purpose.

(8) To pay interest and redeem the debentures: A company shall pay interest and redeem the debentures in accordance with the terms and conditions of their issue.

(9) Filing of petition before the Tribunal by the debenture trustee: Where at any time the debenture trustee comes to a conclusion that the assets of the company are insufficient or are likely to become insufficient to discharge the principal amount as and when it becomes due, the debenture trustee may file a petition before the Tribunal and the Tribunal may, after hearing the company and any other person interested in the matter, by order, impose such restrictions on the incurring of any further liabilities by the company as the Tribunal may consider necessary in the interests of the debenture-holders.

(10) On failure to reedem the debentures/ to pay interest on the debentures: Where a company fails to redeem the debentures on the date of their maturity or fails to pay interest on the debentures when it is due, the Tribunal may, on the application of any or all of the debenture-holders, or debenture trustee and, after hearing the parties concerned, direct, by order, the company to redeem the debentures forthwith on payment of principal and interest due thereon.

(11) Default in compliance of order of the Tribunal: If any default is made in complying with the order of the Tribunal under this section, every officer of the company who is in default shall be punishable with imprisonment for a term which may extend to three years or with fine which shall not be less than two lakh rupees but which may extend to five lakh rupees, or with both.

(12) Specific performance of the contract: A contract with the company to take up and pay for any debentures of the company may be enforced by a decree for specific performance.

(13) Procedure to be prescribed by the Central Government: The Central Government may prescribe the procedure, for securing the issue of debentures, the form of debenture trust deed, the procedure for the debenture-holders to inspect the trust deed and to obtain copies thereof, quantum of debenture redemption reserve required to be created and such other matters.

Fixed and floating charges: Debentures may be secured by a fixed charge or by a floating charge or by a combination of both. A floating charge is an equitable charge which is not a specific charge on any property of the company. Thus, the company may, despite the charge deal with any of the assets in the ordinary course of business. “It is of the essence of a floating charge that it remains dormant until the undertaking charged ceases to be a going concern or until the person in whose favour the charge is created, intervenes. His right to intervene may, of course, be suspended by agreement. But if there is no agreement of suspension, he may exercise his right whenever he pleases after default.”

On the other hand, a specific (fixed) charge is a charge which is expressed to cover specific property like land, building, etc. Although the company usually remains in possession of the property, it can only deal with it subject to the prior rights created by the charge.

It is thus evident that a floating charge is characteristically ambulatory and shifting; it flows “with the property which is intended to affect until some event occurs or some act is done which causes it to settle and fasten on the subject of the charge within its reach and grasp.”But specific charge is a charge which fastens on to the property which is ascertained and definite or capable of being ascertained and made definite.

The main characteristics of a floating charge [as described in Re. Yorkshire Woolcombers’s Association (1903) 2. Ch. 284 and 285] are as follows:

(a) It is a charge on a class of the company’s assets, present and future, that class being one which, in the ordinary course of the business is changing from time to time.

(b) Generally, it is contemplated that the company carry on its business in an ordinary way with such a class of assets till some event occurs on which the charge is to settle down on the property as then existing and the charge becomes fixed. The moment the charge crystallises, it becomes a fixed charge. It takes place when some event contemplated in the agreement creating the charge occurs, e.g. debenture holders enforcing their securities on a default being made by company either in payment of interest or capital on the company being wound up.

There are two major statutory limitations to the rights arising out of floating charge.

Firstly, a floating charge created within 12 months preceding the commencement of the winding up (whether compulsory or voluntary or subject to supervision), shall unless it is proved that the company immediately after the creation of the charge was solvent, be invalid except up to the amount of any cash paid to the company at the time of, or subsequent to the creation of and in consideration for the change together with the interest on that amount @ of 5 per cent per annum or at any other rate as may be notified by the Central Government (Section 332 of the Companies Act, 2013).

[Note: You should note that although these provisions of Section 332 of the Companies Act, 2013 are excluded from your syllabus nonetheless you should read them by way of passing reference].

Secondly, floating charge crystallises, i.e. becomes fixed and consequently the security ceases to be a floating security (i) in the charge, i.e. failure of the company to pay interest or to redeem the debentures as agreed; cessation of businesses by the company, (ii) if a receiver is appointed for the debenture holders either by the Court or by the debenture holders or their trustees under power given by terms of issue of debentures and (iii) if the company is wound up even if it is a voluntary winding up for the purpose of reconstruction [Re Crompton & Co. (1914) 1. Ch. 954.]

Debentures with voting rights not permissible

No company can issue any debentures carrying voting rights at any meeting of the company, whether generally or in respect of any particular classes of business[Section 71(2) of 2013 Act]. The idea behind prohibition of issue of debentures with voting rights is to ensure that debenture holders are not placed in a much more advantageous position than the holders of equity shares and are not in a position to influence the policy of the company in a manner detrimental to the interest of the general body of shareholders.

Distinction between debenture and share

(i) Shares are a part of the capital of a company whereas debentures constitute a loan.

(ii) The shareholders are the owners of the company whereas debenture holders are creditors.

(iii) Shareholders generally enjoy voting right whereas debenture holders do not have any voting right.

(iv) Interest on debenture is payable even if there are no profits. But dividends can be paid to shareholders only out of the profits of the company.

(v) Debentures generally have a charge on the assets of the company but shares do not carry any such charge.

(vi) The rate of interest is fixed in the case of debentures whereas on equity shares the dividend may vary from year to year.

(vii) Fixed amount of interest on debentures gets priority over dividend on shares.