Introduction
In the corporate world, raising capital is crucial for companies to sustain operations, expand, or invest in new projects. Raising money through equity share is the most common way opt by a company but the problem with issuing equity share is that a company has to dilute its shareholding, but this is not the case with debentures. A debenture is essentially a debt instrument used by companies to borrow money from the public or institutional investors, with the promise of repaying the principal amount along with a fixed rate of interest. Among the various debt instruments available to companies, debentures hold a prominent position as a reliable and structured way to raise long-term capital.
Debentures offer several advantages to both companies and investors. For companies, they provide an alternative to diluting equity, allowing them to raise funds without giving up control. For investors, debentures are an attractive option as they offer a fixed income in the form of interest, with the added security of repayment at maturity. Section 71 of the Companies Act, 2013 (hereinafter referred to as "Act") along with relevant rules, outlines the procedural requirements, rights, and obligations associated with debentures.
This blog delves into the concept of debentures, the legal framework governing their issuance, and their significance within corporate financing.
What is Debenture?
A debenture is a type of long-term debt instrument that companies use to borrow funds from the public or institutional investors. Section 2(30) provide the definition of the debenture, and it provides that “debenture” 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. A debenture is essentially a debt instrument under which the company borrows the money for a fixed rate of interest.
In the case of British India Steam Navigation Co. v IRC, the court observed that there is no precise definition of the term "debenture". There are various kinds of instruments commonly called debentures. There may be mortgage debentures, which are charges of some kind on property. There may be debentures which are bonds. There may be a debenture which is nothing more than an acknowledgment of indebtedness. And there may be a thing like this, which is something more; it can be a statement by two directors that the company will pay a certain sum of money on a given day and will also pay interest half-yearly at certain times and at a certain place, upon production of certain coupons by the holder of the instrument.
Further, in the case of Edmonds v. Blaina Furnaces Co., the court said that the term "debenture" itself imports a debt- an acknowledgment of a debt- and speaking of the numerous and various forms of instruments which have been called debentures without anyone being able to say the term is incorrectly used, the court finds that generally, if not always, the instrument imports an obligation or covenant to pay.
In Palmer's Company Law, the author describes the debenture in modern parlance to denote an instrument issued by the company, normally- but not necessarily- called on the face of it a debenture, and providing for the payment of, or acknowledging the indebtedness in, a specified sum at a fixed date, with interest thereon. The term, as used in modern commercial parlance, is of extremely elastic character. The meaning of the term ' debenture' is very wide, it would go too far to assert that every document creating or acknowledging an indebtedness of the company is a debenture.
Therefore, with the help of the observation of the court and the definition as provided in section 2 (30) of the Companies Act, it can be said that the term debenture has very wide connotation and includes various instruments that evidence or show the debt which is payable on a specified date at a specified interest rate. Debenture is not limited to any specific instrument which termed as debenture, but it refers to the class of debt instruments which by their nature evidence indebtedness.
Types of Debentures
Section 2 (30) of the Act read with Section 71 of the Act lays down different types of debentures which can be categorized based on different criteria:
Based on Security
- Secured Debentures: Secured debentures refer to those debentures where a charge is created on the assets of the company for the purpose of payment in case of default. These debentures are backed by the assets of the company. If the company defaults on repayment, the holders of these debentures can claim the specified assets to recover their dues.
- Unsecured Debentures: These debentures are also known as naked debentures. These debentures are not secured by way of charge on the company’s assets. Interest rate payable on unsecured debentures is generally higher than that which is payable on secured debentures. In case of default, the holders of unsecured debentures are treated as general creditors.
Based on Convertibility
- Convertible Debentures: Section 71 of the Act recognise convertible debentures. These debentures can be converted into equity shares of the company after a certain period or under specified conditions.
- Non-convertible Debenture: Non-convertible debenture is the debenture where it does not confer any option on the holder of debenture to convert is into equity shares and are redeemed at the expiry of specified period.
- Partly Convertible Debentures (PCDs): These are the debentures consisting of two parts, namely convertible and non-convertible debentures. The convertible portions are convertible into the equity share at the option of holder and the portion which is non-convertible will be redeemed at the expiry of the period specified.
Based on Redeemability
- Redeemable Debentures: These debentures have a fixed maturity date and are to be redeemed as per the terms of the issue with the interest payable on such debentures. Rule 18 of the Companies (Share Capital and Debenture) Regulation, 2014 provides that the date of its redemption should not exceed 10 years in case of issuance of secured debenture. Section 71 (10) of the Act provides that if a company fails to redeem the debenture at the date specified date of fails to pay the interest the tribunal may order such redemption on the application of the debenture holders or debenture trustee.
- Irredeemable or Perpetual Debentures: Irredeemable debentures are the debentures where the debentures are paid back, and no clause is there as to their redemption. These do not have a specific maturity date. The principal amount is repaid only if the company decides to repay them or during liquidation. Such type of debenture was there in the Companies Act, 1956 under section 120 but in the current Act, there is no such provision. In the current framework, no fresh irredeemable debentures can be issued by the company.
On the basis of Registration
- Registered Debentures: These debentures are registered in the company's books with the details of the holder. Such debentures are payable to the registered holder i.e., person whose name is there in the register of the debenture holder. Transfer of the debenture can be done in the same way as that of shares or according with the condition endorsed on their back.
- Bearer Debentures: These debentures are transferable by mere delivery, and the company does not maintain any record of the holder. Bearer debentures are similar to share warrants as both are negotiable instruments.
Issue of Debentures under the Companies Act
The issuance of debentures in India is primarily governed by Section 71 of the Act, which lays down the legal framework for how companies can raise debt by issuing debentures. Section 71 of the Act clearly provides that the debentures does not carry with it any voting rights which are generally associated with the shares. This section provides for the issuance of the secured debenture and the conditions required for the same. Secured debenture is the instrument which is secured by the charge on the properties or the assets of the company which is sufficient for the due payment of debenture. Rule 18 of the Companies (Share Capital and Debenture) Rule, 2014, provides that the tenure for the debenture is 10 years and after which the company has to redeem back the debenture. In the case of the company related to infrastructure project, the tenure is above 10 years but below 30 years.
Creation of Debenture Redemption Reserve Account
When such debentures are issued by the company, the company is required to create a Debenture Redemption Reserve Account (hereinafter referred to as "DRRA") from the profits of the company that are otherwise available for the payment of dividends. The amount so credited to the DRRA shall be utilised by the company only for the purpose of the redeeming the debenture and not any other. The company at the time of redemption pays the interest at a fixed rate along with the principal amount.
Appointment of Debenture Trustee
When a company issues a prospectus or make an offer or invite public or its members to subscribe its debenture, it is required to appoint a Debenture Trustee in case the subscription exceeds threshold of 500 subscription. Within 60 days from the date of the issue, the company is required to execute a trust deed in favour of trustee to protect the interest of the Debenture Holders. The Debenture Trustee so appointed is responsible for protecting the interest of the Debenture holder in all possible ways. The duties of the Debenture Trustee are provided under Rule 18 of the Companies (Share Capital and Debenture) Rules, 2014, which include convening the meeting of the Debenture holders, appointing the nominee director on the board, ask for periodical reports from the company, communicate immediately of any default to the Debenture Holders, ensuring that company has sufficient funds to pay the amount due, etc. In case of listed company there are more stringent norms in respect of Debenture Trustee and SEBI has made, SEBI (Debenture Trustee) Regulation, 1993 in this regard.
When the debenture trustee thinks that the assets of the company are not sufficient to discharge the liability, he can approach the tribunal, and tribunal may impose the restriction on the company from incurring any further liability. But when the company fails to pay the amount due or the interest thereupon, debenture trustee or debenture holder may file and application before the tribunal and tribunal will then, if satisfied, will direct the company to pay the due amount or the interest as the case may be.
Conclusion
Debentures remain a crucial financial instrument for companies to raise long-term capital, offering a flexible way to manage debt while providing investors with fixed returns. Section 71 of the Companies Act, 2013, plays a pivotal role in regulating the issuance of debentures, ensuring that both the company and the investors are protected. With detailed provisions for security, repayment, redemption reserves, and the appointment of trustees, the Act seeks to balance the company’s financial needs with investor interests. Understanding these legal requirements is essential for companies to raise funds responsibly and for investors to make informed decisions about debenture investments. As the regulatory landscape evolves, debentures continue to offer a reliable, structured method for companies to access capital, fostering growth and innovation in the corporate sector.
*Rishabh Sisodia is a Third Year B.A. LL. B (Hons.) student at National Law Institute University, Bhopal.
Frequently Asked Questions
Question: Do the debentures carry interest?
Yes, Debentures carry a fixed rate of interest because it is a debt instrument as provided under section 2 (30) of the Act.
Question: what is the meaning of the debenture in the company law?
The debenture under the company law is any financial instrument, including debenture stock, and bonds, that evidence a debt. Even if something written on white paper which evidences a debt can be called as Debenture.
Question: What is the tenure of a secured debenture?
The tenure of a secured debenture is 10 years generally, but in the case of a company related to an infrastructure project, it can extend up to 30 years.
Question: Can a private company issue a debenture?
Yes, as the issue of debenture is like any other securities, it can be issued by private company by private placement as provided under section 42 of the Act.