Debentures - An analysis of Indian law

By Cindia S


Cindia S

Debentures under Indian Law ? An Analysis


1.     Introduction


The term debenture originated from the latin term 'debere' meaning borrow. This itself makes it clear that debenture is a method of raising loan capital (other than share capital) for the company. It is an instrument showing in debtness, with a contract for repayment at a specified rate with interest. The term 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.[1] In the case of Laxman Bharamji v. Emperor[2] it was mentioned that it is the substance of the instrument that we need to look into in order to identify whether it is a debenture or not.

This paper will discuss about the meaning and definition of debentures, debenture stock, statutory provisions dealing with issue of debentures, debenture trustee, touching upon the rights, duties and liabilities of a debenture trustee, redemption of debentures, register of debentures and similar provisions in the UK Companies Act 2006.The similarities and differences between a debenture-holder and shareholder will also be discussed. The key changes reflected in the 2013 statute will also be discussed.

2.     Debentures v. Debenture Stock


Debenture stock is also a contract of loan, acknowledging debt, with an obligation to return a fixed amount with specified interest at scheduled intervals of time, secured by company's assets. Certificates are issued to every single debenture stock holder specifying the amount of his holding. The debenture stock is to be fully paid.

When a debenture is part of loan capital of the company, the shares are its equity or preference share capital. The debenture holder is only a creditor while a shareholder may be described as a part owner. Returns from share (dividend) is declared when there are profits and its rate varies year after year. The company has to compulsorily pay return on debenture (interest) at a fixed rate not depending on the fact whether there is profit or not. Debentures, unlike shares, also create a charge on assets.

Based on redemption debentures can be divided into redeemable and irredeemable debentures. The redeemable type of debentures are the ones which needs to be paid back in order to release the mortgaged assets. When there is no condition in the AOA as to cancellation of redeemed debentures then the company shall have the power to reissue them keeping them active.

Irredeemable or perpetual debentures are those that are not required to be paid back during the company's lifetime.

3.     Issue of debentures


s.179 (3) of the Companies Act, 2013 read with rule 8 of Companies (meetings of board and its powers) Rules, 2014 and Companies (meetings of board and its powers) Amendment Rules, 2015 states that the power to issue dentures can be exercised by the Board of directors acting on behalf of the company by  resolutions passed at board meetings.

Process for issuance of debentures along with the penalties imposed for non-compliance of procedure is provided in s.71. A company is disabled from issuing debentures with voting rights but it can issue secured or unsecured ones. The company may issue convertible debentures provided that it is approved by a special resolution passed in the general meeting by shareholders. Such shares can be converted into shares at the time of redemption wholly or in part. 

The company is to maintain a debenture redemption reserve (DRR) account out of profits for paying of dividend, which shall not be utilized for any other purposes other than for redemption. The interest and redemption are in accordance with terms and conditions of issue. S.741 of the Companies Act, 2006 of UK mandates the registration of allotted debentures within a time of 2 months from allotment. A similar provision is s.56(4) in India which states that a certificate should be given within 6 months. In case of default, a punishment with fine of 25,000 which can extend up to 5 lakh shall be paid by the company and a fine of 10,000 which can extend up to 1 lakh is to be paid by the officer who was liable for such default.


4.     Debenture Trustee


Earlier under the 1956 statute a prospectus or a letter of offer to the public could not be issued, unless the company has appointed one or more debenture trustees before such issue along with their consent given to the company on the prospectus. That means whenever an offer is made to the public, not depending on the number of holders, it was mandatory to appoint a public trustee.

In the present scenario the company is barred from issuing prospectus or making an offer to the public or to the  members of the company exceeding 500 for subscription of debentures, unless it has appointed one or more debenture trustees previously, as per conditions laid down in 2014 rules. This is due to the risk faced by small debenture investors of losing their entire investment. A debenture trustee is a person who stands as a holder of debenture stock for the benefit of the debenture holder i.e as a liaison between company and the third party.

 When a large amount of debenture stock is issued the company uses its assets as collateral. So here the property of the company is mortgaged to the holders and the deed is placed in a trust. The debenture trustee acting as a representative of the debenture holder is responsible for liquidating the collateral in the event of default. The trustee will be capable of determining whether the company is complying with the terms and agreements set forth by the debenture offer. In case of breach, the trustee can take steps to remedy the same. The trustee makes sure is the condition regarding creation of security as well as redemption as had been agreed are met with. The trustee can take step to ensure the holder's interest and also to resolve dispute when it arises. The meeting between the two parties i.e the company and the debenture holders are convened by the trustee. The issuing company gets the benefit of dealing with only one person (trustee) as opposed to the many investors who have purchased the debentures.

The consent of the debenture trustee is a pre requisite for issuing debentures especially in case of s.18(c) company. The offer letter should contain the trustee's name. The debenture trustee possesses various rights like right to call for periodical performance report, communicate defaults to the holder, appoint a nominee to BOD provided that there was two consecutive defaults in payment of interest or default in creation of security for debentures or default in redemption of debentures[3]. The trustee can either be a scheduled bank carrying on commercial activity, a public financial institution, an insurance company, or a body corporate registered with SEBI having a capital of 1 crore rupees in order to act as a debenture trustee.

The right of a debenture-holder was examined in the case of Narotamdas Trikamdas Toprani v. Bombay Dyeing & Mfg Consumers Ltd[4] wherein a company proposed to issue a new series of debentures. Of the company?s present debentures 96% were held by institutions, which permitted the new series; of the remaining 4% which were held by individuals, one questioned the validity of the proposal and wanted the Bombay High Court to stay it till he was able to examine the ratio between the assets and liabilities of the company. The company refused to permit him such access to it assets and stock registers.

The court agreed with the company in holding that he had no right to go beyond the declared accounts and allowed the company to go ahead with its debenture-issue only to this that if the aggrieved debenture-holder wanted payment; he should be paid out in cash. The court asserted that it can examine the motive of a petitioner like the present so as to see whether he is really concerned with the interests of the debenture-holders or has something up his sleeves. The court pointed out that the right of a debenture-holder of inspecting the company's records is extremely limited. Under section 118 of the 1956 Act he can inspect the debenture-trust deed and obtain a copy of it. Under s.163 [1956 Act] he could inspect and obtain copies of the register of members and of debenture-holders, annual reports and copies of certificates and documents annexed thereto. He might also have the right to copies of annual accounts. But he did not have the right of detailed inspection of the record and registers and books of account and no adverse inference could be drawn if the company did not permit it.

Issue of secured debentures requires the fulfillment of the following conditions:

·         The maximum rate of redemption from date of issue is 10 years except for companies engaged in infrastructure projects, for which it is 30 years

·         Charges shall be created to secure debentures

·         A debenture trustee shall be appointed  before the issue of prospectus of offer letter

·         A debenture trust deed shall be executed within 60 days from the date of allotment to protect the interest of the debenture holders.

All and sundry cannot become a trustee. There are several disqualifications laid down for a debenture trustee. a person holding shares in that company shall not be appointed as a trustee. He/she shall not be a director/promoter/ any other officer of that company or of its associate or a relative of a director/promoter/ key managerial personnel of the company and also shall not be indebted to that company or its subsidiary or associate company. If he/she receives any remuneration other than in the capacity as a trustee, that will be a disqualification. Furnishing any guarantee in respect of principal debts secured by debentures or having pecuniary relationship with the company of 2% or more of the gross turnover or 50 lakhs or such higher amount as prescribed, whichever being lower, in the course of 2 immediately preceding years or during current financial year is also a disqualification. Any vacancy can be filled by the company with consent of other trustees.[5]

5.     Debenture Trust Deed


It is not feasible to create separate charge in favor of every debenture holder when they are issued for public subscription. So, they are secured by means of a common trust deed conveying the property of the company to the trustees and declaring a trust in favor of the holders. It contains the terms and conditions endorsed on the debentures and define the rights of the debenture-holders and the company. Generally a trust deed confers the trustees with powers like power to sell or lease the property and to renew leases, to compromise claims, to commence and defend actions, to exchange the mortgaged property for other suitable property etc. Any clause in the deed exempting the trustees from liability for breach and which indemnifies them against liability is void. Under the English law, s.750 incorporates the same clause.

6.     Register Of Debenture Holders


S.88 of the 2013 statute requires the maintaining of a register of debenture holders, duly authorized by the company secretary or any other authorized person.  Rule 4 of the Companies (Management and Administration) Rules 2014 discusses the entries mandatorily required in the register of debenture holders. S.743 of the Companies Act 2006[6] is a similar provision dealing with register of debenture holders. This section also lies down that such register should be made available for inspection at the registered office/ a specified place made aware to the registrar by way of notice.

The name of the holder is placed both on the debenture certificate and on company's register. Such a holder is known as a registered holder. He can transfer his shares in the open market in just the same way as shares are transferred.[7]Transfer will have to be registered with the company. The transferee's title will be subject to all equities between the transferor and the company.[8]

7.     Penalties And Other Provisions


S.71 (9) to (12) deals with penalties for default and other such provisions. When a trustee determines that the assets of the company are not sufficient or are likely to be insufficient for discharging the principal amount as and when it becomes due, a petition can be filed before the Tribunal. The Tribunal may, after hearing both sides, impose such restrictions on the incurring of any further liabilities by the company as it may consider necessary in the interests of the debenture-holders.[9]

if the orders of the tribunal are not complied with, whosoever responsible will be liable to be punished with imprisonment fora term which may extend to three years or with fine which shall not be less than 2 lakhs but which may extend to 5 lakh, or with both A contract with the company to pay for any debentures of the company may be enforced by a decree for specific performance.[10]

8.     Redemption of debentures

8.1 Debenture redemption reserve account


A debenture redemption reserve (DRR) is required to be created by every company on or before 30th April every year, out of the profits of the company for which there must be at least 50% of amount that is to be raised to the debenture issue before redemption begins. This amount cannot be used for any other purpose.[11]

The creation of a DRR is not required in case of compulsorily convertible debenture (CCD). As no redemption takes place such companies need not appoint a debenture trustee or execute debenture trust deed. All CCD needs to be converted within ten years[12], otherwise it will be considered as a deposit.

It is also given in the rules that the amount remaining invested or deposited, shall not at any time fall below 15% of the amount of the debentures maturing during 31st day of March of that year i.e year end. DRR is created in respect of the non-convertible portion of debenture issue for partly convertible debentures.

9.     Shareholder v. Debenture Holder


In many aspects debentures and shares are similar. Both shareholder and debenture holder have invested their money in the company; both get some return on their investment , although one gets it by way of dividend and the other by way of interest; perpetual or irredeemable debentures, like shares, are not generally paid back; debentures, like shares, are transferrable; and where debentures carry a charge, the lot of debenture holders like that of shareholders depends upon the assets of the company.

In the first place, the basic difference is that while a shareholder is a member of the company and enjoys all the rights of membership, a debenture-holder is simply a creditor of the company. Unlike shareholders, debenture-holders do not possess voting rights. But they are entitled to a fixed rate of interest which the company must pay whether there are profits or not. But they do not have any right to interfere with the business of the company unless, on the company's default, they step in to enforce their security. Shareholders, on the other hand, have the full right of control and the ultimate destiny of the company is in their hands. Of course, they are entitled to get dividends only out of profits, but the rate of dividend may be much higher than the rate of interest. Lastly, at the time of winding up, debenture-holders, being secured creditors, are paid in priority when the shareholders are paid back only after all other claims have been satisfied.[13]

10.                        Conclusion

The Companies Act 2013, allows a company to issue secured debentures by way of creation of mortgage or charge on company's assets subject to terms and conditions as prescribed, demanding the parties to be more cautious. Now as per s.71(1) convertible debentures can be issued as well. Rules have been laid down for debenture trustee to protect the interest of the debenture holders[14]. A remedy of specific performance has been included in the statute (s.71(12)). All these provisions were not available in the 1956 statute. The provision w.r.t public trustee has been set loose in the new provision as compared to s.117B of the 1956 Act. There is also an increase in the penal provision relating to non-compliance with orders of tribunal. Now ,when the  trustee comes to the conclusion that the assets of the company are not sufficient or likely to become insufficient a petition can be filed before the Tribunal. S.121 of the old statute dealing with re-issue of debentures has been dispensed with.

11.                        Bibliography


·         Avatar Singh, Company Law (16th edn., Eastern Book Company, 2015).

·         Dr.G.K.Kapoor & Sanjay Dhamija, Company Law and Practice A Comprehensive Text Book On Companies Act 2013 (21st  edn., Taxmann Publications, 2016)

·         Avatar Singh, Company Law (16th edn., Eastern Book Company, 2015)

·         Palmer?s Company Law Annotated Guide to the Companies Act 2006 (2nd edn., Sweet & Maxwell, 2009)

·         Dr. H.K. Saharay, Company Law (7th edn., Universal Law Publishing, 2015)

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[1] S.2(30) of Companies Act,2013

[2] CHITTY J in Levy v. Abercorris Slate & Slab Consumers, (1887) 37 Ch D 260, 264: 58 LT 218, cited in Laxman Bharmaji v. Emperor, ILR 1945 Bom 863: AIR 1946 Bom 18: 223 IC 110.

[3] Rule 18 (3) of Companies (Share capital and Debentures) Rules 2014

[4] (1986) 3 Comp LJ 179: (1986) 88 Bom LR 649: (1990) 68 Compp Cas 300.

[5] Rule 18 (2) of the 2014 rules

[6] U.K legislation

[7] S.56, Companies Act 2013

[8] Natal Investment Consumers, re, (1868) LR 3 Ch App 355: 18 LT 171.

[9] S.71(10), Companies Act 2013

[10] S.71 (12)

[11] Rule 18(7)

[12] Companies (Acceptance of Deposits) Rules, 2014 clause ix of Rule 2(1)(c)

[13] The provisions of the Act realting to transfer of shares, remedies against refusal to register a transfer, issue od certificates, etc are also applicable to debentures. (s.56,58,59).

[14] S.71(4), Companies Act 2013

About the Author:

Aspiring law student at National University of Advanced Legal Studies (N.U.A.L.S), Kochi

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