DEBENTURES AS INVESTMENT INSTRUMENT
The term ‘Debentures’ as defined under the Companies Act, 2013 (“Act”) 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”. In general, debentures are medium to long term debt instruments that are used by companies to borrow money from members of the company or third parties. Such debentures do not form part of the share capital of the company and are regarded as a debt that is acknowledged by the company which may or may not carry a charge on the assets of the company, with an option to convert such debentures into equity shares of the company. They may be issued at a particular rate of interest. However, the Act doesn’t impose any restriction upon issue of debentures on discount. Further, one of the distinct features of debentures is that unlike shares, they don’t carry voting rights. A debenture is a moveable property in the form of certificate of indebtedness of the company which is issued by the company itself.
A person who is issued a debenture certificate by the issuing company is known as the debenture-holder. The legal provisions applicable to application, allotment, and issue of share certificate shall be applicable to the process of debentures as well. An allottee of debenture(s) is entitled to obtain a debenture certificate in respect of the debentures issued from the company within 6 (six) months of such allotment.Unlike a shareholder, debenture-holders carry the position of creditors of the company and not the owners of the company and thereby are not included in the day-to day administration and management of the company. They are however, entitled to interest at the rate fixed at the time of issuance. An investor with the ideology of not concerning himself with monitoring and functioning of the company and/or is unwilling to engage with the uncertainty that comes with investing by way of vanilla equity may find the investment through debenture a lucrative option.
B. Private Placement of Debentures
A private company issues debentures through private placement and the same shall be done in consonance with Section 42 of the Act read with Rule 14 of Companies (Prospectus and Allotment of Securities) Rules, 2014 (“Allotment Rules”). Private placement is defined as “any offer or invitation to subscribe or issue of securities to a select group of persons by a company (other than by way of public offer) through private placement offer-cum-application, which satisfies the conditions specified.” A company shall not make any offer or invitation to subscribe to more than 200 (two-hundred) persons, in aggregate in a financial year (excluding qualified institutional buyers and employees of the company under the scheme of employee stock option as per the relevant provisions of the Act)
The company after passing a board resolution in the board meeting and a special resolution at general meeting and filing a copy of the same with the registrar, shall send a private placement cum application letter (“Placement Letter”) in the Form PAS-4 to selected group of persons either in writing or in electronic mode, whose names are recorded by the company, within 30 days of such recording. It is to be noted that said letter shall not be issued by way of public advertisement. The company shall ensure that the Placement Letter does not carry any right of renunciation.
After receipt of Placement Letter, the concerned persons are required to make payment of application money by way of cheque or demand draft or any other banking channel (payment through cash is prohibited). The company is required to allot relevant securities within 60 (sixty) days and if not allotted, application money shall be refunded within 15 (fifteen) days after expiry of 60 (sixty) days.
A record of private placement offers shall be maintained in Form PAS-5. Also, the company needs to prepare return on allotment in Form PAS-3 which needs to be filed within 15 (fifteen) days from the date of allotment. Failure to file the return of allotment within 15 (fifteen) days, the company, its directors and promoters are liable to penalty of for each default of one thousand rupees for each day during which such default continues, subject to maximum of INR 25 (twenty five) lakh.
C. Types of Debentures
(1) Secured Debentures: They are debentures which are secured by a charge on the properties or assets of the company or its subsidiaries or its holding company or its associate companies. A company has the right to issue secured debentures subject to the terms and conditions prescribed under the rules of the Act. A charge cannot be created on intangible asset of the company. A company has to create security by way of charge or mortgage in favour of debenture trustee on any specific movable or immovable property of a company. Therefore, a charge cannot be created as a floating charge in case of issue of secured debentures. A debenture holder of secured debentures is secured in a case the issuer makes a default in payment of either the principal amount or the interest and thereby a debenture holder can invoke the security in order to realize any such amount due to him.
(2) Unsecured Debentures: Unsecured Debentures are different, as they are not secured by any charge on the assets of the company and are also called ‘naked-debentures’. The position of the holder of unsecured debentures is the same as that of an unsecured lender i.e. in case of default by the issuer of either the principal amount or the interest due to such lender. Investors who prefer to invest in unsecured debentures are lured in by their generally higher interest rate and a long-standing goodwill of the issuer.
(3) Redeemable Debentures: Debentures which are issued with the option of redemption on demand /fixed date/ occurrence of a specified event are called redeemable debentures. A company may issue secured debentures for a maximum period of 10 (ten) years from the date of issuance. However, certain specified companies are allowed to issue secured debentures for a period not exceeding 30 (thirty) years. Debenture holders are entitled to redeem their debentures at par or premium, depending upon the agreement.
(4) Convertible Debentures: They are the kind of debentures which can be converted into equity shares of a company, after expiry of a particular period or upon happening of a specified event. They are regarded as hybrid security. The debenture holder agreement gives a right to the holder to get equity shares as per the conversion ratio specified in the agreement after the expiry of a certain period at a price not exceeding the price fixed. A holder of convertible debentures is liable to get equity shares in lieu of debentures owned by him upon conversion.
(5) Non-Convertible Debentures: These debentures do not have the option to convert the same into equity shares and are redeemed at the expiry of a specified period. A holder of non-convertible debenture shall maintain his status quo and receive interest till the redemption of such debentures.
(6) Partly-Convertible Debentures: A company can issue debentures with an option to convert them into shares either wholly or partly at the time of redemption. Thus, providing that a company may issue partly-convertible debentures. They are divided into two portions i.e. convertible and non-convertible portion. On expiry of a particular period the convertible portion is converted into equity shares and the investor is deemed to be equity shareholder for the same whereas the non-convertible portion continues to be regarded as debentures and is redeemed at the expiry of specified period with regards to the term of issue and the investor continues to hold his position as a debenture holder.
D. Debenture Trustee
Debenture trustee means “a trustee of a trust deed for securing any issue of debentures of a body corporate.”.A company shall appoint debenture trustee before issuing a prospectus or make an offer or invitation to the public or its members exceeding 500 (five hundred). Debenture Trustee so appointed shall act as an intermediary between the company and the debenture holders. The prime responsibility of debenture trustee is to protect the interest of debenture holders and for the same it is its obligation to take the following steps:
(1) It has to satisfy himself that the letter of offer doesn’t contain any inconsistent matter with the terms of issue of debentures or trust deed.
(2) It has to ensure that the covenants of the trust deed are not prejudicial to the interest of debenture holders.
(3) It has the responsibility to communicate any breach with regard to payment of interest or redemption of debenture and any action taken by the trustee in this regard and take necessary steps to remedy the said breach.
(4) It has the obligation to take steps to convene meeting of debenture holders and when there is a need for such meeting.
(5) It has to ensure that debentures have been converted or redeemed in accordance with terms of issue of the debentures.
E. Rights and remedies of a debenture holder
(1) Debenture holder is entitled to fixed rate of interest and redemption in accordance with conditions of their issue.
(2) In the event that a company makes a default either in payment of interest due or the redemption of debenture at the time of maturity, the debenture trustee or debenture-holder may apply to tribunal to pass an order to redeem the aforementioned debentures with payment of principal amount and interest due.
(3) Where the tribunal has passed an order for payment of principal and interest and the company has made a default in complying with such order, in that case every officer of the company who is in default shall be punishable with imprisonment which may extend upto 3 (three) years or fine which may be atleast INR 2 (two) lakhs and may extend upto INR 5 (five) lakhs or both.
(4) Any directors who has defaulted in redemption of debentures at the time of maturity and if such default has continued till 1 (one) year or more shall be disqualified and shall be not be entitled to become the director of the same company. He may however, be allowed to become a director of another company after expiry of 5 (five) years from the date of default.
F. Methods of redemption of debentures
Redemption of debentures signifies repayment of total amount due to the debenture holder by the company pertaining to the debentures issued in accordance with the terms and conditions of the issue. Once a debenture is redeemed the liability of company cease to exist towards the debenture-holder with regard to that debenture. Generally, debentures are redeemed in the following manner:
(1) Payment in lump sum- at the end of the stipulated period the debenture holder receives the principal amount as well as the total interest due to him at the date of redemption in the lump sum manner as per the terms of issue.
(2) Payment in instalments: through this mode after the total liability of company towards the debenture holder is calculated the same is divided into instalments to be paid to the holder over a period of time as per the terms of the issue.
(3) By conversion: Convertible debentures can be redeemed by converting them into equity shares. On redemption by conversion the investor sheds his status as a debenture holder and becomes a shareholder.
G. Foreign investment through debentures
Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (“NDI Rules”) defines equity instruments as “equity shares, convertible debentures, preference shares and share warrants issued by an Indian company”. Therefore, foreign investment through convertible debentures is permitted provided that the convertible debenture is fully, compulsorily and mandatorily convertible, however non-convertible debentures are not considered for investment by non-resident India’s under the NDI Rules (i.e. under the equity route). A person who is resident outside India may subscribe, purchase or sell these instruments subject to Schedule I of the NDI Rules.Transfer of equity instruments of an Indian company by or to a person resident outside India shall be subjected to the provisions of the aforementioned NDI Rules.
A debenture is an instrument for a company that recognizes a credit to the organization where the holder exists as a financial creditor of the company. The terms of issue of debenture enumerates the relationship between the issuer and the holder. Issue of debenture is a standout amongst the widely established modes of raising funds by a company and is also considered a fairly safer option for providing a fixed rate of interest. Further, a debenture holder is given a preference over a shareholder for repayment at the time of liquidation of the company.