DEBENTURES AS INVESTMENT INSTRUMENT
A.
Introduction
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.
H.
Conclusion
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.