A Debenture is A Formal Loan given by an Individual to the Company.

Introduction

A debenture is a debt instrument that acknowledges the borrowing or debt of an organization. It is a contract between the borrower & the lender for repayment of the principal amount after a specified interval of time along with the interest which is payable half-yearly or annually.

Debenture issue is one of the many other ways to raise funds to meet the financial needs as well as the working capital needs of the organization.

Debentures are issued in many forms such as:

✔      Convertible or non-convertible

✔      Secured

✔      Unsecured, etc

Debentures don't carry any voting rights, unlike shares. It is a certificate or document signed by an authorized officer of the company acknowledging that the money has been lent to the organization, and has to be paid within the stipulated period along with interest.

Regulatory Framework for Governing the Debentures

Following are the applicable rules and acts for regulating the provisions of debenture issue in companies:

●       Companies Act 2013 earlier Companies Act 1956

●       Company (Share Capital & Debentures) Rules, 2014

●       Companies (Acceptance of Deposit) Rules, 2014

●       Companies (Acceptance of deposit) amendment rules, 2016

●       SEBI (Debenture Trustees) Regulation, 1993

●       SEBI (LODR) Regulations.

Conditions for the Issue of Debentures

The company can issue the debentures only if it fulfills the following conditions:

●       Debentures can be issued with the date of redemption not exceeding 10 years from the date of its issue.

●       The term of 10 years gets extended for 30 years in case the company is issuing debentures for setting any infrastructure project.

●       In case a company issues secured debentures, such issues will be secured by creating a charge on the assets or property of the company.

●        The company must appoint a debenture trustee before the issuance of prospectus or Letter Offer for the subscription of the debenture. The name of such trustee shall be mentioned in the Letter of Offer or any future notice or communication sent to the debenture holders.

●        Consent of the debenture trustee has to be obtained before appointing him as a trustee.

●       No person shall be appointed as a trustee in case:

✔      He is a shareholder of the company

✔      Is entitled to receive any money other than remuneration as a trustee

✔      Has any debt due to the company

✔      Is related in any manner to the KMP, director, promoter or any other person who is connected with the Company

●       The company, in order to protect the interest of the debenture holders, shall also execute debenture trust deed within 60 days of allotment.

●       Consent of the majority debentures holder must be taken to fill the vacancy caused by the resignation of the trustee.

●       The removal of a trustee from his office before the expiry of his tenure can be executed when it has the approval of at least three-fourth of the debenture holders.

Debenture Redemption Reserve Account

In case the company issues redeemable debentures, it shall create Debenture Redemption Reserve account for the redemption of debentures on the specified date. As per Rule 18(7) of Company (Share Capital & Debentures) Rules, 2014, following are the conditions that govern redemption:

●       DRR shall be created only out of the profits of the Company available for distributing the dividend.

●       DRR shall be created of at least 25% of the amount raised through the issue of debentures.

●       Every company that creates the DRR account shall invest or deposit the sum of at least 15% of the amount of its debentures maturing during the relevant financial year in the following methods:

✔      Deposit with any scheduled bank

✔      Invest in any unencumbered securities of Central Government & State Government

✔      Invest in any unencumbered securities under the Indian Trust Act, 1882

✔      The amount invested can be used only for the sole purpose of redemption but not for any other purpose

●       DRR shall be created for the partly convertible debentures in proportion to the  non-convertible part.

Categories of Debentures

Here is the list of different types of debentures that can be issued by the company based on the following criteria:

Issue of Debentures

a)      Secured Debentures: These debentures get secured by creating a charge on the assets or any property of the Company. Payment of debenture on its maturity obtains assurance by setting a clause which entails that the asset will be sold out in case of any default from the company's side. This form of debenture is the most secure form of debenture as the holders have a sense of assurance that their invested money will be repaid along with interest.

b)     Unsecured Debentures: These debentures are not secured as there is no charge on any assets or property, unlike secured debentures. However, the rate of interest provided in these debentures is generally higher than that provided in the secured debenture.

c)      Redeemable debentures: These debentures are liable to repay after the fixed interval. The redeemable period for these debentures does not exceed the maximum period of 10 years.

d)     Irredeemable debentures: These are also called perpetual debentures. There is no fixed maturity date for these. These debentures are repaid on the winding up of the company or after a long period.

e)      Fully convertible debentures: These debentures are issued with the option of being converted into shares after the expiry of a fixed period.

f)       Partly convertible debentures: These debentures are issued with a mix of two options.  The convertible part will convert into shares, and the non-convertible part gets redeemed after the expiry of tenure. These debentures are secured by creating a charge on the assets or any property of the Company. Payment of debenture on its maturity is secured in a way that the asset will be sold in case of any default from the company’s side. This form of debenture is the most secure form of debenture as the holders are convinced that the money invested by them would be repaid along with interest.

g)      Non-Convertible debentures: These debentures are issued with no option of conversion into shares, either fully or partly.

Steps to issue debentures

Following are the steps to be pursued by a company who intends to raise the money by issuing debentures:

●       Call Board Meeting: Send the notice of 7 days and convene a meeting of the board to discuss the following agendas, pass a necessary resolution and approve the following:

✔      Form PAS-4 for offer letter

✔      Debenture Subscription Agreement

✔      PAS-5 for Private Placement

✔      Written consent of debenture trustees

✔      Appointment of debenture trustee

✔      Resolution for creating a charge on the company's assets

✔      Day date & time for EGM.

●       Documentation: After the board meeting is convened and concluded, the following forms and documents are prepared:

✔      Debenture Subscription Agreement

✔      Form PAS-4

✔      Form PAS-5

✔      Debenture Trustee Agreement

✔      A mortgage agreement in case of secured debentures

●       EGM: Hold and convene the extraordinary general meeting for passing the Special Resolution for approving the issue of the debenture and to increase the borrowing power of the directors.

●       Filing of forms online: After the successful conclusion of EGM and approving the issue of debentures, the following forms are filed with government online through MCA:

✔      Form MGT-14: File the form online within 30 days of passing the Special Resolution for filing the Certified True Copies (CTC) of the board resolution, special resolution, offer letter, debenture subscription agreement, and debenture trust deed with ROC.

✔      Form GNL-2: File this form with the necessary attachments of form PAS-4 and PAS-5 with ROC

✔      Form CHG-9: File this form within 30 days of creating the charge on the company's assets with ROC.

✔      Form PAS-3: This form is filed as a return of allotment within 30 days of allotment of the debenture.

●       Last Board Meeting: The board shall, after the completion of the other processes, conduct the last board meeting for approving the allotment of debentures within 60 days of the receipt of the entire fund.

●       Debenture certificate: Debenture certificate must be issued by the company within 6 months of the date of allotment of debentures.

Advantages of Debentures by Swarit Advisors

Following are the benefits of raising the fund via issue of debentures:

●       Secured Investment: Investor interest amount and the principal amount is secured in case the issued debentures are secured debentures, as they are secured by creating the charge against the property.

●       Fixed Return: Debentures are interest-bearing loans as they give regular income to investors in the form of interest unlike, dividends in shares, which is paid only in cases where profit is incurred.

●       Stability: Prices of debentures remain stable even in extreme economic conditions, with very slight changes in the price movement of debentures.

●       Control: Unlike shareholders, the debenture holders don’t have ownership in the company, and thus, they don’t interfere in day to day management.

●       A feasible method of raising funds: This method of raising funds is cheaper due to its interest-bearing cost as compared to other forms of borrowing.

●       Simplified Process: The fund is easily raised through the Issue of Debentures as the issue of debentures is a less complicated process in comparison to the IPO, FPO, or issue of equity & preference shares.

●       Fixed Income: Investors get a regular source of income in the form of Interest Income.

Disadvantages of Debentures

Despite several benefits, there are certain shortcomings of issue of debentures:

●       Fixed burden on the company: Although the fixed interest income is advantageous for the investor, it is a constant burden to the company as it has to pay interest at a fixed rate irrespective of its profit-making situation.

●       Creditworthiness: The creditworthiness of the company can fall in the eyes of the public as well as the bank if its assets are continuously mortgaged with the debenture holders as security.

●       Heavy cost: The Company has to make specific provisions for the redemption of debentures, even during the period when the company does not have a stable financial position.

FAQs 

What are the provisions for Interest on Debentures?

Section 71(8) of the Companies Act, 2013 governs the interest portion of the debenture issue:

●       The company shall pay the interest on debentures at the rate specified and decided by the parties as per the terms and conditions

●       The interest can be freely determined by the Company

●       Interest can be paid half-yearly, quarterly or on an annual basis as decided by the issuer

●       Company can also issue Zero Interest Rate debentures

Explain in brief the responsibilities of a debenture trustee.

Appointment of debenture trustee shall be governed by section 71 of Companies Act, 2013. Debenture Trustee means the trustee of a trust deed who is responsible for securing the issue of debentures. Trustees regulate the issue of debenture right from its issue of letter of offer till the allotment of debentures & subsequently.

Responsibilities:

●       The company cannot issue debentures without obtaining the consent of the trustee

●       The company shall always specify the name of trustee in the offer letter

●       The trustee can call upon the company and inspect the utilization of funds generated through the issue of debentures

●       The trustee has the right to appoint a nominee director on the board

●       The trustee shall ensure that there is no breach in the terms & conditions of the issue

●       The trustee has to take all the necessary steps to resolve disputes arising between the company and the debenture holders

●       The trustee shall take the necessary steps to secure the interest of debenture holders

What are the characteristics of debenture?

Following are the characteristics of debentures that make it a suitable option for raising the funds by a company:

●       Debentures are the certificate of debt that acknowledges the debt of the company

●       Debenture holders are the creditors of the company who have given loan to the company and not the owners like shareholders

●       Debenture certificate is issued under the common seal of the company and it contains the entire terms & condition for the issue of debentures such as interest rate, redemption period, type of debentures, etc.

●       Debenture holders don’t get the benefits of any voting rights

What are the different modes of debenture issues that a company can rely upon?

The company can issue debentures in three different modes:

●       Issue of debentures in cash: Company can issue the debentures to an individual against the receipt of cash from debenture holders. Such an issue can be made in three ways:

✔      Issued at par: Issue price is equal to its nominal value.

✔      Issued at a discount: As per Section 54 of the Companies Act, there is no restriction on the Issue of Debentures at a discount, i.e. the debentures can be issued at a value less than their nominal value.

✔      Issue at a premium: In this case debentures are issued at a price higher than their nominal value

●       Issue of Debentures for Consideration other than Cash: A company can issue debentures to any person from whom it has purchased any property or assets, instead of paying cash.

Issue of Debentures as a Collateral Security: Company can issue the debentures to the banks as collateral security against any bank loan or borrowing.