Debentures – CA Inter Law Notes is designed strictly as per the latest syllabus and exam pattern.
Debentures – CA Inter Law Notes
Borrowing Power Of Company
Company is authorised to borrow money if:
- It is authorised by its Object clause; or
- It is trading company. (Trading company has implied power to borrow money)
Power to Borrow
- As per section 179(3), power to borrow money shall be exercised by the Board at duly convened Board meeting.
- Board Resolution is required to be filed with ROC in Form MGT-14.
In case of section 8 Company, the resolution to borrow money can be passed by circular resolution instead of Board Meeting. – MCA notification dated 5-6-2015
Limit on Borrowing
- The Board shall not borrow money exceeding the aggregate of paid up capital and free reserves of company without consent of its members at General Meeting.
- If AOA provides any limit for borrowing, Board shall borrow within limit specified under its AOA.
Ultra vires Borrowing
Where the company borrows money without the authority conferred on it by the AOA or beyond the amount specified in the AOA, it is ultra vires borrowing.
In case of ultra vires borrowing the lender has following remedies available:
- Injunction (Stay order from Court) and recover of loan
- Suit against directors
The power to borrow money includes power to give security by way of mortgage, charge, hypothecation, lien, guarantee and pledge etc.
Debenture & Its Features
- Debenture is a loan certificate issued by a company, yielding a fixed (or floating) interest rate.
Definition – Section 2(30)
- ‘Debenture’ includes debenture stock, bonds and any other securities of the company, whether constituting a charge on the assets of the company or not.
- However following instruments are not treated as debenture:
- Instrument referred to in Chapter III-D of the RBI Act, 1934; and
- Other instrument prescribed by the Central Government in consultation with the Reserve Bank of India.
- A ‘debenture’ is a movable property transferable in the manner provided by Articles of the company. -Section 44
- A debenture holder is not a member of company but creditor.
- A debenture is a document, which either creates debt or acknowledges it.- CIT vs. Cochin Refineries Ltd.
- Debenture may be secured or unsecured.
- Debenture is, in effect, a debt and acknowledgement of debt. It is one of the ways of raising loans.
- The difference is that debentures can be issued to public, while company takes loan from an Institution or bank. The debenture certificate is an acknowledgement of loan.
- Debenture carrying voting rights cannot be issued.
- A ‘bond’ is also a debenture. Since debentures are freely transferable, a company cannot issue non-transferable bonds.
- A private company cannot issue debentures to public. It can make only a private issue of debenture.
- Debenture is a ‘security’ for purposes of the Companies Act, 2013. “
- Pari Passu Clause in case of Debentures Meaning
- ‘Paripassu ’means equal, equally treated, at the same rate, or at par with.
Debentures with pari passu clause
- Debentures are usually issued in a series with a pari passu clause.
- In the case of debentures with pari passu clause, security amount realised shall be divided pro rata (i.e. proportionate amount) in the event of insufficient fund.
Debentures without pari passu clause
- If the words ‘paripassu ‘are not used, the debentures will be payable according to the date of issue.
- If they are all issued on the same day, they will be payable accordingly to their serial number.
Restriction on power of company
Company cannot issue new series of debentures to rank pari passu with prior series, unless the power to do so is expressly reserved and contained in the debentures of the previous series.
Difference Between Debenture and Share
|Debenture constitutes a loan.||Shares are part of the capital of a company.|
|Debenture holders are creditors.||Shareholders are owners of the company.|
|Debenture holders do not have any voting right.||Shareholders enjoy voting right.|
|Interest on debenture is payable even if there are no profits i.e. even out of capital.||Dividend can be paid to shareholders only out of the profits of the company and not otherwise.|
|Debenture holders get fixed Interest, which carries priority over dividend.||No fixed rate is decided for dividend to shareholders except in case of preference shares. Dividend depends upon the profitability of the company and BOD decisions to declare dividend.|
|Interest paid on debenture is a business expenditure and allowable deduction from profits.||Dividend is not allowable deduction as business expenditure.|
|Generally debentures have a charge on the assets of the company.||Shares do not carry any such charge.|
- Debenture stock is type of stock that makes fixed payments at scheduled intervals of time.
- Generally, debenture Stock is secured by a trust deed.
Difference Between Debenture and Debenture Stock
|It is an instrument.
It is borrowed c apital in the form of a security or an instrument.
|It is debt or sum secured by an instrument.
It is borrowed capital consolidated into one mass for the sake of convenience.
|Each security is a separate and distinct debt.||It is one aggregate loan fund or composite stock of debt|
|It may be f ully paid or party paid.||It is always fully paid.|
Difference Between Debenture and Loan
|Debenture represents debt to the debenture holder owed by a company usually arising of loan.||A loan creates a right on the creditor to demand repayment.|
|Company can issue debenture.||Loan can be given to anyone.|
|Debenture can be classified as secured or unsecured; convertible or non-convertible; redeemable or perpetual.||Loan can be classified as secured or unsecured; short term or long term.|
|Debenture trust deed is executed at the time of issue of debenture.||No trust deed is executed at the time of granting loan but loan agreement is entered into between borrower and creditor.|
|Debenture trustee is appointed||No requirement to appoint trustee.|
Kinds Of Debentures Or Classification Of Debentures
Debentures can be classified on following basis:
- On the basis of convertibility
- On the basis of security
- On the basis of redemption
- On the basis of registration
Non-Convertible Debenture (NCD)
Instruments retain the debt character and it cannot be converted into equity shares.
- Part or whole of debenture is converted into equity shares later at a pre-deter- mined rate per share.
- The ratio of conversion is decided by the issuer. This is normally decided at the time of subscription.
- Upon conversion, the investors enj ov the same status as ordinary shareholders of the company.
- The debentures continue to remain debentures and earn interest until they are converted into equity shares of the company.
- The debentures may be f ully convertible or partly convertible.
Fully Convertible Debenture
The debentures fully convertible into equity shares at the issuer’s notice.
Out of debenture of ₹ 100, entire ₹ 100 may be converted into two shares of ₹ 10 each and there is no portion considered as non-convertible. It means that a share of company of face value of 110 is issued at a premium of “ 40 per share.
Partly Convertible Debenture
In partly convertible debenture, parts of these instruments are converted into equity shares in the future at notice of the issuer.
Out of debenture of t 100, ₹ 60 may be converted into one share of ₹ 10 and balance 140 will be treated as non-convertible portion. It means that a share of company of face value of ₹ 10 is issued at a premium of ₹ 50 per share.
Optionally Fully Convertible Debenture
On the Basis of Convertibility
The investor has option to convert these debentures into shares at price decided by the issuer/agreed upon at the time of issue.
On the Basis of Security
- Debentures can be secured or unsecured.
- The security may be charge on assets.
- Secured debentures can be secured against property (fixed assets) of the company or its subsidiary company or its holding company or associate company.
- Securities for debentures shall be created in favour of debenture trustee.
- Securities by way of charge or mortgage can be created on any specific movable or immovable property of company or its subsidiary company or its holding company or associate company.
- Requirement of creation of charge is not applicable to Government Company if debenture is fully secured by guarantee given by Government.
- Secured debentures can be issued by company subject to prescribed conditions bv Central Government.-Section 71(3)
- If the debenture is not secured by the property of the issuer, it is known as unsecured debenture.
- If the issuer defaults on payment of the interest or principal amount, the investor has to be along with other unsecured creditors of the company.
- Unsecured debenture is ‘Public deposit’.
On the Basis of Redemption Redeemable Debenture
- Debentures can be redeemable or irredeemable.
- Redeem means ‘full repayment’ of debentures.
- Redeemable debentures are issued with a condition that the debentures will be redeemed:
- at a fixed date; or m upon demand; or
- after notice; or
- under a system of periodical drawings.
- Date of redemption of debentures cannot be more than 10 years. However, following companies can issue secured debenture for a period exceeding 10 years but upto maximum 30 years;
- Infrastructure project company m Infrastructure finance company
- Infrastructure Debt Fund Non-Banking Financial Companies
- Companies permitted by Central Government, RBI or National Housing Board
- Debentures are generally redeemable and on redemption, these can be reissued or cancelled.
- The Companies Act, 2013 does not provide any provision for reissue of debentures.
- The holders of the reissued debentures will have the same rights and priorities as if the debentures had never been redeemed.
- Irredeemable debenture is also known as ‘Perpetual Debenture’.
- Irredeemable debenture does not have time fixed for the company to pay back the money.
- After the commencement of the Companies Act, 2013, now a company cannot issue perpetual or irredeemable debentures.
- Until the company is a going concern and does not make default in interest payments, the debenture holder cannot demand principal payment.
- Principal amount is payable when company goes into liquidation.
On the Basis of Registration Registered De-benture
- Debentures issued in the name a particular person, whose name appears in the Register of debenture holders of the company.
- Debentures transferable by transfer documents duly stamped and executed (similar to shares).
- Debentures issued to bearers.
- They are negotiable instruments transferable by mere delivery, (similar to share warrants)
- The holder becomes ‘holder in due course’.
Debentures with or without Option
- ‘Option’ means right to sell or purchase before maturity.
- Debenture may or may not provide option.
- ‘Put option’ means right to sale.
- ‘Call option’ means right to purchase.
Provisions For Issue Of Debentures – Section 71
Issue of Conver-tible Debentures
- A company may issue debentures with an option to convert such debentures into shares, either wholly or partly at the time of redemption.
- Only Board of Directors at the meeting can issue the debentures. These powers cannot be delegated to a committee or the resolution for issue of debentures cannot be passed by circulation.
- Convertible debenture can be issued by passing Special Resolution at General Meeting.
- Debenture can be issued at either par or premium or discount.
- Convertible debentures cannot be issued at discount, as it would amount indirectly issuing shares at discount, which is not permitted.
- Non-convertible debentures can be issued at discount.
Provisions Simi-larly Applicable
Following provisions regarding shares are similarly applicable to debentures:
- Issue of shares
- Issue of prospectus a Application money s Allotment
- Transfer and transmission
- issue prospectus; or
- make an offer; or
a invite public or its members exceeding 500, for the subscription of its debenture, unless company has appointed one or more debenture trustee.
Company cannot issue debenture with voting right.
Payment of Interest &Redemption Debenture
Company, which has issued debenture, shall pay interest and redeem debenture as per terms and conditions of issue.
Creation of DRR
If company has issued debentures as per section 71, it shall create Debenture Redemption Reserve (DRR). (Explained in detail under later part of the chapter)
Rights of Debenture holder
Debenture holder has following rights:
- To receive interest and/or redemption when due
- To receive a copy of trust deed on request
- To apply for winding up, if the company fails to pay its debt
- To approach debenture trustee with grievance, if any
- To inspect register of charges, copy of instrument creating charges, Register of Investment in shares and securities not held in company’s name, copy of trust deed, Register of members, debenture holders and indexes
- These rights are not absolute. These are subject to provisions of the Companies Act, Memorandum and Articles of the company.
Debenture Redemption Reserve (DRR)
What is Debenture Redemption Reserve?
A provision created out of profits of the company to protect investors against the possibility of default by the company.
- Section 71(4) of the Companies Act, 2013
- Rule 18(7) of Companies (Share Capital and Debentures) Rules, 2014
Creation of Debenture Redemption Reserve – Section 71(4)
A company issuing redeemable debentures must create a Debenture Redemption Reserve (DRR) for redemption of such debentures.
Amount to be Transferred from Profits
- DRR shall be created out of the profits of the company available for payment of dividend.
- The company shall create DRR equivalent to at least 50% of the amount raised through the debenture issue before debenture redemption commences.
- Adequate amounts should be transferred to DRR out of profits of the company every year until such debentures are redeemed.
- DRR should be adequate to pay value of debentures and accrued interest, if not already paid.
The amounts transferred to DRR cannot be used for any other purpose.
What if there are no profits?
Since DRR is to be created out of profits, there is no obligation to create DRR, if there is no profit.
Debentures issued by AIFI, RBI and Banks
- No DRR is required for debentures issued by All India Financial Institutions regulated by RBI and banking- companies, as they have to transfer 20% of profits to Reserve fund as per RBI norms.
- Other Financial Institutions shall create DRR in same way like NBFC.
Debentures issued by NBFCs &NHB
- NBFC registered with RBI and National Housing Financing Companies registered with National Housing Board should create DRR of 25% of value of outstanding debentures issued through public as per RBI guidelines.
- No DRR is required for privately placed debentures.
Debentures issued by manufacturing companies
- For manufacturing and infrastructure companies, ‘adequacy’ of DRR will be 25% of value of outstanding debentures issued through public issue and 25% for privately placed debentures by listed company.
- For unlisted companies issuing debenture on private placement basis, the DRR will be 25% of the value of outstanding debentures.
DRR for Convertible and Non-convertible Debentures
- In case of convertible debentures, DRR provisions apply to non-convertible portion of debentures.
- Thus, if debentures are fully convertible, question of creating DRR should not arise, as really no redemption is involved.
Time for Creating DRR
Every company required to create DRR should on or before 30th April of each year invest or deposit sum not less than 15% of amount of its maturing debentures during year in following:
- Deposit in schedule bank, free from any lien or charge
- Unencumbered government securities or securities specified under Trust Act.
Use of DRR
- The amounts transferred to DRR cannot be used for any other purpose.
- It should be used for redemption.
- Section 71 of the Companies Act, 2013
- Debentures cannot be issued to public without appointment of debenture trustee.
- Rule 18 of Companies (Share Capital and Debentures) Rules, 2014.
- The names of the debenture trustees shall be stated in :
- Letter of offer inviting subscription for debentures; and
- All the subsequent notices or other communications sent to the debenture holders.
Before the appointment of debenture trustee(s),
- a written consent shall be obtained from such debenture trustcc(s) proposed to be appointed; and
- a statement to that effect shall appear in the letter of offer issued for inviting the subscription of the debentures.
Who can be appointed?
- Company cannot issue prospectus or invite public or members more than 500 without appointing debenture trustee.
- Debenture trustee is appointed by executing debenture trust deed.
- A person cannot be appointed as a trustee:
- If he is beneficially holds shares in the company.
- If he is a promoter, director or KMP or any other officer or an employee of the company or its holding, subsidiary or associate company.
- If he is beneficially entitled to money which is to be paid by the company otherwise than remuneration paid to the debenture trustees.
- Is indebted to the company, or its subsidiary or its holding or associate company or a subsidiary of such holding company
- If he has given guarantee in respect of repayment of debentures
- If he has any pecuniary relationship with the company amounting to 2% or more of its gross turnover or total income or ₹ 50 lacs, whichever is lower, during the two immediately preceding financial years or during the current financial year
- If he is relative of any promoter or any person who is in the employment of the company as a director or KMP.
- The Board may fill casual vacancy of trustee.
- If casual vacancy is due to resignation, it can only be filled with the written consent of the majority of the debenture holders.
Debenture trustee may be removed before expiry of his term only with approval of minimum 3/4th majority debenture holders in their meeting.
Duties of Debenture Trustee
- Functions of trustee are to protect the interest of debenture holders and to redress grievances of debenture holders effectively. In particular debenture trustee may take steps as he may deem fit. – Section 71 (6)
- As per Rule 18(3) of Companies (Share Capital and Debentures) Rules, 2014, duties of debenture trustee are as under:
- To ensure that assets of company are sufficient to discharge principal amount at all the time.
- To satisfy himself that prospectus or letter of offer does not contain any matter, which is inconsistent with terms of debentures or the trust deed.
- To ensure that company does not commit any breach of covenants and provisions of the trust deed.
- To take steps to call a meeting of debenture holders as and when required.
- In case of listed companies, the trustees have to check whether SEBI guidelines are being followed by the company, in respect of debenture redemption reserve and other matters.
- If company defaults in payment of interest or repayment of debentures, the trustees can take action for enforcing the security.
- Sell or lease the property and to renew lease.
- Take a mortgage so that title deeds are transferred to the trustees.
- Appoint receiver if the security has to be enforced. If receiver is appointed, the provisions in respect of receiver as during winding up apply.
- Obtain periodic report or information from company.
- Inspection of mortgaged property and related register and books of account.
- Restrictions on creation of further charge on same property without permission of trustees.
- The trustees should show due care and diligence.
- A trust deed cannot exempt trustee from liability of breach of trust.
Steps to be Taken by Debenture Trustee if the Assets are Insufficient
- The trustee may file petition to Tribunal, if they are of the opinion that:
- the assets of company are insufficient; or
- are likely to become insufficient to discharge the principal amount as and when it becomes due.
- The Tribunal will hear the company and any other person interested in the matter.
- The Tribunal is required to pass order within 60 days from date of receipt of application.
- The Tribunal may by order, impose such restrictions on incurring further liabilities as it thinks necessary in the interest of debenture holders.
Debenture Trust Deed
Execution of Trust Deed Time
The trust deed shall be executed:
- within 3 months of closure of issue
- by the issuer company
- in favour of debenture trustees
Form- Rule 18(5)
Trust deed shall be in Form SHI2 or as near thereto as possible.
Exemption Clause Section 71(7)
- A trust deed cannot exempt trustee or provide indemnify him from liability of breach of trust.
- However, liability of the debenture trustee shall be subject to such exemptions as may be agreed upon by not less than 3/4th in value of debenture holders at meeting held for that purpose.
Inspection of Trust Deed-Rule 18(8)
- A copy of trust deed shall be open for inspection to any member or debenture holder.
- Any debenture holder or member of the company is entitled to get a copy of the trust deed on payment of prescribed fees.
- Company is required to forward copy of trust deed within 7 days of demand.
Default In Payment of Interest Or Redemption of Debenture
If company makes default in payment of interest or redemption of debenture as per terms and conditions of issue, debenture holder has following remedy available:
- As per Companies Act, 2013
- As per other Acts
Remedy Available to Debenture holders
Under the Com- parties Act, 2013
A debenture holder or debenture trustee can able winding up petition.
Application to Tribunal
- Debenture holder or debenture trustee can apply to Tribunal.
- Tribunal can order company to redeem debenture forthwith and pay interest due after hearing both parties.
Default in complying order of Tribunal
If default is made in complying order of Tribunal, every officer of company who is in default shall be punishable with:
- Imprisonment for period upto 3 years; or
- Fine of not less than ₹ 2 lacs and not more than ₹ 5 lacs; or
Under other Acts
- Debenture holder is consumer as per the Consumer Protection Act, 1986. He can take action for deficiency in service.
- Debenture holder being creditor can take action as per civil law to recover his due amount.
Consequence of Default
If company fails to redeem debentures on due date and such failure continues for 1 year or more, directors become disqualified to be re-appointed in same company or to be appointed as director in any other public company for period of 5 years.
Can debentures be re-issued?
The Companies Act, 2013 does not have provisions for reissue of redeemed debenture.
Ajay Ltd. borrowed t 100 crore from Prem, without the authority conferred on it by the Articles of association. Later, the money borrowed by Ajay Ltd. was used by its Board of directors to pay off lawful debts of the company. In this scenario, Prem, the lender seeks your advice for recovery of his money. Advise him.
Prem, the lender can recover money from directors of company, if money borrowed by Ajav Ltd. is ultra vires. For ultra vires transaction, company is not liable.
Which of the following documents can be treated as debenture?
I. A legal mortgage of freehold and leasehold land
II. A note by which company undertook to pay a loan but gave no security
III. A series of income bonds by which a loan to the company was repayable only out of its profit.
Please refer the definition of debenture as given in paragraph no. 2.
Past Examination Questions
Whether the following can be appointed as ‘Debenture Trustee’?
II. A shareholder who has no beneficial interest
III. A creditor whom the company owes ₹ 499 only
IV. A person who has given a guarantee for repayment of amount of debenture issued by the company (CA November 2003)
I. Yes II. No. III. No.
Explain briefly the distinction between shares and debentures and state whether a company can issue debentures with voting rights. (CA November 2004)
Issue of debenture with voting rights is not permissible examine. (CA May 2012)
Debentures with voting rights can be issued only, if permitted by the Articles of Association. (CA May 2015, November 2016)
Board of Directors of PQR Limited wants to create a ‘Debenture Redemption Reserve (DRR)’ for the redemption of debentures issued by the company under the provisions of the Companies Act, 2013. Explain the provisions of the Companies (Share Capital and Debenture) Rules, 2014 in this regard. (CA May 2015)
What are the provisions of the Companies Act, 2013, relating to the appointment of ‘Debenture Trustee’? (CA November 2016)