Debt Instruments and Deposits – Company Law Important Questions

Debt Instruments and Deposits – Company Law Important Questions

Question 1.
What are the rights, powers, and disabilities of debenture trustees?
Or
With reference to the provisions of the Companies Act, 2013 and the rules framed thereunder, state the disqualifications for a Debenture Trustee. Ex¬plain whether the following persons can be appointed as Debenture Trustee?
(i) A relative of the whole-time director of the company.
(ii) A shareholder who has no beneficial interest. (June 2019) (5 marks)
Answer:
1. Section 71(6) read with Rule 18(3) of aforesaid rules provide that a debenture trustee shall take steps to protect the interests of the debenture holders and redress their grievances.

2. It shall be the duty of every debenture trustee to-
(a) satisfy himself that the letter of offer does not contain any matter which is inconsistent with the terms of the issue of debentures or with the trust deed;
(b) satisfy himself that the covenants in the trust deed are not prejudicial to the interest of the debenture holders;
(c) call for periodical status or performance reports from the company;
(d) communicate promptly to the debenture holders defaults, if any, with regard to payment of interest or redemption of debentures and action taken by the trustee, therefore;
(d) appoint a nominee director on the Board of the company in the event of:

  • two consecutive defaults in payment of interest to the debenture holders; or
  • default in the creation of security for debentures; or
  • default in the redemption of debentures.

(e) inform the debenture holders immediately of any breach of the terms of issue of debentures or covenants of the trust deed;

3. The disqualifications for debenture trustees are as under as per Rule 18(2):
(a) Beneficially holds shares in the company;
(b) Is a promoter, director, or key managerial personnel or any other officer or an employee of the company or its holding, subsidiary, or associate company;
(c) Is beneficially entitled to money which is to be paid by the com¬pany otherwise than as remuneration payable to the debenture trustee;
(d) Is indebted to the company, or its subsidiary or its holding or associate company or a subsidiary of such holding company;
(e) Has furnished any guarantee in respect of the principal debts secured by the debentures or interest thereon;
(f) Has any pecuniary relationship with the company amounting to 2% or more of its gross turnover or total income or fifty lakh rupees or such higher amount as may be prescribed, whichever is lower, during the two immediately preceding financial years or during the current financial year;
(g) Is relative of any promoter or any person who is in the employment of the company as a director or key managerial personnel.

Question 2.
Ajay Limited borrowed INR 100 crore from Prem, without the authority confirmed on it by the articles of association. Later, the money borrowed by Ajay Limited was used by its Board of directors to pay off the lawful debts of the company. In this scenario, Prem, the lender seeks your advice for the recovery of his money. Advise him. (June 2012) (5 Marks)
Answer:
1. In T.R. Pratt. (BOM) Ltd. v. E.D. Sassoon and Co. Ltd., (1936) 6 Com Cases 90, there was no limit on the borrowing for business in the memorandum of the company. But the directors could not borrow beyond the limit of the issued share capital of the company without the sanction of the general meeting.

The directors borrowed money from the plaintiff beyond their powers. It was held that the money having been borrowed and used for the benefit of the principal either in paying its debts, or for its debts, or for its legitimate business, the company cannot repudiate its liability on the ground that the agent had no authority from the company to borrow. When these facts are established a claim on the footing of money had been received would be maintainable

2. It was also held that under the general principle of law when an agent borrows money for a principal without the authority of the principal, but if the principal takes benefit of the money so borrowed or when the money so borrowed have gone into the coffers of the principal, the law implies a promise to repay.

3. In that connection, it was observed that there appears to be nothing in the law that makes this principle inapplicable to the case of a joint-stock company and even in cases where the directors or the managing agent had borrowed money without there being authorization for the company, if it has been used for the benefit of the company, the company cannot repudiate its liability to pay.

4. Thus, Prem can recover the money borrowed by the director of Ajay Ltd. without any authority as money has been used to pay off the lawful debts of the Company.

Question 3.
Alok, the Managing Director of Yellow Limited, borrowed a large sum of money and misappropriated the same. Later, when the lender demanded his money, the company refused to repay, contending that the money borrowed by Managing Director was misappropriated by him and the company is not liable for repayment. Decide, giving reasons, whether the lender would succeed in recovering the money from the company. (June 2015) (4 marks)
Answer:
1. In V.K.R.S.T Firm v. Oriental Investment Trust Ltd., AIR 1944 Mad 532 under the authority of the company, its managing director bor-rowed large sums of money and misappropriated it. The company was held liable stating that where the borrowing is within the powers of the company, the lender will not be prejudiced simply because its officer has applied the loan to unauthorized activities provided the lender had no knowledge of the intended misuse.

Based on the above-mentioned decided case law, in the present case Alok, the Managing Director of Yellow Limited, borrowed a large sum of money and misappropriated the same. Later, when the lender demanded his money, the company refused to repay, contending that the money borrowed by Managing Director was misappropriated by him and the company is not liable for repayment is not tenable/legal.

Thus, the lender would succeed in recovering the money from the Company.

Question 4.
Distinguish Between: Redemption of shares and redemption of debentures. (June 2018) (4 marks)
Answer:
Following are the main points of difference between the redemption of shares and redemption of debentures:

Points Redemption of Shares Redemption of debentures
Nature Redemption of preference shares is payment to the owner of the company. Redemption of debentures amounts to the repayment of the loan as debenture holders are creditors of the company.
Conditions of Redemption Preference shares can be issued for a maximum period of 20 years after which such preference shares must be redeemed as provided in Section 55. Companies can issue redeemable as well as irredeemable debentures.
Redeemable debentures are required to be redeemed within the period specified in the offer document while irredeemable debentures are redeemed only at the time of liquidation of the company.
Proceeds at the time of redemption As per Section 55, preference shares shall be redeemed out of profits available for dividend or out of the proceeds of a fresh issue of shares. Debenture can be redeemed only out of the profit of the company and not out of proceeds of a fresh issue of shares.
Nature of Reserves to which Transfer is made Where preference shares are proposed to be redeemed out of the profits a sum equal to the nominal amount of the share should be transferred to the Capital Redemption Reserve Account. When debentures are redeemed then an amount equal to the nominal value of debentures is transferred to General Reserve as per sound accounting policy.
If the sinking fund is created then the balance of the sinking fund is transferred to the general reserve.

Question 5.
Provision of section 73 is not applicable to guarantee companies and Section 8 companies (that is association not for profit). (June 2009) (5 marks)
Answer:
Proviso to Section 73(1) read with Rule 1(3) of the Companies (Acceptance of Deposits) Rules, 2014:
The provisions under Sections 73 to 76 of the Companies Act, 2013 and the Companies (Acceptance of Deposits) Rules, 2014 shall apply to all companies except:

  • a banking company and
  • a non-banking financial company as defined in the Reserve Bank of India Act, 1934 and
  • a housing finance company registered with the National Housing Bank established under the National Housing Bank Act, 2013; and
  • such other company as the Central Government may, after consultation with the Reserve Bank of India, specify on this behalf.

Question 6.
The Board of directors of Green Field Limited decides to accept deposits, from the public at a compound interest rate of 12% per annum. Examining the provisions of the Companies Act, 2013, advise whether the Board can go ahead with its proposal. (June 2016) (4 marks)
Answer:
Ceiling on the rate of interest on deposits [Rule 3(6)]:
No company or any eligible company shall invite or accept or renew any deposits carrying a rate of interest or pay brokerage at a rate exceeding the maximum rate of interest or pay brokerage at a rate exceeding the maximum rate of interest or brokerage prescribed by the RBI for acceptance of deposits by non-banking financial companies

Thus, Green Field Ltd. can accept deposits at the compound interest rate provided that the rate of interest should not exceed the rate prescribed by the RBI for acceptance of deposits by non-banking financial companies.

Question 7.
Issue of unsecured debentures by a company to another company, where the debentures have an option for compulsory conversion into equity share within seven years, cannot be termed as deposits. (December 2016) (5 marks)
Answer:
1. According to the Section 2(31) of the Act read with Rule 2(c)(ix) of Companies (Acceptance of Deposits) Rides, 2014, ‘deposit’ includes any receipt of money by way of deposit or loan or in any other form by a company, but does not include any amount raised by the issue of bonds or debentures secured by a first charge or a charge ranking pari passu with the first charge on any assets referred to in Schedule III of the Act excluding intangible assets of the company or bonds or debentures compulsorily convertible into shares of the company within 10 years.

2. The exclusion essentially signifies that a secured debenture, regardless of its tenure or convertibility, shall be exempt from the purview of de-posits.

3. However, the non-convertible unsecured debentures would be considered as deposits.

4. According to Rule 2(c)(vi) of the Companies (Acceptance of Deposits) Rules, 2014, excludes from deposits any amount received by a company from any other company.

Thus, the issue of unsecured debentures by a company to another company, where the debentures have an option for compulsory conversion into equity share within seven years, cannot be termed as deposits under Companies (Acceptance of Deposits) Rules, 2014

Question 8.
Define the term ‘deposits’ and list out the receipts of money which are not considered deposits. (December 2016) (8 marks)
Answer:
According to the Section 2(31) of the Act read with Rule 2(1) (c) of Companies (Acceptance of Deposits) Rules, 2014, ‘deposit’ includes any receipt of money by way of deposit or loan or in any other form by a company, but does not include:
1. any amount received from the Central Government or a State Government, or any amount received from any other source whose repayment is guaranteed by the Central Government or a State Government or any amount received from a local authority, or any amount received from a statutory authority;

2. any amount received from foreign Governments, foreign/international banks, multilateral financial institutions, foreign government-owned de¬velopment financial institutions, foreign export credit agencies, foreign collaborators, foreign bodies corporate and foreign citizens, foreign authorities, or persons resident outside India subject to the provisions of Foreign Exchange Management Act, 1999;

3. any amount received as a loan or facility from any banking company or from the State Bank of India or any of its subsidiary banks or from a banking institution notified by the Central Government;

4. any amount received as a loan or financial assistance from Public Financial Institutions, regional financial institutions, Insurance Companies, or Scheduled Banks;

5. any amount received against the issue of commercial paper or any other instrument issued in accordance with the guidelines or notification issued by the Reserve Bank of India;

6. any amount received by a company from any other company;

7. any amount received and held pursuant to an offer made in accordance with the provisions of the Act towards a subscription to any securities, including share application money or advance towards allotment of securities pending allotment, so long as such amount is appropriated only against the amount due on allotment of the securities applied for:
(a) If the securities for which application money or advance for such securities was received cannot be allotted within 60 days from the date of receipt of the application money or advance for such securities and such application money or advance is not refunded to the subscribers within 15 days from the date of completion of 60 days, such amount shall be treated as a deposit under these rules. For the purpose of this rule any adjustment of the amount for any other purpose will not be treated as a refund;

(b) Any adjustment of the amount for any other purpose shall not be treated as a refund.

8. any amount received from a person who, at the time of the receipt of the amount, was a director of the company. The director from whom money is received, furnishes to the company at the time of giving the money, a declaration in writing to the effect that the amount is not being given out of funds acquired by him by borrowing or accepting loans or deposits from others;

9. any amount raised by the issue of bonds or debentures secured by a first charge or a charge ranking pari passu with the first charge on any assets referred to in Schedule III of the Act excluding intangible assets of the company or bonds/debentures compulsorily convertible into shares of the company within ten years. If such bonds or debentures are secured by the charge of any assets referred to in Schedule in of the Act excluding intangible assets, the number of such bonds or debentures shall not exceed the market value of such assets as assessed by a registered valuer.

10. any amount received from an employee not exceeding his annual salary, under a contract of employment with the company in the nature of non-interest bearing security deposit;

11. any non-interest bearing amount received or held in trust;

12. any amount received in the course of or for the purposes of the business of the company:
(a) as an advance for the supply of goods or provision of services provided that such advance is appropriated against supply of goods or provision of services within a period of three hundred and sixty-five days from acceptance of such advance. In case of any advance which is the subject matter of any legal proceedings before any court of law, the said time limit of three hundred and sixty Eve days shall not apply.

(b) as advance, accounted for in any manner whatsoever, received in connection with consideration for property under an agreement or arrangement, provided that such advance is adjusted against the property in accordance with the terms of agreement or arrangement.

(c) as a security deposit for the performance of the contract for the supply of goods or provision of services.

(d) as advance received under long-term projects or for the supply of capital goods except those covered under item (b) above.

(e) as an advance towards consideration for providing future services in the form of a warranty or maintenance contract as per writ¬ten agreement or arrangement, if the period for providing such services does not exceed the period prevalent as per common business practice or five years, from the date of acceptance of such service whichever is less;

(f) as an advance received and as allowed by any sectoral regulator or in accordance with directions of Central or State Government;

(g) as an advance for a subscription towards publication, whether in print or in electronic to be adjusted against receipt of such publications;

If the amount received under (a) (b) and (d) above becomes refundable (with or without interest) because the company accepting the money does not have the necessary permission or approval to deal in the goods or properties or services for which the money is taken, the amount received shall be deemed to be a Deposit under these rules.
Explanation: For the purpose of sub-clause the amount shall be deemed to be deposits on the expiry of 15 days from the date they become due for refund.

Question 9.
A private limited company can accept deposits from its member under the provisions of the Companies Act, 2013. (June 2018) (4 marks)
Answer:
1. As per Section 2(68) of the Companies Act, 2013 a private company means a company, which has a minimum paid-up capital as may be prescribed, and by its articles:
(a) Restricts the right to transfer its shares;
(b) Limit the number of its members to 200 excluding past and present employees; who are/was also a member.
(c) prohibits any invitation to the public to subscribe to any securities.

2. A private company may issue debentures to any number of persons.

3. The only condition is that an invitation to the public to subscribe for debenture is prohibited.

Thus, A private company can only accept deposits from its members only and not from the public.

Question 10.
A single fixed deposit holder, after marriage, applied for adding the name of his wife as joint holder. The company refused to do so. Comment (June 2011) (4 marks)
Answer:
1. Rule 2(1 )(d) under Chapter V defines depositor as under ‘Depositor’ means-

  1. any member of the company who has made a deposit with the company in accordance with subsection (2) of section 73 of the Act, or
  2. any person who has made a deposit with a public company in accordance with section 76 of the Act.

2. As per Rule 3(2), where depositors so desire, deposits may be accepted in joint names not excluding three, with or without any of the clauses namely, “Jointly”, “Either or Survivor”, “First named or Survivor”, “Anyone or Survivor”.

Thus, the company cannot refuse to add the name of the wife of the deposit holder.

Question 11.
Shine Well Limited has accepted deposits from the public under the Companies (Acceptance of Deposits) Rules, 2014. The company now decided to repay some of its deposits before maturity. Can the company do so? If yes, what are the conditions attached there too? (June 2011) (4 marks)
Answer:
Rule 15: General provisions regarding premature repayment of deposits:
When a company makes repayment of deposits, on the request of the depositor, after the expiry of a period of 6 months from the date of such deposit, the rate of interest payable on such deposit shall be reduced by 196.

Thus, on request of the depositor Shine Ltd. can repay the deposits before the maturity but interest payable on such deposit shall be reduced by 1%.

Question 12.
Sun-beam Limited failed to pay interest on repayment of deposits. One depositor approached the consumer forum with the request to issue an order against the company for payment of interest on deposits. The company contended that the consumer forum was not a proper authority to issue search directions Advice the company suitably. (December 2014) (8 marks)
Answer:
1. In Neela Raje v. Amogh industries [RP No. 409 of 1992 dated 26.8.1993,84012 CLA 90 (NCDRC)], the National Commission was faced with a query as to whether a complaint lodged in regard to the failure to pay interest on repayment of the principal amount on the maturity of a deposit by a Company could be entertained by a consumer forum.

2. The commission pointed out that after the Amendment Act, 1993, a consumer forum can direct payment of amounts due to a depositor under the provisions of Section 14 of the Consumer Protection Act, 1986.
Thus, the contention of Sun-beam Ltd. is not valid.

Question 13.
Prism Limited has accepted rupees INR 10 lakh as an advance towards the supply of goods to certain parties. As per the agreement/the company will supply the goods after two years from the date of deposit. Letter on, internal auditors qualified their report on the ground that the company has violated the provisions of the Companies Act, 2013. Directors explained that this is required to complete the order. Examining the relevant provisions of the
Companies Act, 2013, state whether the explanation given by the directors is justified. (June 2016) (4 marks)
Answer:
1. According to Section 2(31) of the Companies Act, 2013,
‘Deposit’ includes any receipt of money by way of deposit or loan or in any other form by a company but does not include such categories of amount as may be prescribed in consultation with the RBI.

2. As per Rule 2(c), (xii) (a) of the Companies (Acceptance of Deposit) Rules, 2014, the deposit does not include any amount received in the course of or for the purpose of the Business of the company as an advance for the supply of goods or provision of services provided that such advance is appropriated against supply of goods or provision of services within a period of 365 days from acceptance of such advance.

3. As per facts given in the case Prism Ltd. has accepted INR 10 lakh as an advance towards the supply of goods to certain parties.

4. As per the agreement, the company will supply the goods after two years from the date of deposit.

Thus, the company has accepted advance for more than 365 days for the supply of goods, and hence it is ‘Deposit’ as per Section 2(31) read with Rule 2(l)(c) (xii)(d) of the Companies (Acceptance of Deposit) Rules, 2014. The Company has defaulted in accepting deposit without complying with the provision and hence remark passed by the internal auditor is correct and explanation given by the director is not sufficient.

Question 14.
Fun and Frolic Limited has received INR 5,00,000 from its Promoters as an unsecured loan in pursuance of the stipulation of credit facilities from the Bank. Can the company accept the unsecured loan? What would be your answer if the company has repaired in full its amount of credit facility and after such repayment, the company continues this unsecured loan? Referring to the provisions of the Companies Act, 2013. Advice the company (June 2018) (4 marks)
Answer:
1. As per Rule 2(l)(c), (xiii) of the Companies (Acceptance of Deposits) Rules, 2014, the deposit does not include any amount brought in by the promoters of the company by way of an unsecured loan in pursuance of the stipulation of any lending financial institution or a bank subject to fulfillment of the following conditions:-

2. the loan is brought in pursuance of the stipulation imposed by the lending institutions on the promoters to contribute such finance; and

3. the loan is provided by the promoters themselves or by their relatives or by both.
The exemption under this sub-clause shall be available only till the loans of financial institutions or banks are repaid and not thereafter.

4. As per the facts given in the case, Fun and Frolic Limited has received INR 5,00,000 from its Promoters as an unsecured loan in pursuance of the stip¬ulation of credit facilities from the Bank. Such unsecured loan will not be treated as a deposit as per Rule 2(1) (c)(xiii) of the Companies (Acceptance of Deposits) Rules, 2014.

However, after repayment of the credit facility if the company continues the unsecured loan of its promoter then it will be treated as a deposit.

Secured Irredeemable Debentures

Question 15.
A public company may issue secured irredeemable debentures. Comment December 2018) (5 marks)
Answer:
1. A Debenture, in which no time is fixed for the company to pay back the money, is an irredeemable debenture. The debenture holder cannot demand payment as long as the company is a going concern and does not make default in making payment of the interest. But all debentures, whether redeemable or irredeemable become payable on the company going into liquidation.

However, after the commencement of the Companies Act, 2013, now a company can now issue perpetual or irredeemable debentures.

2. Term of issue of debentures: An issue of secured debentures may be made, provided the date of its redemption shall not exceed 10 years from the date of issue.

However, the following classes of companies may issue secured debentures for a period exceeding 10 years but not exceeding 30 years:

  1. Companies engaged in setting up of infrastructure projects;
  2. Infrastructure Finance Companies;
  3. Infrastructure Debt Fund Non-Banking Financial Companies;
  4. Companies permitted by a Ministry or Department of the Central Government or by RBI or by the NHB or by any other statutory authority to issue debentures for a period exceeding 10 years. Hence, irredeemable debentures cannot be issued.

Question 16.
A private company and a banking company can freely accept deposits. (June 2019) (5 marks)
Answer:

  1. A private company can accept deposits only from its members and not from the public.
  2. As per the Proviso to Section 73(1) read with Rule 1(3) of the Companies (Acceptance of Deposits) Rules, 2014, excludes Banking Companies, NBFC, Housing Finance Company registered with NHB, and any other company specified by the government in this regard from the provisions relating to the deposit.

In the case of a private company. The Company cannot freely accept deposits from the public; it can accept deposits only from its members and not from the public.

In the case of banking companies: The Banking Company can accept deposits freely from the public in its ordinary course of business.

CS Executive Company Law Questions and Answers

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