DEBENTURES:

Quite often the money raised through the issue of shares is found inadequate to meet the growing
financial requirements of business. Hence, to meet the financial requirements a company resort to
borrowings. Such borrowings may be short-term and long term. Short term borrowings are overdraft,
bills payable etc. Long term borrowings may be debentures, bonds, term loan from banks, public
deposits etc. Issue of debentures is very common source to raise borrowings.

MEANING:
A debenture is a type of debt instrument which is issued by a company to raise capital.
Debenture is a long-term debt instrument which may be in the form of a bond or a loan which
is secured by the charge upon the assets which have been provided as securities. It is one of
the best ways to acquire capital. Debenture has its own features with respect to both the
companies and the debenture-holders. It is good for the company as it helps the company to
acquire capital without diluting any of its ownership, and it is also good for the debenture-
holders as they are secured through their right to charge.
According to Section 2(30) of the Companies Act, 2013 – the term “debenture” 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. The definition in the Companies
Act, 2013 does not mandate the creation of a charge. So, a debenture can be issued without
creating a charge on the company’s assets. Example-unsecured debentures are issued.

CHARACTERSTICS OF DEBENTURES:
The characteristic features of a debenture are as follows:

1. It is a movable property.
2. It is issued by the company and is in the form of a certificate of indebtedness.
3. It usually specifies the date of redemption. It also provides for the repayment of
principal and interest at specified date or dates.
4. It generally creates a charge on the undertaking or undertakings of the company.
5. A debenture is a written acknowledgement of debt taken by the company.

DEBENTURE STOCK:
A company, instead of issuing individual debentures, evidencing separate and distinct debts,
may create one loan fund known as “debenture-stock” divisible among a class of lenders,
each of whom is given a debenture-stock certificate evidencing the parts of the whole loan to
which he is entitled.
This debenture-stock, which is analogous to the loan stocks of Governments and local and
public authorities, is then the indebtedness itself, and the certificate evidences the
stockholder’s interest in it.

A consequence of the distinction is that whereas a debenture is a single thing which can be
legally transferred only as one entity, debenture-stock can be sub-divided and transferred in
any fractions which the holder wishes.

One more distinction between the two is that while “debenture-stock” must be fully paid, a
debenture may or may not be fully paid.

However, for the purposes of the Companies Act, ‘debenture’ includes ‘debenture-stock’.
KINDS OF DEBENTURES:
Debentures are several types and each has its own features and characteristics. The different
types of debentures are listed below.

 Debentures based on security (Secured and Unsecured)

 Debentures based on tenure (Redeemable and Non-Redeemable)
 Debentures based on conversion (Convertible and non-convertible)
 Debentures based on registration (Registered and Bearer)

1. Registered Debentures
These are debentures which are payable to the registered holders, i.e., persons whose names
appear in the Register of debenture holders. Such debentures are transferable in the same way
as shares or in accordance with the conditions endorsed on their back. The debenture itself
consists of two parts:
(a) The covenants by the company to pay the principal and interest, and
(b) The endorsed conditions, e.g., the term of the loan.

The endorsed conditions vary, but they normally contain a provision that the debenture is one
of a series all ranking pari passu. Where debentures rank pari passu, they will be discharged
in proportion to the amount due in respect both of capital and interest, i.e., in the event of a
deficiency of assets, if the interest on some debentures is paid down to a later date than
others, the interest due on each is added to the capital thereof, and a proportionate distribution
of the assets made. If there were no such provision, the debentures would rank in the order of
issue regarding the assets charged by the company.

Unregistered or Bearer Debentures

The company can avoid the registration of the debenture holders if it issues the debentures to
the bearer. Such types of debentures are transferable, like negotiable instruments, by way of
simple delivery and are also called debentures payable to the bearer.

2. Perpetual or Irredeemable Debentures

A debenture which contains no clause as to payment or which contains a clause that it shall
not be paid back is called a perpetual or irredeemable debenture. Though irredeemable
debentures were allowed under Section 120 of the Companies Act, 1956, no corresponding
provision has been made under the Act of 2013. Thus, no fresh irredeemable debentures may
be issued by the companies.

Redeemable Debentures
Redeemable debentures are to be redeemed as per the terms of the issue. Section 71 and the
rules framed thereunder regulate the issue of such debentures, and the same have been
discussed in the aforesaid paragraphs.

3. Naked Debentures
Normally, debentures are secured by a mortgage or a charge on the company’s assets.
However, debentures may be issued without any charge on the assets of the company. Such
debentures are called ‘Naked or unsecured debentures’. They are mere acknowledgements of
a debt due from the company, creating no rights beyond those of ordinary unsecured
creditors. Unsecured debentures are treated as deposits and should, therefore, conform to
requirements applicable to public deposits accepted by a company.
Secured Debentures
Secured debentures are also known as mortgage debentures. They are a type of debenture that
is secured by a charge, either fixed or floating, on a company’s assets. The holder of this type
of debenture has the right to recover the principal amount and the interest from the assets
which have been given as securities.

4. Convertible Debentures
A company may also issue convertible debentures, in which case an option is given to the
debenture holders to convert them into equity or preference shares at stated rates of exchange
after a certain period. Section 71 requires the company to pass a special resolution for the
issue of convertible debentures, whether wholly or partly. Such debentures, once converted
into shares, cannot be reconverted into debentures.

According to convertibility, debentures are further classified into three categories:

1. Fully Convertible Debentures (FCDs)

2. Non-Convertible Debentures (NCDs)
3. Partly Convertible Debentures (PCDs)

 Fully Convertible Debentures: Fully convertible debentures are those debentures

that are converted into equity shares of the company on the expiry of specified period
or periods. Where the conversion is to be made at or after 18 months from the date of
allotment but before 36 months, the conversion is optional on the part of the
debenture holders in terms of SEBI guidelines.
 Non-Convertible Debentures: Non-convertible debentures are those debentures that
do not confer any option on the holder to convert the debentures into equity shares
and are redeemed at the expiry of a specified period(s).
 Partly Convertible Debentures: Partly convertible debenture consists of two parts,
viz., convertible and non-convertible. The convertible portion(s) is/are convertible
into equity shares at the expiry of specified period(s). The non-convertible portion, on
the other hand, is redeemed at the expiry of a certain period(s). Where the conversion
takes place at or after 18 months, as per SEBI’s guidelines, the conversion is optional
at the discretion of the debenture holder.

DEBENTURE TRUST DEED:

When debentures are issued for public subscription, involving a considerable number of
debenture holders, it is not feasible to create a separate charge in favour of thousands of
debenture holders. Therefore, the most common and convenient form of securing them is to
execute a Trust Deed conveying the property of the company to the trustees and declaring a
trust in favour of the debenture holders.

A trust deed normally grants the trustees a fixed charge over the company’s freeholds and
leaseholds and a floating charge over the rest of the property. The trust deed contains the
terms and conditions endorsed on the debentures and defines the rights of the debenture
holders and the company. A trust deed normally contains clauses giving the trustees the
following powers:

1. To take a mortgage over the company’s property in which case the title deeds are
transferred to them and the company is thereafter prevented from creating further
charges ranking in priority to debentures.
 2. To sell or lease the property and to renew leases.
3. To exchange the mortgaged property for other suitable property.
4. To modify subsisting contracts applying to any part of the property.
5. To compromise claims.
6. To commence and defend actions.
7. To appoint a receiver on the security becoming enforceable.

The advantage of a trust deed is that it becomes the function of the trustees to watch the
interest of the debenture holders who are bound to act honestly and with due care and
diligence. In fact, any clause in the trust deed exempting them from liability for breach of
their duty as trustees or which indemnifies them against liability is void.

The Companies Act, 2013, vide Rule 18 of the Companies (Share Capital and Debentures)
Rules, 2014, contains the following provisions in this regard:

1. Appointment of Debenture Trustee:

The company shall appoint a debenture trustee before the issue of prospectus or letter of offer
for subscription of its debentures and, not later than sixty days after the allotment of
debentures, execute a debenture trust deed in Form No. SH.12 or as near thereto as possible
to protect the interest of the debenture holders.

2. Creation of Security:
The security for the debentures by way of a charge or mortgage shall be created in favour of
the debenture trustee on—
(i) any specific movable property of the company (not being in the nature of pledge); or
(ii) any specific immovable property wherever situate, or any interest therein.

3. Consent of Debenture Trustee:

(a) The names of the debenture trustees shall be stated in the letter of offer inviting
subscription for debentures and also in all subsequent notices or other communications sent
to the debenture holders;
(b) Before the appointment of debenture trustee(s), a written consent shall be obtained from
such trustee(s) proposed to be appointed, and a statement to that effect shall appear in the
letter of offer issued for inviting the subscription of debentures.

4. Disqualifications of Debenture Trustee:

A person shall not be appointed as a debenture trustee if he—
(i) beneficially holds shares in the company;
(ii) 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;
(iii) is beneficially entitled to moneys which are to be paid by the company otherwise than as
remuneration payable to the debenture trustee;
(iv) is indebted to the company, or its subsidiary, or its holding or associate company, or a
subsidiary of such holding company;
(v) has furnished any guarantee in respect of the principal debts secured by the debentures or
interest thereon;
(vi) has any pecuniary relationship with the company amounting to two percent 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;
(vii) is a relative of any promoter or any person who is in the employment of the company as
a director or key managerial personnel.

5. Casual Vacancy in the Office of Debenture Trustee:

The Board may fill any casual vacancy in the office of the trustee, but while any such
vacancy continues, the remaining trustee(s), if any, may act. However, where such vacancy is
caused by the resignation of the debenture trustee, the vacancy shall only be filled with the
written consent of the majority of the debenture holders.

6. Removal of Debenture Trustee:

Any debenture trustee may be removed from office before the expiry of his term only if it is
approved by the holders of not less than three-fourths in value of the debentures outstanding
at their meeting.

7. Duties of Debenture Trustee:

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 therefor;
(e) appoint a nominee director on the Board of the company in the event of—
(i) two consecutive defaults in payment of interest to the debenture holders; or
(ii) default in creation of security for debentures; or
(iii) default in redemption of debentures.
(f) ensure that the company does not commit any breach of the terms of issue of debentures
or covenants of the trust deed and take such reasonable steps as may be necessary to remedy
any such breach;
(g) inform the debenture holders immediately of any breach of the terms of issue of
debentures or covenants of the trust deed;
(h) ensure the implementation of the conditions regarding creation of security for the
debentures, if any, and debenture redemption reserve;
(i) ensure that the assets of the company issuing debentures and of the guarantors, if any, are
sufficient to discharge the interest and principal amount at all times and that such assets are
free from any other encumbrances except those which are specifically agreed to by the
debenture holders;
(j) do such acts as are necessary in the event the security becomes enforceable;
(k) call for reports on the utilization of funds raised by the issue of debentures;
(l) take steps to convene a meeting of the holders of debentures as and when such a meeting
is required to be held;
(m) ensure that the debentures have been converted or redeemed in accordance with the terms
of the issue of debentures;
(n) perform such acts as are necessary for the protection of the interest of the debenture
holders and do all other acts as are necessary to resolve the grievances of the debenture
holders.

8. Meeting of Debenture Holders:

The meeting of all the debenture holders shall be convened by the debenture trustee on—
(a) requisition in writing signed by debenture holders holding at least one-tenth in value of
the debentures for the time being outstanding;
(b) the happening of any event, which constitutes a breach, default or which, in the opinion of
the debenture trustees, affects the interest of the debenture holders.

9. The provisions of sub-rules (2) to (5) of rule 18 shall not be applicable to the public offer
of debentures.

RIGHTS/REMEDIES OF DEBENTURE-HOLDER:
As per Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014, the Debenture
Trustee shall 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 therefor.
Besides, he will 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 redemption
of debentures.

Again, section 71 provides that where a company fails to redeem the debentures on the date
of their maturity or fails to pay interest on the debentures when it is due, the Tribunal may, on
the application of any or all of the debenture holders, or debenture trustee and, after hearing
the parties concerned, direct, by order, the company to redeem the debentures forthwith on
payment of principal and interest due thereon [Section 71(10)].

If any default is made in complying with the order of the Tribunal under this section, every
officer of the company who is in default shall be punishable with imprisonment for a term
which may extend to three years or with fine which shall not be less than two lakh rupees but
which may extend to five lakh rupees, or with both [Section 71(11)].

Features of Convertible Debentures

The main features of convertible debentures may be noted as follows:

1. The debentures are converted into a specified or unspecified number of equity shares
at the end of a specified period. The ratio at which the convertible debentures are
exchanged for equity shares is known as the conversion price or conversion ratio. The
conversion ratio is worked out by dividing the face value of a convertible debenture
by its conversion price. For example, if the face value of the convertible debenture is
Rs. 100 and it is convertible into two equity shares of Rs. 10 each, the conversion
price is Rs. 50 and the conversion ratio is 2. Since the difference between the
conversion price and the face value of the equity share is Rs. 40, the conversion
premium per share is Rs. 40.
2. Convertible debentures may be fully or partly convertible. In the case of fully
convertible debentures, the entire face value is converted into equity shares at the
expiry of a certain period(s). In the case of partly convertible debentures, the
convertible portion is converted into equity shares at the expiry of certain period(s),
and the non-convertible portion is redeemed at the expiry of a certain period.
3. Convertible debentures, whether fully or partly convertible, may be converted into
equity shares at the end of specified periods or in one or more stages. In terms of
SEBI guidelines, fully convertible debentures with a conversion period of more than
36 months can be issued only with put and call options. If the conversion is at or after
18 months but within 36 months, conversion will be at the option of the debenture
holder; otherwise, conversion is compulsory. The premium amount, if any, should be
 determined at the outset, and the lower and upper limits of the premium should be
stated in the offer document.
4. If one or more parts of debentures are convertible after 18 months, the company
should get a credit rating of the debentures done by a credit rating agency.
5. Interest on debentures may be paid as per market forces. With effect from 1-8-1991,
interest rates on debentures have been deregulated, and companies are permitted to
pay any interest they consider reasonable. Debentures can also be issued as zero-
interest debentures, where no interest is payable on the debentures.
6. Convertible debentures are listed on the stock exchanges. However, in practice,
convertible debentures are not actively traded on the stock exchanges in India, except
those of reputed companies.

In addition to the SEBI Regulations, 2009 on Issue of Capital and Disclosure Requirements,
an issuer making a public issue or rights issue of convertible debt instruments must comply
with the following conditions:

1. Credit Rating

 The issuer must obtain a credit rating from one or more credit rating agencies.

2. Appointment of Debenture Trustees

 One or more debenture trustees must be appointed in accordance with Section 71 of

the Companies Act, 2013 and the SEBI (Debenture Trustees) Regulations, 1993.

3. Creation of Debenture Redemption Reserve

 A debenture redemption reserve must be created as per Section 71 of the Companies

Act, 2013 and the related rules.

4. Creation of Security

 If a charge or security on the issuer’s assets is proposed for secured convertible debt
instruments, the following conditions must be fulfilled:
o (i) Assets must be adequate to discharge the principal amount at all times.
o (ii) Assets should be free from encumbrance.
o (iii) Consent of financial institutions, banks, or lessors must be obtained where
a second or pari passu charge is created, and submitted to the debenture trustee
before the issue opens.
o (iv) Security/asset cover must be calculated after reducing liabilities with a
first or prior charge, in cases where the debt instruments are secured by a
subsequent charge.

5. Redemption of Convertible Debt Instruments

 The issuer must redeem the convertible debt instruments as specified in the offer
document.
Roll Over of Non-Convertible Portion of Partly Convertible Debt Instruments

1. Conditions for Roll Over

o The non-convertible portion of partly convertible debt instruments issued by a
listed issuer, exceeding Rs. 50 lakh, may be rolled over without altering the
interest rate, if the following conditions are met:
 (a) Approval of 75% of the holders via a resolution through postal
ballot.
 (b) Issuer sends notice with an auditor’s certificate on cash flow and
liquidity status to the holders.
 (c) Redemption of the non-convertible portion for holders who
disagree with the resolution.
 (d) A credit rating is obtained from a SEBI-registered agency within
six months before the due date of redemption and is communicated to
the holders.
2. Trust Deed and Security for Roll Over
o Fresh security creation and trust deed execution are not mandatory if the
existing trust deed or security documents provide continuity until redemption:
 Provided, the debenture trustee decides if fresh security and a trust
deed are necessary.

Conversion of Optionally Convertible Debt Instruments into Equity Share

Capital

1. Consent Requirement
o Conversion is only allowed with explicit consent from holders. Non-receipt of
a response does not imply consent.
2. Option to Not Convert
o For listed issuers where the convertible portion exceeds Rs. 50 lakh and the
conversion price was not pre-determined, holders must be given the option to
avoid conversion unless:
 If an upper price limit was disclosed with justification at issue, no
conversion option is needed within the limit.
3. Redemption on Non-Exercise of Conversion Option
o If holders choose not to convert, the issuer must redeem those instruments
within one month after the option period ends, at a price not lower than face
value.
4. Exception
o Sub-regulation (3) does not apply if redemption terms were disclosed in the
offer document.

Issue of Convertible Debt Instruments for Financing

1. Restrictions on Purpose
 o Convertible debt instruments cannot be issued for fund replenishment, loan
provision, or share acquisition of entities within the same group or under the
same management:
 Exception: Fully convertible debt instruments may be issued for these
purposes if converted within 18 months from issuance.

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