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Debentures - Meaning
A debenture is an instrument of debt executed by the company
acknowledging its obligation to repay the sum at a specified rate
and also carrying an interest. It is only one of the methods of
raising the loan capital of the company. A debenture is thus like
a certificate of loan or a loan bond evidencing the fact that the
company is liable to pay a specified amount with interest and
although the money raised by the debentures becomes a part of the
company's capital structure, it does not become share capital.
Provisions regulating issue of Debentures
The power to issue debentures can be exercised on behalf of the
company at a meeting of the Board of Directors {Section 292(1)(b)
of the Companies Act}. A public company may, however, require the
approval of shareholders to borrow money in excess of the
aggregate of its paid up capital and free reserves.{Section 293
(1) (d)}. Consent of the shareholders would also be required for
selling, leasing or disposing of the whole or substantially the
whole of the undertaking of the company under section 293 (1) (a).
Debentures have been defined under Section 2 (12) of the Act to
include debenture stocks, bonds and any other securities of the
company whether constituting a charge on the company's assets or
not.
The attributes of a debenture are:
a. A movable property.
b. Issued by the company in the form of a certificate of
indebtedness.
c. It generally specifies the date of redemption, repayment of
principal and interest on specified dates.
d. May or may not create a charge on the assets of the company.
Section 372 A of the Companies Act also regulates inter-corporate
loan and investments and stipulates the ceiling limits on
investments and the amount of loan that can be borrowed by a
company. The explanation clause of this section states that the
loan shall include debentures.
Section 117 to Sections 123 of the Companies Act, 1956 regulate
the provisions relating to debentures, appointment of debenture
trustees, their duties, creation of Debenture Redemption Reserve
Account, liability of trustees etc.
The debentures issued under the Act shall not carry any voting
rights. In the case of public issue of debentures, there would be
a large number of debenture holders on the register of the
company. As such it shall not be feasible to create charge in
favour of each of the debenture holder. A common methodology
generally adopted is to create Trust Deed conveying the property
of the company. A Trust deed is an arrangement enabling the
property to be held by a person or persons for the benefit of some
other person known as beneficiary. The Trustees declare the Trust
in favour of the debenture holders. The Trust Deed may grant the
Trustees fixed charge over the freehold and leasehold property
while a floating charge may be created over other assets. The
Company shall allow inspection of the Trust Deed and also provide
copy of the same to any member or debenture holder of the company
on payment of such sum as may be prescribed. Failure to provide
the same would invite penalties by way of fine under the Act. Any
provision contained in the Trust Deed, which exempts a Trustee
from liability for breach of Trust, is void.
As per Section 125 (4) of the Companies Act, registration of a
charge for purpose of issue of debentures is mandatory. Section
128 stipulates that where a company issues series of debentures
which is secured by charge, benefit of which will be available to
all debenture holders pari passu, the company shall file the
prescribed particulars in Form 10 and 13 with the Registrar of
Companies for registration of charge. These forms shall be filed
within 30 days after the execution of the deed.
Appointment and Duties of Debenture Trustees
In terms of Section 117 B, it has been made mandatory for any
company making a public/rights issue of debentures to appoint one
or more debenture trustees before issuing the prospectus or letter
of offer and to obtain their consent which shall be mentioned in
the offer document. The Debenture Trustees shall not:
a. beneficially hold shares in a company.
b. be beneficially entitled to monies which are to be paid by the
company to the debenture trustees.
c. enter into any guarantee in respect of principal debt secured
by the debentures or interest thereon.
This section also lists the functions that shall be performed by
the Trustees. These include:
i. Protecting the interests of the debenture holders by addressing
their grievances.
ii. Ensuring that the assets of the company issuing debentures are
sufficient to discharge the principal amount.
iii. To ensure that the offer document does not contain any clause
which is inconsistent with the terms of the debentures or the
Trust Deed.
iv. To ensure that the company does not commit any breach of the
provisions of the Trust Deed.
v. To take reasonable steps as may be necessary to undertake
remedy in the event of breach of any covenant in the Trust Deed.
vi. To convene a meeting of the debenture holders as and when
required.
If the debenture trustees are of the opinion that the assets of
the company are insufficient to discharge the principal amount,
they shall file a petition before the Central Government and the
latter may after hearing the parties pass such orders as is
necessary in the interests of the debenture holders. As per the
SEBI (Debenture Trustees) Regulations, 1993, {hereinafter referred
to as the 'Regulations'} a Debenture Trustee can be a scheduled
bank, an insurance company, a body corporate or a public financial
institution.
Debenture Trust Deed
A Debenture Trust Deed shall, interalia, include the following:
a. An undertaking by the company to pay the Debenture holders,
principal and interest.
b. Clauses giving the Trustees the legal mortgages over the
company's freehold and leasehold property.
c. Clauses that may make the security enforceable in the event of
default in payment of principal or interest i.e. appointment of
receiver, foreclosure, sale of assets etc.
d. A clause giving the Trustees the power to take possession of
the property charged when security becomes enforceable.
e. Register of Debenture holders, meeting of all debenture holders
and other administrative matters may be included in the Deed.
In addition thereto, the SEBI regulations have laid format of the
Trust Deed in Schedule IV to the regulations. Some of the
important provisions would include
f. Time limit of creation of security for issue of debentures.
g. Obligations of the body corporate towards the debenture
holders.
h. Obligations towards the debenture holders - equity ratio and
debt service coverage ratio.
i. Procedure for the inspection of charged assets by the Trustees.
Creation of debenture Redemption Reserve
Section 117 C of the Act casts an obligation on the company to
create a Debenture Redemption Reserve. This account will be
credited with proceeds from the profits of the company arrived at
every year till redemption of the debentures. The Act, however,
does not stipulate the time period for creation of security. SEBI
regulations provides for creation of security within six months
from the date of issue of debentures and if a company fails to
create the security within 12 months, it shall be liable to pay 2%
penal interest to the debenture holders. If the security is not
created even after 18 months, a meeting of the debenture holders
will have to be called to explain the reasons thereof. Further,
the issue proceeds will be kept in escrow account until the
documents for creation of securities are executed between the
Trustees and the company.
Compliances under Registration Act and Stamp Duty Act
In the case of English Mortgage, the trust deed will attract ad
valorem stamp duty. After execution, such deed will be registered
with the sub registrar of Assurances. Registration charges will
have to be paid in addition to the stamp duty. While in case of an
equitable mortgage, if no document, deed etc. is signed then
nothing is required to be registered with the sub registrar of
Assurances. If however, a note or letter is made then it will
attract stamp duty. It is pertinent to mention that once a
mortgage is created by registration then no further stamp duty is
payable on registration.
Default
In the event of failure on the part of the company to redeem the
debentures on the date of maturity, the Company Law Tribunal may,
on the application of any debenture holder, direct redemption of
debentures forthwith by payment of principal and interest due
thereon. If a default is made in complying with the orders of the
Tribunal, every officer of the company who is in default shall be
punishable with imprisonment for a term which may extend to three
years and shall also be liable to fine of not less than Rs.500/-
for every day during which the default continues. (Section 117C)
Further this offence is not compoundable under section 621A of the
Act.
There are contradictions between the Companies Act and the SEBI
regulations on issues relating to:
a. Utilisation of Debenture Redemption Reserves. The Act provides
that the Debenture Redemption Reserve will be used towards
redemption of debentures only whereas the SEBI regulation states
that these will be a part of the General Reserves, which can be
utilised for the purpose of bonus issues.
. Any debentures issued with a maturity period of 18 months or
less is exempted from the creation of Debenture Redemption Reserve
Account, whereas no such exemption is provided under the Companies
Act.
c. No Public Issue/Rights Issue of Debentures shall be made by a
company unless it has appointed one or more Debenture Trustees for
such debentures whereas under SEBI guidelines, appointment of
Debenture Trustees is compulsory only in case of debentures with
maturity of 18 months or more.
A listed company though subjected to SEBI regulations must comply
with stringent norms between the two legislations / regulations
made there under.
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"Regulation of
Debentures Issue- An overview"
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author can be reached at: gpsahi@lemeridien-newdelhi.com /
