Debentures under Companies Act, 2013

Securities are issued by companies to acquire capital from investors. A security is a negotiable instrument issued by a company or a government which has a certain monetary value to acquire capital from the persons who invest in it. There are three types of securities in company law – a) equity securities which give the equity share value as a security to the person who is investing; b) derivatives securities which give value through another financial instrument or promise or contract and, c) the debt securities which gives the creditor a value through an instrument which comes with a charge on the assets provided as a collateral or security.

Meaning of debentures according to Companies Act, 2013

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. Debentures have a fixed rate of interest and other characteristics which are described in detail later in the article.

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. For example, unsecured debentures are issued without creating a charge, where the company is not required to provide any property or asset as a security for the debt amount acquired by issuing the debentures.

Types of debentures

Debentures based on security
Debentures based on tenure
Debentures based on conversion
Debentures based on registration

Debenture based on security- Usually, the debenture-holder has less or no risk for the amount he has lent to the company to get the debentures since he has securities to charge, upon the default of payment by the company. The debentures based on security are of two types – secured and unsecured debentures.

Secured debentures- Secured debentures are also known as mortgage debentures. They are a type of debenture that are 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.

Unsecured debentures- In this type of debenture, the companies are not required to pledge any of their properties or assets as collateral for the debt amount. Since the unsecured debentures do not require any assets to be used as a security, the lender usually is at high risk of losing his principal amount in case the company defaults. This type of debenture has a high rate of interest.

Debentures based on tenure- Redemption of the debenture occurs when on the maturity date, the company pays back the principal amount along with the interest and releases its properties or assets from the charge given to the debenture-holder. It is divided into two types – redeemable and irredeemable debentures.

Redeemable debentures- Most of the debentures are redeemable, meaning on the expiry of the maturity date, the debenture is redeemed by the company by paying back the principal amount with interest to the debenture-holder and releasing its assets from charge.

Perpetual or Irredeemable debentures- If a debenture does not contain any clause as to the payment of the principal amount by the company and redeeming the debenture, then it is known as a perpetual or irredeemable debenture. This type of debentures, unlike redeemable debentures, does not cease on the maturity date.

Debentures based on conversion- The company has the right to convert the debentures into equity shares. There are two types of conversion of debentures – convertible and non-convertible debentures.

Convertible debentures- The company issuing debentures has the right to convert these types of debentures into equity shares. So the debenture-holder who was just a creditor to the company becomes a member of the company and enjoys ownership of the company to the extent to which he has the equity shares of the company.

Non-convertible debentures- This type of debenture cannot be converted into equity shares of the company. So the debentures will always be redeemed and will never have the characteristics of equity shares of the company.

Debentures based on registration- As most of the important deeds and instruments of a company are usually registered in the company, debentures are no exception. There are two types – registered and unregistered debentures.

Registered debentures- If debentures are issued by the company, the company is required to maintain a register of its debenture-holders as Section 88 of the Companies Act, 2013 provides that every company shall register the holders of its debentures. Both, the debenture certificate and the company’s register, shall have the name of the debenture holder.

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.

Why are debentures issued

Retained Earnings – a leftover profit after paying all the direct and indirect costs, all the interests to the lenders and the payment of dividends to the shareholders. The retained earnings of the company are used for further investment in the company.

Equity Capital – It is a source of capital generated by giving out the equity of a certain part of ownership to the person who invests in the company. For example, shares.

Debt Capital – It is a source of capital generated through debt which is lent by banks and other lenders who get a fixed rate of interest. For example, loans and debentures.

Advantages of debentures

Advantages of debentures to the company

Secure way of raising money: Debentures are one of the most effective and safer ways for a company to raise funds when compared to equity or shares. Issuing debentures is safer because it can be paid back by the company.
Less authoritative: Since the debenture-holders do not have any voting rights as mentioned in Section 71(2) of the Companies Act, 2013, the company is not under the authority of so many persons and can function more independently.
Less risk of dilution: The company has less risk towards diluting its equity as the company does not provide any ownership to the debenture-holders.
Option of redemption: Since the debentures can be paid back by the company when they have surplus funds, there is no limitation to the company for the perpetual obligation that they would have to give security to the debenture-holders once they pay back their debt to the debenture-holders.

Advantages of debentures to the debenture-holder

A secured way to invest money: There is very minimal or no risk to the amount invested by the debenture-holder in the debentures. Irrespective of the market’s fluctuation or the company’s performance, the amount invested by the debenture-holder is always secured even if the company winds up.
Fixed-rate of Interest: The debenture-holder gets a fixed amount of interest no matter how the company is performing or the company is in loss.
Right to charge: The debenture-holder has the right to charge against the properties or assets of the company which have been given as security for the amount lent by the debenture-holders.

Disadvantages of debentures

Disadvantages of debentures to the company

Expensive during depression: In times of depression of a company, there may be a chance that the debentures can become expensive, but since the rate of interest would be the same and hence the company would suffer a loss by paying more interest.
Burden of Interest Payment: Since the performance of the company and the trends of the market does not affect the payment of interest to the debenture-holder by the company, the interest payment is generally a burden on the company when it is not performing well.
Imbalance of debt-equity ratio: Though the debentures do not affect the company’s equity, it would force the company to depend on debt, and the financial feasibility of the company would be disturbed by the imbalanced debt-equity ratio.
Major cash outflow: When in the times of redeeming debentures, a major cash is transferred to the debenture-holders from the company which would result in the imbalance of a company’s in-hand capital.

Disadvantages of debentures to the debenture-holder

No ownership: Though the debenture-holders help a company to acquire capital by issuing debentures, they cannot be given ownership of the company to any extent.
Fixed interest: Unlike shares, where the dividends may be high when the company is performing well, in debentures, there is a fixed interest irrespective of how bad the company is doing.
Not always secured: Though debentures are more secure than shares, all types of debentures are not secured, unsecured debentures have more risk than the secured debentures.

PROCEDURE TO ISSUE DEBENTURES UNDER THE COMPANIES ACT, 2013

[Applicable Provisions: Section 56, 72, of the Companies Act, 2013 read with Rule 18 and 19 of the Companies (Share Capital and Debentures) Rules, 2014]

Call and hold Board meeting and decide which types of the debenture will be issued by the Company.
If the Company decides to issue secured debenture the company has to comply with the condition prescribed in the Rule 18 of the Companies (Share Capital & Debentures) Rules, 2014.
In case appointment of Debenture Trustee, consent shall be obtained from a SEBI registered Debenture Trustee, who is proposed to be appointed. If debentures to be issued are Secured Debentures, a Debenture Trust Deed in Form No. SH – 12 or as near thereto as possible shall be executed by the Company in favour of Debenture Trustees within sixty days of allotment of Debentures.
In the Board meeting pass resolutions for i) Approval of Offer letter for private placement in Form No. PAS – 4 and Application Forms (In case of private placement of debentures); ii) Approval of Form No. PAS – 5 (In case of private placement of debentures); iii) Approval of Debenture Trustee Agreement and appointment of a Debenture Trustee (In case of Secured Debentures only); iv) Appointment of an expert for valuation (In case of private placement of debentures); v) Approval of increase of borrowing powers, if required; vi) To authorize for creation of charge on the assets of the company; vii) Approve the Debenture Subscription Agreement; viii) To fix day, date and time for the extraordinary general meeting of shareholders.
Prepare the draft of i) Debenture Subscription Agreement; ii) Offer Letter for private placement in Form No. PAS – 4 and Application Forms; iii) Records of a private placement offer in Form No. PAS – 5; iv) Debenture Trustee Agreement; v) Mortgage Agreement for creation of charge on assets of the company.
Issue notices of extraordinary general meeting along with the explanatory statement.
Hold extraordinary general meeting and pass special resolution to issue convertible secured debentures and increase borrowing powers of the company and to authorize the Board to create charge on the assets of the company.
File Form No. PAS – 4 and PAS – 5 in Form No. GNL – 2 with the Registrar of Companies.
File Offer Letter in Form No. MGT – 14 with the Registrar of the Companies.
File copy of Board resolutions, Special Resolution, Debenture Subscription Agreement, Debenture Trustee Agreement etc in Form No. MGT – 14 with the Registrar of Companies.
File Form No. PAS – 3 (Return of allotment) with the Registrar of Companies after making allotment of debentures.
File Form No CHG – 9 for creation of charge on assets of the Company.

FAQs

Can a company buy its own debentures?

A company can buy or purchase its own debentures in the open market. Companies do so with the motive of investing in them and at a later period of time selling them at a higher price and earning a profit thereby. According to Section 68 of the Companies Act, 2013 and Section 17 of the Companies (Share Capital and Debentures) Rules, 2014 defines the procedure for buyback of securities by a company.

What is the time period to redeem debentures?

There is as such no time period to redeem debentures, it may vary from company to company but most of the time, the redemption happens after the maturity date. It may be a fixed number of years, any time after a stipulated number of years has passed since its issue or any time after the debenture-holder has issued a notice showing his intention to get back his principal amount through annual drawing.

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