When a company is formed, one of its initial challenges is generating funds. The company can raise funds by either taking a loan, with the help of investors or by issuing debentures and shares.
Issue of debentures meaning: Debentures are an instrument used to raise long term debt capital for the company. The debenture that a company issues is seen as an acknowledgement that the company has borrowed an amount, which it will have to repay at some time in the future. Because of this, a debenture holder will be referred to as the company’s creditors.
Debentures
According to Section 2 (30) of the Companies Act, 2013, “Debenture” includes debenture stock, bonds or any other instrument of a company that is evidence of a debt, whether it has or not constituted a charge on the assets. Debenture can be classified as:
- Secured Debenture
- Unsecured Debenture
Types of Debentures
- Redeemable debentures: Redeemable debentures are those that are issued for a fixed specified period of time. The company has to repay the creditor the full amount with interest on the predetermined date. This type of debenture ensures that the company fulfils its obligation to the holder.
- Non-redeemable debentures: As the name suggests, non-redeemable debentures can not be redeemed during the company’s lifetime. These debentures are repaid during the liquidation of the company.
- Mortgage debentures: These debentures are issued by mortgaging an asset of the company. On repayment failure from the company, the debenture holder can sell the asset and recover the dues.
- Non-convertible debentures: A non-convertible debenture can not be converted into an equity share at any given point. The debenture holders remain as creditors till their debentures are matured.
- Partially convertible debentures: A partially convertible debenture holder is given the option to convert a part of their debentures into equity shares. If they choose to convert that part, they will enjoy the benefits of both debentures as well as shares.
- Fully convertible debentures: These can be fully converted into a specified number of shares after their maturity.
Issuing of debentures
Debentures are issued at face value. Even though that is the case, the market price of debentures usually fluctuates. In case the face value is higher than the market value, the company will discontinue the debentures. However, if the face value is lower than the market value, the debentures are premium issued.
Conditions for Issue of Debenture
- No company will issue any debentures that carry any voting rights.
- No company will issue a prospectus or make an offer or invitation to the public or to its members in excess of five hundred for the subscription of its debentures, unless the company has, previous to such issue or offer, selected one or more debenture trustees and the prescribed conditions that govern the appointment of such trustees.
- An issue of debenture for more than 500 members or any number of public that is subject to clarification from government without the creation of a debenture trust is forbidden.
- A debenture trustee will take steps to protect the interests of the debenture holders and remedy their grievances.
- Any provision of trust deed or contract that is protected by trust deed, exempting a trustee or indemnifying him against any liability for violation of trust will be void.
- If any default is made in compliance with the order of the Tribunal under this section, every officer of the company who is in default will be punishable with imprisonment for a term which may extend to a period of 3 years or with fine which will not be less than Rs 2 lakh but which may extend to Rs five lakh or with both.
Procedure to Issue Debentures
Call Board Meeting
Call and hold Board meeting and make a decision which types of the debenture will be issued by the Company. In the Board meeting pass resolutions for Approval of the following:
- Offer letter for private placement in Form No. PAS – 4 and Application Forms
- Approval of Form No. PAS – 5
- Sanction of Debenture Trustee Agreement and appointment of a Debenture Trustee
- Appointment of an expert for approval of increase of borrowing powers, if required
- To authorize for creation of charge on the assets of the company
- Agree to the Debenture Subscription Agreement
- To fix day, date and time for the extraordinary general meeting of shareholders.
Prepare the Following Documents
Based on the decisions of the Board Meeting, prepare the following documents and issue notice for extraordinary general meeting:
- Debenture Subscription Agreement
- Offer Letter for private placement in Form No. PAS – 4 and Application Forms
- Records of a private placement offer in Form No. PAS – 5
- Debenture Trustee Agreement
- Mortgage Agreement for creation of charge on assets of the company
Finally, issue notices of extraordinary general meeting together with the explanatory statement.
Extraordinary General Meeting
Hold extraordinary general meeting and enable special resolution to issue convertible secured debentures and augment borrowing powers of the company and to sanction the Board to create charge on the company assets.
Prepare and File Documents
On approval of the debenture issue, prepare and file the following documents
- File Form No. PAS – 4 and PAS – 5 in Form No. GNL – 2 with the Registrar of Companies (ROC).
- File Offer Letter in Form No. MGT – 14 with the Registrar of the Companies (ROC).
- File copy of Board resolutions, Special Resolution, Debenture Subscription Agreement, Debenture Trustee Agreement and so on Form No. MGT – 14 with the Registrar of Companies.
- File Form No. PAS – 3 related to return of allocation with the Registrar of Companies (ROC) after making allocation of debentures.
- File Form No CHG – 9 for the creation of charge on assets related to the Company.
Certificate of Debenture
The certificate of debenture should be issued within a period of 6 months from the date of allocation in the case of any allocation of debenture.
Journal Entries on Issue of Debentures
DATE | PARTICULARS | LF | Debit Amount | Credit Amount |
Bank A/c to Debentures Application A/c (receiving the application money) | — |
— | ||
Debentures Application A/c to Debentures A/c (transfer of application money) | — |
— | ||
Debentures Allotment A/c to Debentures A/c (allotment money is due) | — |
— | ||
Bank A/c to Debentures Allotment A/c (receiving the allotment money) |
FAQs
How is the issue of debentures different from that of shares?
Even though the issue of debentures and the issue of shares are quite alike in their objective of raising capital for the company, issues of debentures are a loan that a company takes from the holders. In contrast, shares are the capital of the company.
Where do the debentures rank during asset liquidation?
In the case of liquidation of a company, debentures get the first preference during the repayment of debts.
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