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Overview of Debentures

One of the biggest challenges for a company during its initial days is raising funds. Though there are various options available like Angel Investors, Bank Loans, Venture Capitals and Personal Investment, raising funds from Issue of Debentures to the public is considered the best option for a new company. Debentures are long-term instruments issued by companies to borrow funds at a fixed rate of interest. This interest is known as the Debenture Interest, and the person holding debentures is called the debenture holder.

As per the Companies Act, 2013, debentures are debt instrument issued by companies, whether secured or unsecured. Further, debentures represent the company's debt, which includes the details like Rate of Interest, Loan Amount, and Maturity Date. Moreover, a company can also transfer debentures according to its AOA (Article of Association).

Key Features of Debentures

The key features of debentures are as follows:

  • Debentures do not carry voting rights;
  • Debentures represent the debt of the company;
  • Debentures can be secured or unsecured;
  • Debentures can be convertible or non-convertible;
  • Debentures may be redeemable or irredeemable;
  • Debentures carry interest at a fixed rate;
  • Debentures can also carry a zero rate of interest;
  • The Issuer company needs to create a DRR (Debenture Redemption Reserve) account out of the profits available for the payment of dividends. Further, the company cannot use the amount credited to this account except for the redemption of debentures;
  • Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014, provides a period of ten years for the redemption of secured debentures. However, there is no period prescribed for the redemption of unsecured debentures;
  • During winding-up, debenture holders are given priority over shareholders;
  • Debenture-holders are not the owners of the company;
  • The Debenture bears a common seal of the company.

Laws Relating to Issue of Debentures

In India, the key legislation regulating the concept of Issue of Debentures are as follows:

  • Section 71 of the Companies Act, 2013;
  • Rule 18 of the Companies (Share Capital and Debenture) Regulation, 2014.

Advantages of Issue of Debentures

The advantages of the Issue of Debenture can be summarised as:

  • Issue of Debentures does not alter the company’s share capital and voting right pattern;
  • The stamp duty payable on the issue of debentures is 0.05%, which is less than the amount of stamp duty payable on the shareholder loan;
  • The company pays interest yearly;
  • There is no statutory limit provided for the conversion/ redemption of unsecured debentures;
  • At the time of winding-up, debenture holders are given priority over shareholders;
  • Issue of debenture is a cheaper form of finance as compared to other borrowings;
  • Debentures promote both long-term funding and long-term planning;
  • Issue of Debentures involves the least risk, as the company needs to pay interest even if it incurs losses also;
  • Debenture interest is a tax-deductible expense.

Difference between Debentures and Shares

Point of Difference

SHARE

DEBENTURE

Ownership

A share is a part of the company’s share capital.

 A debenture is a part of the company’s borrowed capital.

Return

The return on shareholdings is known as Dividend.

The return on debentures is known as Interest.

Charge v. Appropriation

The payment of dividends is an appropriation out of profits.

The payment of interest is a charge. It means the company needs to pay the interest even if it incurs losses also.

Priority

Shareholders are not given preference at the time of liquidation.

Debenture Holders are given priority over Shareholders.

Security

Shares are not secured, i.e., does carry any charge on assets.

Debentures are usually secured, i.e., carry a fixed or a floating charge over the assets.

Convertibility

Shareholders cannot convert their shares into debentures.

Debentures Holders can convert their debentures into shares.

Voting Rights

Shareholders are given voting rights.

Debenture holders are not given any voting rights.

Owner v. Creditor

Shareholders are known as owners of a company.

Debenture holders are known as creditors of a company.

 

Types of Debentures in India

The different types of Debentures in India are as follows:

Based on Security:

Secured Debentures

1. The debentures that carry a charge on the assets are known as secured debentures;

2. Assets of the company fund these debentures;

3. If the company fails to pay the interest or principal, the holders can sell assets of the  company to satisfy their claims;

4. These debentures are also known as Mortgage Debentures.

Unsecured Debentures

1. The debentures that do not carry any charge on the assets are known as unsecured    debentures;

2. If the company fails to make the payment, the holders can only file a money recovery suit.

3. These debentures are also termed as Naked Debentures.

 

Based on Time:

Redeemable Debentures

1. The debentures that are repayable by the company after a specified period are known as Redeemable Debentures;

2.  The issuer company can pay these debentures either in lumpsum or in instalments.

Irredeemable Debentures

1.  The debentures that are repayable during the existence of the company are known as Irredeemable Debentures;

2.   The issuer company can repay these debentures only at the time liquidation.

 

Based on Convertibility:

Convertible Debentures

The debentures which are convertible into the equity shares after the expiry of a specified period are known as convertible debentures.

Non-Convertible Debentures

The debentures that cannot be converted into equity shares are known as non-convertible debentures.

 

Based on Coupon Rate:

Specific Coupon Rate Debentures

1. When a company issues debenture with a specific rate of interest, they are called Coupon Rate Debentures;

2. The rate of these debentures can either be fixed or floating.

Zero-Coupon Rate Debentures

1. The debentures that do not carry a Specific Rate of Interest are known as Zero Coupon Rate Debentures;

 2. A company issues these debentures to compensate their investors.

 

Based on Registration:

Registered Debentures

Registered Debentures means a company issuing debentures by recording the name of the holder in the made.

Bearer Debentures

When a company transfers debentures by mere delivery, they are known as Bearer Debentures.

 

Based on Priority:

First Debentures

The Debentures that are given priority in repayment are called the First Debentures.

Second Debentures

The Debentures that are repaid after first debentures are known as Second Debentures.

 

Different Ways for Issue of Debentures

When a company invites application from the public to apply for debentures, it can issue its debentures in either of the following ways:

  • Issue of Debentures for Cash:
  1. Issue of Debentures at Par: When the issue price and face value of a debenture are equal, it is known as the issue of Debenture at Par. In this case, the long-term borrowings in the liabilities section equals the cash in the balance sheet's assets side.
  2. Issue of Debenture at Discount: It means the issue price of a debenture is below its face value.
  3. Issue of Debenture at Premium: When a company issues its debenture at a price more than its face value, it is known as the Issue of Debenture at Premium.
  • Issue of Debenture as Collateral: At times, debentures can also act as collateral security to the lenders. It happens when the lenders demand additional assets as security besides the primary security. If the lenders were not able to realise the amount of loan from the sale of primary assets, they can realise the same from the additional assets. Hence, many companies issue debentures to the lenders, together with the physical assets already pledged.
  • Issue of Debenture for the Consideration other than Cash: Normally, companies follow this method with their vendors/ sellers. In this case, instead of paying the cash, a company issues its debentures for consideration apart from cash for the assets bought from the vendor. Moreover, a company can also issue debentures at par, premium or discount and are also accounted for in a similar fashion.
  • Over Subscription of Debentures: Over Subscription of Debenture means when a company invites the public to subscribe to its debenture and the applications received are more than the number of debentures offered. In this case, a company cannot issue more debentures than it had initially invited the public for. Therefore, the company needs to refund the application money to the applicants to whom it does not allot debentures.

Process for the Issue of Debentures

The steps involved in the process for Issue of Debentures in India are as follows:

  • Hold a Board Meeting: A company needs to hold a Board Meeting to take into account and pass resolutions for the following items:
  1. Issue of Debentures;
  2. Approving the Offer Letter;
  3. Approving Private Placement of shares;
  4. Debenture Subscription Agreement;
  5. Opening of a bank account; and
  6. Calling of the EGM (Extraordinary General Meeting).
  • Call an EGM: The company also requires to call an EGM (Extraordinary General Meeting) to consider and pass a special resolution for the following items:
  1. Increment in the borrowing capacity of the company;
  2. Issue of the Non-Convertible Debentures.
  • File MGT-14 with ROC: The company needs to file MGT-14 with the ROC (Registrar of Company), within thirty days of passing Special Resolution in the EGM.
  • Maximum Limit: The company needs to restrict the offer letter to a maximum of 200 investors in any financial year;
  • Investment Size: The investment size for each investor should not be less than Rs. 20000.
  • Letter of Offer: The company needs to dispatch the letter of offer to the investors and open a bank account.
  • File Offer Letter with ROC: The directors of the company need to file the offer letter with the ROC and Form GNL-2, PAS 4, and PAS 5.
  • Receive Money from Investors: The directors then collect application money from the investors for the allotment of debentures.
  • Convene a Board Meeting: The company requires to hold another board meeting after the closure of offer to discuss the agendas given below:
  1. To allot its debentures within sixty days starting from the date of receiving application money;
  2. To approve the agreement for charge creation;
  3. To approve the debenture trust deed.
  • File CHG-9: Within thirty days of creating a charge on assets, the company needs to file Form CHG-9 with the ROC (Registrar of Companies).
  • Restriction on using Application Money: The issuer company cannot use the funds collected until it allots its debentures to all the investors.
  • File Return of Allotment: The director of the issuer company needs to file the Return of Allotment in Form PAS 3 with the Registrar of Companies within fifteen days of allotment.
  • File the Corporate Action: The issuer company needs to file its Corporate Action within two working days of allotment.

Package Inclusions

  • Resolution of legal queries over the phone
  • Preparation of Documents
  • Discussion on the terms of Issue of Debentures
  • Certificate of Debenture

FAQs for Issue of Debenture

If a company issues Debenture at Par or at a Discount, which is Redeemable at a Premium, the Premium payable on Redemption of the Debentur should also be treated as a Capital Loss, and as such, it should be apportioned in the same manner as a discount on issue of debentures. Further, Redemption on Debenture at a Premium is known as a Loss at the time of Issue of Debenture as the term of issue generally contains such provision for redemption. As such, it would be prudent to write off such loss during the lifetime of the debenture.


Example – Q Ltd issues 5000, 11% debentures of Rs 100 each at Par, redeemable at the end of 5 years at a Premium of 5%

Date

Particulars

Dr

Cr

1

Bank A/c                                                   Dr

Loss on Issue of Debenture A/c                Dr

To Debenture A/c

To Premium on Redemption of Debenture A/c

(Being the issue of 5000 11% debentures of Rs 100 each redeemable at 5% premium as per the Board Resolution No____ dated)

5,00,000

50,000

 

 

5,00,000

50,000

Discount on issue of debenture is considered as a Capital Loss to the company. Hence, it should be shown on the Assets Side of the Balance Sheet as the "Miscellaneous Expenditure” as a Fictitious Asset.

Whenever a company issues debenture at a price lesser than the nominal value, the shortage amount is known as the Discount on Issue of Debentures.
For example, the debenture of the nominal value of Rs.1000 issued at Rs.950, the difference Rs.50 is a discount on the issue of debenture.

Date

Particulars

Dr

Cr

 

Debenture Application A/c                                    Dr

Or

Debentures Allotment A/c                                    Dr

Or

Debenture Call A/c                                              Dr

Discount on Issue of Debenture A/c                      Dr

To Debentures A/c

 

 

The Write-off Discount on Issue of Debenture is a sound business policy that demands that discount on the issue of debenture should be written off as quickly as possible.

Treatment:

  • It being a Capital Loss can be written off against capital profits. Section 52 of the Companies Act, 2013 also permits the “Securities Premium Account” to be utilized in writing off the Discount on Issue of Debentures.

It can be treated as Deferred Revenue Expenditure and Written off against revenue over the period of life of debentures.

The following listed are the two methods which are generally adopted for this purpose:

  • Fixed Instalment Method – The total amount of the discount is spread over the life of debentures equally, and every year a fixed amount is written off against revenue.
  • Fluctuating Instalment Method – In this method, the amount of discount to be written off every year should bear a proportion to the debentures outstanding at the beginning of each year.

Collateral Security” means additional security given for a loan. Where a company takes a loan from a bank, it may issue its own debentures to the lender as collateral security against the loan in addition to any other security that may be offered. In such a case, the lender has the absolute right over the debentures until and unless the loan is repaid. On repayment of loan, the lender has the right to release the debenture. But in case the loan not repaid by the company, the lender has the right to retain these debentures and not to realise them. The holder of such debenture is entitled to interest only to the amount of loan, but not on the debentures. Such an issue of debenture is known as “Debenture issued as Collateral Security.”

Date

Particulars

Dr

Cr

 

For Taking Loan

Bank A/c                                                             Dr

To Loan A/c

(Being Bank Loan Taken)

 

  XXXX

 

 

  XXXX

 

For Issuing Debenture as Collateral Security

Debentures Suspense A/c                                     Dr

To 12% Debentures A/c

(Being 600, 12% Debentures of Rs 100 each issued as collateral security as per contract)

 

  XXXX

 

 

  XXXX

 

Date

Particulars

Dr

Cr

 

At Par

Bank A/c                                                              Dr

To Debenture Application A/c

 

  XXXX

 

 

  XXXX

 

Debenture Application A/c                                  Dr

To Debenture A/c

  XXXX

 

  XXXX

 

At Premium

Bank A/c                                                              Dr

To Debenture Application A/c

 

  XXXX

 

 

  XXXX

 

Debenture Application A/c                                  Dr

To Debenture A/c

To Securities Premium A/c

   XXXX

 

 

  XXXX

  XXXX

 

At Discount

Bank A/c                                                              Dr

To Debenture Application A/c

 

  XXXX

 

 

  XXXX

 

Debenture Application A/c                                  Dr

Discount on Issue of Debenture A/c                    Dr

To Debenture A/c

  XXXX

  XXXX

 

 

  XXXX

The Issue of Debentures appears to be much similar to the Issue of Shares by an enterprise. Here, in this case, the money can be collected either in the form of a lump sum or in instalments. Further, the accounting treatment of both is also quite similar. Now, the debentures can be issued either for some other considerations or for cash. At times, the issue or circulation of debentures is also done as collateral security.

A company issues debenture for raising capital through it whenever it requires the money and pay it back when the company has a fund surplus.

The maximum rate of discount should not exceed the threshold of 10% or such other rate as the company law board may allow.

  • On the basis of Security
  1. Secured Debentures
  2. Unsecured Debentures
  • On the basis of Time
  1. Redeemable Debentures
  2. Irredeemable Debentures
  • On the basis of Convertibility
  1. Convertible Debentures
  2. Non-Convertible Debentures
  • On the basis of Coupon Rate
  1. Specific Coupon Rate Debenture
  2. Zero Coupon Rate Debenture
  • On the basis of Registration
  1. Registered Debentures
  2. Bearer Debenture
  • On the basis of Priority
  1. First Debentures
  2. Second Debentures

No company shall issue any debentures that carry any voting rights.

Yes, Debentures are the liabilities of the company as they represent debts that are required to be repaid in the future. Further, Liabilities are shown on the balance sheet either as current liabilities or long-term liabilities. Furthermore, Debts are Long-term liabilities, which mean that they are not required to be repaid within a period of one year.

A person taking the debentures is known as the Debenture Holder. Debentures Holders are considered as the creditors of the company as debenture is a part of the loan. Debentures are issued a fixed rate of interest for a fixed time, and the same are eligible to be issued on a discount. Further, Debenture holders are not associated with the management, operations, and regulation of the said company.

A Debenture is a written instrument acknowledging a debt of the company. It comprises of a contract for repayment of the principal after a specified period and also for payment of interest at a fixed rate.

Company has to consider the following things while issuing debentures:

  • Debentures can’t be issued with voting rights
  • Debenture trustee has to be appointed by the company in case it issue debenture to more than 500 people.
  • The company has to create a Debenture Redemption Reserve Account.
  • Debenture Trustee can reach tribunal in case of any defaults in payments.
  • The company can issue secured debentures with the date of the Redemption being less than 10 years from the date of issue.
  • Secured debenture shall be issued by creating a charge.
  • The company shall appoint a debenture trustee & shall execute debenture trust deed before the issue of prospectus.
  • The charge shall be created in the favor of debenture trustee.
  • Debenture trust deed has to be in format SH-12

 Following are the different methods of redemption of debenture:

  • Lump-Sum method
  • Conversion method
  • Installment method
  • Purchasing method

When the applications received are more than the original number of shares offered for debenture issue. In this case of over subscription, debentures are not allotted to certain applicant & the money is refunded to an applicant for non-allotment of debenture. Although money is not refunded to the applicant to whom debentures are issued and the money is adjusted against subsequent calls to be made.

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