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Guide to Debentures
Finance is the blood of corporate irrespective of its size, nature, or capital. The company has to procure a large sum of money, which cannot be entirely met by a single tender, and thus the company splits the loan into several units. One of the methods to raise the fund is borrowing through the issue of debentures to the public who, in return, finance the companies for the fixed rate of return in the form of interest.
Companies Act defines the debenture as a debt instrument that indicates the debt, whether secured by an asset of the company or unsecured. Debentures act as evidence of a loan taken by a Company that contains the details such as loan amount, maturity date, rate of interest, etc. A debenture is a movable property transferable as per Article of Association (AOA).
A debenture is an acceptance by the company of a debt it owes to the public. It is a written promise of its debt under its common seal, which contains the terms and conditions about the liability of the company. Therefore the holder gets the right
Features of the Debentures
Following are the features salient features if debentures:
- Like shares, it is also the source of investment in the company.
- Debentures form part of the total capital of the company.
- Debenture holders are the creditors of the company for the loan given by them in the form of debentures.
- Debenture holders are entitled to fixed income for their investment in the form of interest.
- Debentures maximize Earning per share (EPS) as they meet the requirement of long-term capital budgeting.
- Debentures are freely transferable instruments from one person to another.
- The interest of debentures is charged against profit and loss account that reduces the income tax burden.
Types of Debentures
Debentures are classified based on different categories, such as:
- Based on Redemption
- Based on Conversion
- Based on Security
- Based on registration
a) Types of debentures based on Redemption
- Redeemable Debentures: Company has to pay back the debenture-holders on the maturity date to release the property from mortgage or charge. Redeemable debentures can be re-issued unless they have been canceled to be redeemed through its article, or through any resolution passed.
- Irredeemable Debentures: These debentures are not paid back throughout the life of the company, i.e. the company is not obliged to pay the principal amount during its lifetime. These are also known as perpetual debentures. These debentures are repaid on the following events:
- Liquidation of the company
- On the happening of a contingency
- Expiration of the longer period
- The company breaches the terms & conditions of debentures.
b) Types of Debentures based on Conversion
- Convertible Debentures: Company can issue the debentures convertible into equity shares after a fixed period. Such debentures are issued after the authorization through a special resolution passed in general meeting. They are of two types, i.e. partly convertible and fully convertible.
- Partly Convertible Debentures: These debentures are partly converted into shares so that holder has the benefits of both equity & debentures.
- Fully Convertible Debentures: These are fully converted into shares subject to issuer’s notice on the ratio of conversion determined by the Company.
- Non-Convertible Debentures: These debentures are not convertible into equity of the issuing company. Debentures holders of these debentures are compensated through a higher rate of interest.
c) Types of Debentures based on Registration
- Registered Debentures: The debenture holders of these debentures are registered in the record of debenture holders containing all the details such as quantum of debentures, amount of debentures held, and type of debentures held. These debentures are non-negotiable and its transfer requires registration.
- Unregistered Debentures: These debentures are not recorded in the company’s record book. These are also known as bearer documents and are easily transferable without any need for registration.
d) Types of Debentures based on Security
- Secured Debentures: These debentures are secured by creating the charge on assets or property of the company. These are secured as the debenture holders have the right to recover the principal amount in case the company failed or defaults in repaying the principal amount.
- Unsecured Debentures: These debentures are non-secured, and no charge is created on the assets of the company. They are also known as naked debentures.
How the Company issues the Debentures to the Public?
Following is the procedure for issuing the debentures that have to be followed by the company:
- Call the board meeting to decide upon the type of debentures to be issued and other matters such as
- Fixing the date, time, and venue of the extra-ordinary general meeting.
- In case of a private placement of debentures, approve offer letter for private placement in form PAS-4.
- For approving form PAS-5.
- Approval of terms and conditions of appointment of debenture trustee and the agreement signed with it.
- Approval for appointing expert valuer for valuation.
- In case the borrowing power is required to be increased, authorization regarding the same.
- Authorizing the creation of charge in case of secured debentures.
- Approval of debentures subscription agreement.
- Take the consent of a debenture trustee to be appointed.
- Debenture trust deed shall be executed in form SH-12 in favor of debenture trustee within 60 days of allotment of debentures in case the secured debentures are issued.
- Prepare the following draft after board meeting:
- Debenture subscription agreement
- Offer letter in form PAS-4
- Record of the offer in form PAS-5
- Debenture Trustee Agreement
- Mortgage agreement, in case of secured debentures.
- Issue the 21 days notice for EGM before the date of the meeting and pass the special resolution for the issuance of the secured debenture.
- Submit form PAS-4 and PAS-5 by attaching in form GNL-2 to ROC.
- File special resolution by attaching the same in the form MGT-14 with ROC.
- File form PAS-3 for return of allotment to ROC after the allotment of debentures.
- File form CHG-9 for the creating charge on assets of the company.
Favorable points on financing through debentures
Following are the advantages of financing the fund needs of companies through the issuance of debentures:
- The company can raise a large number of funds through debentures because investors prefer the safety of capital at a fixed return.
- Interest paid on debentures is an allowed expense and can be deducted from the profit thus reducing the tax liability.
- Debentures holders have no voting right and thus they cannot affect the shareholder’s control in the company.
- Debentures are issued for the long term allowing the company to take the projects for further expansion.
- Raising the fund through debentures is a less costly affair due to the rate of interest is less as compared to a dividend payment to shareholders.
Points against debenture issue
Since everything has it’s both sides of the pros and cons and so do the debenture issue had. Following are the various demerits of issuance of debentures:
- The fixed interest-bearing nature of debentures makes it a burden for the company. The company has to compulsorily pay the interest even when no profit incurred.
- Debentures lead to the loss of credit in the stock market by creating several charges on assets of the company for issuing secured debenture.
- The company is liquidated if it failed to pay the interest continuously that makes the debenture issue riskier on the part of the company.
Certain points have to be kept in mind by the company for debenture issue:
- The company has to approve the issuance of convertible debenture through the passing of the special resolution in general meeting.
- The company cannot issue the debentures with voting rights.
- Before the issue of the offer letter, the company shall appoint the debenture trustee.
- Execute the trust deed within 60 days of allotment for protecting the rights of debenture holders.
- The company shall redeem the debentures only through Debenture Redemption Reserve Account, which is created out of the profits of the Company.
- The company cannot issue debentures to the members exceeding 500.
- Certificate of debentures shall be issued within 6 months of allotment of debentures.
- The company shall take the necessary steps to protect the interest of debenture holders and redress their grievances.
- Interest rate, payment of interest, the redemption of debentures shall be done as per the debenture agreement.
- Debenture holders have the right to apply to Tribunal if the company defaults or failed in the redemption of debentures or interest payment
- Tribunal on such receipt shall pass the order directing the company to repay the amount or redeem the debenture.
- On failure to follow the orders of Tribunal, Company is liable with the fine of 2 Lakhs and extendable up to INR 5 Lakhs.
Additional conditions to be fulfilled in case of secured debentures:
- The company cannot issue debentures for a period exceeding 10 years (30 years if the company is setting up the infrastructure projects) from the date of its issue.
- The company shall create the charge on the assets or property of the company of such value, which will be sufficient for the repayment of principal amount and interest in case the company defaults to repay the same.
- Security for the repayment of debentures is created on the immovable or movable property by way of:
- A charge is created by way of mortgage on immovable property
- A charge is created by way of pledge or hypothecation in the case of movable property.
Debenture rules have prescribed certain conditions concerning the debenture trustee for the issue of debentures:
- Name of debenture trustee shall be mentioned in every Offer letter or prospectus issued for inviting subscription. Apart from that, in all the notices or communication about debentures.
- Before appointing a debenture trustee company shall take the consent of such trustee.
- The board shall fill the casual vacancy if it occurs in the office of a debenture trustee. A vacancy caused due to resignation of the debenture trustee shall only be filed with the written consent of majority debenture holders.
- For removing the debenture trustee from his office before the expiry of his tenure it is mandatory to take the approval of at least 3/4th of debentures holder.
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Disqualification of Debenture Trustee
Following persons are disqualified for the appointment as a debenture trustee:
- If he is a beneficial shareholder of the company
- If he is a promoter, director, KMP in issuer company.
- If he is a promoter, director, KMP in the subsidiary, holding or associates of the issuer company.
- The company owes him a certain amount of money other than remuneration payable to debenture trustee.
- He is indebted to the company for certain some of the money.
- He has given any sort of guarantee concerning debt that is secured by the debenture
- He is related to the promoter, director or any other person connected to the issuer company.
Following are the duties of debenture trustee that shall be adhered to, by the debenture trustee:
- To be assured about the charged property is sufficient to repay the debentures.
- To be assured that the company doesn’t breach any provision of the debenture trust deed.
- In case of breach of contract, he is authorized to take necessary action against the company.
Anyone who invests in the debentures of the company is said to the debenture holder. Debenture can be issued to any person including individual, firm or company. Companies Act requires that every company shall maintain the debenture holder registers.