DR.

RAM MANOHAR LOHIA NATIONAL

LAW UNIVERSITY

2018-2019

Corporate Law

“DEBUNTRES”

SUBMITTED TO: SUBMITTED BY:

Ms. Priya Anuragini Raj Kunwar Singh
Asst. Professor , Enroll. no. -160101118
Dr. RMLNLU,Lucknow
INTRODUCTION

Debenture is essentially a Corporate debt instrument acknowledging money lent and

guaranteeing repayment with interest and creating security on the assets of the company for
due performance of its obligation.
Debenture includes debenture stock, bonds and any other securities of a company whether
constituting a charge on the assets of a company or not as defined in the Companies Act. This
is an inclusive definition and amounts to borrowing of monies from the holders of debentures
on such terms and conditions subject to which the debentures have been issued. Basically it is
a document or certificate signed by the authorized officers of a company acknowledging
money lent and guaranteeing repayment with interest and creating security on the assets of
the company for due performance of its obligation. This is a debt instrument and is the
commonest method of raising loan capital, as part of project financing. Debentures may be
redeemable as envisaged in the Companies Act or mandatorily convertible wholly into the
equity shares of a company as envisaged under FEMA. While the articles of a company
should contain an enabling provision for issue of debentures and creation of security therefor
by the Board, the quantum of such issue should be adequately covered by a borrowing
resolution of its shareholders under section 293(l)(d) of the Companies Act,1956 (the Act).

MEANING OF DEBENTURES

It is to be noted that the term ‘debenture’ is derived from the Latin term ‘debere’ which
means ‘to borrow’. A company may find it difficult to borrow large sum of money from a
single lender, therefore it may split it into several units and offer the public to purchase
‘debentures’. A debenture is thus a certificate of loan issued by a company to the holder of
the debenture. The person who is holding debenture is called debentureholder. It is
undoubtedly a kind of security.

The term ‘debenture’ has been defined in section 2(30) of the Companies Act, 2013 which
says, “debenture includes debenture stock, bonds and any other securities of a company
whether constituting a charge on the company’s assets or not.”
According to Topham, “Debenture is a document given by a company as an evidence of a
debt to the holder usually arising out of a loan and most commonly secured by a charge.”1

In Laxman Bharamji v. Emperor,2 the Bombay High Court observed that debentures
normally indicate the security against the loan taken by the company and contain the
conditions of repayment, date, rate of interest payable to the holder. They may even create a
charge on the company’s property, but it is not always necessarily so. Briefly speaking,
debentures are the acknowledgement of debt, the promise to return it.

In United Dominion Trust Ltd. v. Kirkwood3, receipt or a certificate for a deposit made with
a company (other than a bank) when the deposit was repayable at a fixed period after it was
made, was held to be debenture.

CHARACTERISTICS OF DEBENTURES

 A debenture is usually in the form of a certificate (like a share certificate) issued

under the common seal of the company.
 The certificate of the company is an acknowledgement by the company for the
indebtedness to a holder.
 A debenture usually provides for the payment of a specified sum at a specified date.
 A company may issue a perpetual debenture wherein no specific date of repayment
may be stated. Further4 perpetual debentures are not invalid simply because they are
made irredeemable or redeemable only on the happenings of a contingency, however
remote or on the expiration of a period however long.5
 A debenture usually provides for payment of interest until the principal sum is paid
back.
 A company shall not issue any debenture carrying voting rights.6
 A contract with the company to take up and pay for any debentures of the company
may be enforced by a decree for specific performance.7

1
Topham’s Company law (12th Ed.), 168.
2
AIR 1946 Bom. 18
3
(1966) 1 All ER 968.
4
Section 71 of the Companies Act provides that
5
Knightsbridge Estates Ltd. v. Byrne (1940)
6
Section 71 (2)
  Debentures are generally issued in series but a single debenture may be issued in case
of a sole-lender of the company.8
 Debenture generally creates a charge on the undertaking of the company or on some
of its assets. This is, however, not an essential characteristic and a debenture creating
no charge is also perfectly legal.9
 The holders of the debentures is the creditor of the company not its member.

KINDS OF DEBENTURE

Redeemable and Secured And

Convertible
Irredeemable Unsecured
Debentures
Debenturs Debentures

1. Redeemable Debentures: - From the point of view of redeemability, debentures may

either be redeemable or they may be irredeemable. Debentures are generally
redeemable, that is to say, they are issued on the terms that the company is bound to
repay the amount of debentures, either at a fixed date, or upon demand, or after notice,
or under a system of periodical drawings. Redeemable debentures may be re-issued
unless the articles prohibit their re-issue or there is a resolution showing the intention of
the company to cancel the redeemed debentures. The person who is re-issuing the
debentures shall continue to have the same rights and priorities as he was enjoying prior
to re-issue.10

2. Secured and Unsecured/Naked Debentures: - Where debentures are secured by a

mortgage or a change on the property of the company, they are called secured

7
Section 71 (12)
8
Robson v. Smith (1895)
9
Seva Singh v. Mukha Singh AIR 1936
10
Gower : Modern Company Law (3rd Ed.), 343.
 debentures. Where they are not secured by any mortgage or charge on any property of
the company, they are said to be naked or unsecured.

3. Convertible Debentures: - Convertible debentures are those in which an option is

given to the debentureholders to exchange a part or whole of their debentures for shares
in the company under certain conditions and limitations imposed regarding the period
during which the option may be exercised. This enables the investor to change his
position from a debentureholders to a shareholder when he finds that company is in a
sound position financially and begins to make profit.

ISSUE OF DEBENTURES

The power to issue debentures is usually set out in the memorandum of the company. The
debentures can be issued in the same manner as shares in accompany. But unlike shares they
can be issued at a discount if the articles so authorize, the reason being that they do not form
a part of the capital of the company. Debentures can also be issued at a premium. The interest
payable on debentures id debt and can therefore be paid out of capital.

The form of application of debentures must be accompanied by a copy of memorandum

containing the salient features of the prospectus of the company. The document by which the
offer is made to the public, shall for purposes be deemed to be a prospectus of the company.11
The copy of the prospectus sent for registration must be signed by every director or proposed
director and also for offerers.

Where the company has not issued any prospectus, an allotment of debentures cannot be
made unless a statement in lieu of prospectus is filed with the registrar of companies at least
three days before the first allotment.12

LIABILITY OF COMPANY TO CREATE SECURITY AND

DEBENTURE REDEMPTION RESERVE

11
Section 25 of The Companies Act, 2013.
12
Section 39 of companies Act, 2013
Where a company issues debentures after the commencement of this Act, it shall create a
debenture redemption reserve for the redemption of such debentures, to which adequate
amount shall be credited, from out of its profit every year until such debentures are redeemed.

Where the company fails to redeem the debentures on the date of maturity, the Tribunal may,
on the application of any or all the debenture holders, after hearing the parties concerned,
direct the company to redeem debentures forthwith along with the interest due thereon.

If default is made complying with the order of the Tribunal, the officer of the company who
is in default shall be punishable with imprisonment which may extent to three years and shall
also be liable to a fine of not less than two lakh rupees which may extend to five lakh rupees,
or with both.13

DEBENTURE TRUSTEE

Section 71 (5) provides the appointment of debenture trustee and enumerates the duties of
such trustees. A person holding shares beneficially in the issuer company or beneficially
entitled to receive moneys from that company and has provided any guarantee in respect of
principal debts secured by the debentures or interest there on cannot be appointed as a trustee,
as specified in the Act. SEBI (Debenture Trustee) Regulations, 1993 additionally provide that
no entity shall be entitled to act as debenture trustee unless at is either a scheduled bank
carrying on commercial activity or a public financial institution within the meaning of section
4A of the Act or an insurance company, or a body corporate. It is also necessary that such an
entity should have capital adequacy of net worth of one crore of rupees and have been
licensed by SEBI to act as a debenture trustee.

FUNCTIONAL ROLE OF DEBENTURE TRUSTEE

The Debenture Trustee is an intermediary between the issuer of debentures and the holders of
debentures. Accordingly the main responsibility of debenture trustee is to protect the interest
of holders of debentures including creation of security by the company issuing the debentures
and to redress their grievances.

A. Companies Act

13
Section 71(11)
Under the Companies Act, 1956 the debenture trustee has the following responsibilities:
1) To ensure that the assets of the company issuing debentures and each of the guarantors
are sufficient to discharge the principal amount at all times.
2) To satisfy that the prospectus or the letter of offer does not contain any matter which is
inconsistent with the terms of debentures or with the trust deed.
3) To ensure that the company does not commit any breach of covenants and provisions of
the trust deed.
4) To take such reasonable steps to remedy any breach of the covenants of the trust deed or
the terms of issue of the debentures.
5) To take steps to call a meeting of holders of debentures as and when such meeting is
required to be held.
Needless to say that the aforesaid responsibilities envisaged in Section 117B(3) of the Act are
intended to protect the interest of the debenture holders. One of the aforesaid requirements
relate to adequacy of security so that in the event of failure of issuer of security to redeem the
debentures,(which is an event of default) the Debenture Trustee should enforce the security
and pay off the debenture holders by disposing off the secured assets.

B. SEBI Regulations

Regulation 15 of SEBI (Debenture Trustees) Regulations, 1993 prescribes the following

duties of the Debenture Trustee:
1) Call for periodical reports from the body corporate, i.e., issuer of debentures.
2) Take possession of trust property in accordance with the provisions of the trust deed.
3) Enforce security in the interest of the debenture holders.
4) Ensure on a continuous basis that the property charged to the debenture is available and
adequate at all times to discharge the interest and principal amount payable in respect of
the debentures and that such property is free from any other encumbrances save and
except those which are specifically agreed with the debenture trustee.
5) Exercise due diligence to ensure compliance by the body corporate with the provisions
of the Companies Act, the listing agreement of the stock exchange or the trust deed.
6) To take appropriate measures for protecting the interest of the debenture holders as soon
as any breach of the trust deed or law comes to his notice.
7) To ascertain that the debentures have been converted or redeemed in accordance with
the provisions and conditions under which they are offered to the debenture holders.
 8) Inform the Board immediately of any breach of trust deed or provision of any law.
9) Appoint a nominee director on the board of the body corporate in the event of: -
 Two consecutive defaults in payment of interest to the debenture holders; or
 default in creation of security for debentures, or
 default in redemption of debentures.
10) No debenture trustee shall relinquish its assignments as debenture trustee in respect of
the debenture issue of anybody corporate, unless and until another debenture trustee is
appointed in its place by the body corporate.
Rule 17A of the aforesaid Regulation provides that every debenture trustee should appoint a
compliance officer and he shall be responsible for monitoring the compliance of the Act,
rules and regulations, notifications, etc., issued by the Board or the Central Government for
redressal of investor’s grievances.
Thus a Debenture Trustee occupies a pivotal position of trust and confidence between the
company which issues debentures and the debenture holders who subscribe for the
debentures.

GUIDELINES FOR ISSUE OF DEBENTURES:

The Government, on 17 April 1982, have issued the following, revised guidelines for issue of
debentures to the public by public limited listed companies in supersession of the guidelines
issued earlier on 27 October 1980:14

1. Applicability: The guidelines will apply to issues of secured convertible as well as non-
convertible debentures by public listed companies.
2. Objects of issue: The object of the issue can be either to raise long-term funds for the
financing of any expansion or diversification project or to augment the long-term
resources of the company for working capital requirements.
3. Quantum of issue: The amount of issue debentures in the case of working capital
requirements shall not exceed 20 per cent of the gross current assets, loans and advances.

14
Vide Ministry of Finance, Department of Company Affairs, Office of The Controller of Capital Issues Vide
Notification No. S-11(9)-CC(II) 84 Dated 15th September, 1984
 The amount of issue of debentures for project financing will be considered on the basis of
the approvals of the scheme of finance by the financial institutions/ government under the
provisions of the M.R.T.P. Act, etc.
4. Debt-equity ratio: The debt-equity ratio including the proposed debenture issue shall not
normally exceed 2:1. For this purpose— ‘Debt will mean all term loans, debentures and
bonds with an initial maturity period of five years or more, including interest accrued
thereon. It also includes all deferred payment liabilities but it does not include short-term
bank borrowings and advances, unsecured deposits or loans from the public, shareholders
and employees, and unsecured loans or deposits from others. It should also include the
proposed debenture issue. ‘Equity’ will mean paid-up share capital including preference
capital and free reserves.
Notes:
 The computations under guidelines 3 and 4 mentioned above will be based on the
latest available audited balance sheet of the company.
 A relaxation in the norm of debt-equity ratio of 2 : 1 will be considered favorably
for capital intensive projects such as fertilizers, petro-chemicals, cement, paper,
shipping, etc
5. .Interest rate: In the case of convertible debentures the rate of interest shall not exceed
13.5 per cent per annum. In the case of non-convertible debentures the rate of interest
shall not exceed 15 per cent per annum. 15
6. Period of redemption: The debentures shall not be redeemable before the expiry of a
period of seven years.
7. Price at the time of redemption: A premium upto 5 per cent of the face value can be
allowed at the time of redemption in the case of non-convertible debentures only.
8. The face value of the debentures will ordinarily be Rs 100 each.
9. The debentures shall be listed on the stock exchange,
10. Only secured debentures will be permitted for issue to the public.
11. The issue of debentures shall be underwritten. A relaxation is permitted in this regard if
the Controller of Capital Issues is otherwise satisfied that the issue need not be
underwritten.
12. The shares of the company proposing to issue the debentures must be listed in one or
more stock exchanges and the market quotation of its equity shares must have been at or
above par value during the six months prior to the date of application for issue of
debentures.

CONCLUSION

Issue of Debentures, whether redeemable or convertible involves compliance with the

substantive and procedural aspects of law. Documentation is equally important. The benefit
of raising loan capital lies in the fact that it does not disturb equity structure of the company
and consequently the existing management. However, the success of a debenture issue be it
private or public issue depends, to a large extent, on the goodwill and rapport built up by the
company with the investing public. Another aspect o f the matter is the protection of interest
of debenture holders. This is sought to be achieved by an independent Debenture Trustee who
is required to be appointed by listed companies in regard to public issue or further issue of
capital as the number of debenture holders are considerably large Creation of DRR which is
statutory obligation is intended to provide liquid resource built out of profits of a company
for redemption of debentures.