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Debenture and Debentures Holders: Law of Investment and Securities
Debenture and Debentures Holders: Law of Investment and Securities
Roll No. 49
(FACULTY OF LAW)
DATE:09-04-2019
Acknowledgement
I would like to thank my subject TEACHER PROF. SHail Shakya his support and cooperation
to our group for preparation of this project Also, we are very thankful to library staff, DSMNRU
FACULTY OF LAW for providing me all the relevant material easily. Lastly, friends and
family is thanked by me for their help
TABLE OF CONTENTS
Abstract ……………………………………….…………………… 3
Introduction………………………………………………………… 4
Classification of Debentures……………………………. 8
Conclusion……………………………………………………………….. 30
Abstract
Introduction:
Finance is the lifeblood of every business. It is perhaps the most crucial factor in deciding fate of
any business enterprise. Finance is required in day-to-day transactions of business as well as for
carrying out capital (long term) investments of the business. Keeping this in view, it is the most
important function of a financial manager that is to arrange funds for the business from different
sources. This becomes necessary under the fact that pre determined goals of business could only
be achieved when a business does not suffer from lack of finance. It is evident in daily lives too
that a person cannot carry on his daily tasks without having financial support. Other than this,
just like daily lives, a business cannot run smoothly in absence of finance.
This therefore is the most crucial decision that a financial manager needs to take up- composition
of capital structure of an organization. Following diagram shows capital structure and its various
components:
shareholders' capital employed) is the interest in remaining assets, spread among individual
shareholders of common or preferred stock. At the start of a business, owners put some funding
into the business to finance assets. Businesses can be considered to be, for accounting purposes,
sums of liabilities and assets; this is the accounting equation. After liabilities have been
accounted for, the positive remainder is deemed the owner's interest in the business.
Preference Capital: Preferred stock, also called preferred shares or preference shares, is
typically a 'higher ranking' stock than voting shares, and its terms are negotiated between the
corporation and the investor. Preferred stock usually carries no voting rights, but may carry
superior priority over common stock in the payment of dividends and upon liquidation. Preferred
stock may carry a dividend that is paid out prior to any dividends being paid to common stock
holders. Preferred stock may have a convertibility feature into common stock. Preferred
stockholders will be paid out in assets before common stockholders and after debt holders in
Debt Capital: Debt capital is the capital that a business raises by taking out a loan. It is a loan
made to a company that is normally repaid at some future date. Debt capital differs from equity
or share capital because subscribers to debt capital do not become part owners of the business,
but are merely creditors, and the suppliers of debt capital usually receive a contractually fixed
annual percentage return on their loan, and this is known as the coupon rate.
Debt capital ranks higher than equity capital for the repayment of annual returns. This means that
legally, the interest on debt capital must be repaid in full before any dividends are paid to any
suppliers of equity.
Main part of Analysis:
Our analysis will be based on long-term sources of funds: most specifically debt finds. In India,
it is important to understand that, there is no bond market. Companies and government most
often come up with issue of a long-term debt instrument known as debenture. Let us move
forward and understand meaning of term debenture, especially in context of Indian financial
markets.
A debenture is defined as a certificate of agreement of loans which is given under the company's
stamp and carries an undertaking that the debenture holder will get a fixed return (fixed on the
basis of interest rates) and the principal amount whenever the debenture matures.
In finance, a debenture is a long-term debt instrument used by governments and large companies
to obtain funds. It is defined as "a debt secured only by the debtor’s earning power, not by a lien
on any specific asset." It is similar to a bond except the security conditions are different. A
debenture is usually unsecured in the sense that there are no liens or pledges on specific assets. It
is, however, secured by all properties not otherwise pledged. In the case of bankruptcy,
debenture holders are considered general creditors. The advantage of debentures to the issuer is
they leave specific assets burden free, and thereby leave them open for subsequent financing.
Debentures are generally freely transferable by the debenture holder. Debenture holders have no
voting rights and the interest given to them is a charge against profit.
The term debenture includes debenture stocks, bonds and any other security of a company,
Following are the basic features of debentures that differentiate them from other sources of
peculiar characteristics of debentures that make them different from commonly used finance
sources:
● Investors who invest in the debentures of the company are not the owners of the
company. They are the creditors of the company or in other words, the company borrows
● Funds raised by the company by way of debentures are required to be repaid during the
life time of the company at the time stipulated by the company. As such, debenture is not
● In practical circumstances, debentures are generally secured i.e. the company offers some
● Return paid by the company is in the form of interest. Rate of interest is predetermined,
but the company can freely decide the same. The interest on debenture is payable even if
● In financial terms, debentures prove to be a cheap source of funds from the company’s
point of view
So this thing needs to be kept in mind by a company that an investor is expected to invest in
debentures only when liquidity and financial position of company is very sound. An investor is
always careful before investing in any company, especially in debt instruments where there is
hardly any chance of capital appreciation. So, a company that is very much sure about it financial
well-being could very well come up with issue of debentures. Debentures are also ideal for
companies, which do not want any kind of dilution in control of management. That means,
organizations, which do not want to issue shares, could come up with issue of debentures.
Apart from that, financial manager must make sure that company is in sound enough position to
make periodic interest payments and also, repayment of principal amount at the right time.
Classification of debentures
In India, debentures could be classified in basically two categories: on the basis of security and
Indian context:
Let us now discuss each of the types of debentures, which are issues in market by companies to
raise funds.
● Fully convertible Debentures (FCD): These are fully convertible into Equity
shares at the issuer's notice. The issuer decides the ratio of conversion. Upon conversion
the investors enjoy the same status as ordinary shareholders of the company.
into Equity shares in the future at notice of the issuer. The issuer decides the ratio for
either convert these debentures into shares at price decided by the issuer/agreed upon at
● Secured Debentures: These instruments are secured by a charge on the fixed assets
of the issuer company. So if the issuer fails on payment of either the principal or interest
amount, his assets can be sold to repay the liability to the investors.
● Unsecured Debentures: These instruments are unsecured in the sense that if the
issuer defaults on payment of the interest or principal amount, the investor has to be
Along the dimension of security, we have seen that debenntures have been classified into
unsecured(Straight) and secured (mortgage) debentures. Unsecured debentures do not carry any
cahrge on specific assets of the company while secured debentures carry a fixed or floating
The distinction between secured and unsecured debentures becomes relevant in case the issuer
defaults in payment of interest and principal amount so taken from investors. Secured debenture
holders are entitled to take possession of security given to them and realize their dues by selling
these assets, which are most commonly- land, buildings, plant, machinery of business. This right
is valuable to debenture holders provided security is valuable, easily saleable and has not been
simultaneously given as security to other creditors as well. All these factors have to be examined
while evaluating debenture. Unsecured debenture are not backed by any such security, but an
investor needs not worry about that if he has a belief that company is doing financially and
Continuing the classification of debentures, next step to be undertaken during course of our
analysis is to look at fact as to how debentures have an advantage over other sources of
long-term finance. In this section of our study, we shall look as to what are the pros and cons of
debentures that make it one of the most reliable sources of long-term finance and also create a
Following are advantages of debentures that make them a reliable source of finance as compared
Let us divide our analysis into three major points i.e., division of advantages of debentures by
different prospective:
Let us now take a look at the description of above-mentioned topics in brief. During course of
description, efforts will be made to make sure that a reader understands relative advantage of
debentures and conclusions could be drawn out as to how under utilized this very source of
General Advantages:
These advantages are highly dependable on the success rate of the current interest rate and
are usually much more rewarding than government debentures or bank investments and
provide a higher rate of financial return for their investors. If a company is selling
debentures to people, it means that they definitely need the money and are willing to pay
you quite a bit of additional money to use it. The fact of receiving a greater return on
the lending period companies usually offer the assets in the form of stock, which can
ultimately be very valuable. Stocks are another great form of investment and are
sometimes better than receiving immediate cash in return. Although the advantages of
debentures can be clearly seen, there are a number risks and disadvantages to investing in
corporate debentures.
● Success or Failure: You are taking a great risk when investing in a corporate
debenture because the success of the company will determine how valuable your
debenture is. A company debenture is only valuable when the company is successful and
profitable, but if it fails, then you will lose a great amount of money. Debentures and
bonds hold greater risks because the company could eventually go out of business, so this
Debentures can be a very attractive form of investment, but only should be taken advantage of
with companies that have a very high probability of being successful. Large and already
successful businesses are smart forms of investments when considering buying corporate
debentures.
Advantages to investors:
● They have the possibility to acquire shares at a lower price to that of the market- by way
shares.
● They have the right for subscription of shares at a lower price to that of the market.
● The price of conversion is always lower to that of the market so the effects of a possible
inflation are mitigated. This inflation effects causes a rise on the stocks quotations.
● There is an improvement in the financial structure of the company, because the extra
resources (debentures) are transformed into own resources (shares). It transforms debt
into capital.
● The financial cost is lessening, because if the investor chooses for the conversion they
don’t have to obey the requisites from the debentures: to pay interests and to refund the
capital. On the other side, the interests from the debentures or bonds are usually lower
than that on the market, this way, in case of not converting, the company will finance
● The sooner the conversion is made, the greater are the discounts, so the lesser are the
After talking about advantages of debentures, lets take a look on various demerits this source of
finance suffers from. No doubt that there are few cons from which debentures suffer, but these
demerits are small enough to overlook and advantages always override the disadvantages:
General Disadvantages:
● By issuing the debentures, the company accepts the risk of two types. These are payment
of the interest at a fixed rate, irrespective of the non-availability of profits and repayment
of principal amount at the pre-decided time. If earnings of the company are not stable or
if the demand for the products of the company is highly elastic, debentures prove to be a
very risky proposition for the company. Any adverse change in the earnings or demand
and usually the security offered to the investors is the fixed assets of the company. A
company, which requires less investment in fixed assets, such as a trading company, may
find debentures as a wrong source for raising the long-term requirement of funds, as it
● The securities have a less quotation price due that temporarily they have lesser rights.
● They are less liquid, due that there is a lesser amount of them.
● You can’t dispose of money soon due to the former explanation. Usually the type of
interests that they offer is inferior to that of the ordinary debentures due that they offer
● You can’t foresee an exact dividend distribution politic due that existing amounts of
shares swill depend on the number of debentures that will exercise their option of
conversion.
● There are doubts when you can’t calculate the interests of the debentures. Again, the
The next step in our analysis will be to take a look at legal complications and compliances that
have to be kept in mind while issuing debentures. Being a company secretary, one needs to keep
in mind that this very professional is responsible for complying all the legal and mandatory
implications involved here. Being a part of good corporate governance, a company secretary
shall make efforts to make sure that no point of law is not missed out by anyway possible. Other
than this, a company secretary shall be responsible for any discrepancies that might arise after
government and SEBI have been stringent enough while formulating procedures and policies for
issuing guidelines. More than company’s interests, interests of investors have been given much
more weight while formulating rules and regulations of debenture issue. We shall look at them in
brief and that will help us in understanding role of a company secretary in complying with
Debentures which, include fully convertible debentures (FCDs), partly convertible debentures
(PCDs) or non-convertible debentures (NCDs) may be offered to the public by prospectus by:
● Unlisted public company or a private company proposing to convert itself into public
company.
As per the SEBI guidelines, a company is required to file a draft prospectus with the SEBI
though an eligible merchant banker, at least 21 days prior to filing of the same with the registrar
of companies. Any offer of securities to public shall be in DEMAT mode. for this purpose,
company shall enter into an agreement with a depository before public issue is made.
For issue of all types of debentures, credit ratings from a credit rating agency of not less than
investment grade shall be obtained from not less than two registered credit rating agencies and
In the case of public issue of debentures, there would be a large number of debenture holders on
the register of the company. As such it shall not be feasible to create charge in favour of each of
the debenture holder. A common methodology generally adopted is to create Trust Deed
conveying the property of the company. A Trust deed is an arrangement enabling the property to
be held by a person or persons for the benefit of some other person known as beneficiary. The
Trustees declare the Trust in favour of the debenture holders. The Trust Deed may grant the
Trustees fixed charge over the freehold and leasehold property while a floating charge may be
created over other assets. The Company shall allow inspection of the Trust Deed and also
provide copy of the same to any member or debenture holder of the company on payment of
such sum as may be prescribed. Failure to provide the same would invite penalties by way of fine
under the Act. Any provision contained in the Trust Deed, which exempts a Trustee from
of debentures is mandatory. Section 128 stipulates that where a company issues series of
debentures which is secured by charge, benefit of which will be available to all debenture holders
pari passu, the company shall file the prescribed particulars in Form 10 and 13 with the Registrar
of Companies for registration of charge. These forms shall be filed within 30 days after the
In terms of Section 117 B, it has been made mandatory for any company making a public/rights
issue of debentures to appoint one or more debenture trustees before issuing the prospectus or
letter of offer and to obtain their consent which shall be mentioned in the offer document.
● Insurance company.
● Body Corporate.
b) Be beneficially entitled to monies, which are to be paid by the company to the debenture
trustees.
c) Enter into any guarantee in respect of principal debt secured by the debentures or interest
thereon.
This section also lists the functions that shall be performed by the Trustees. These include:
I. Protecting the interests of the debenture holders by addressing their grievances.
II. Ensuring that the assets of the company issuing debentures are sufficient to discharge
III. To ensure that the offer document does not contain any clause which is inconsistent
IV. To ensure that the company does not commit any breach of the provisions of the
Trust Deed.
VII. If the debenture trustees are of the opinion that the assets of the company are
insufficient to discharge the principal amount, they shall file a petition before the
Central Government and the latter may after hearing the parties pass such orders as is
necessary in the interests of the debenture holders. As per the SEBI (Debenture
a) An undertaking by the company to pay the Debenture holders, principal and interest.
b) Clauses giving the Trustees the legal mortgages over the company's freehold and leasehold
property.
c) Clauses that may make the security enforceable in the event of default in payment of principal
d) A clause giving the Trustees the power to take possession of the property charged when
e) Register of Debenture holders, meeting of all debenture holders and other administrative
In addition thereto, the SEBI regulations have laid format of the Trust Deed in Schedule IV to
h) Obligations towards the debenture holders - equity ratio and debt service coverage ratio.
Section 117 C of the Act casts an obligation on the company to create a Debenture Redemption
Reserve. This account will be credited with proceeds from the profits of the company arrived at
every year till redemption of the debentures. The Act, however, does not stipulate the time period
for creation of security. SEBI regulations provides for creation of security within six months
from the date of issue of debentures and if a company fails to create the security within 12
months, it shall be liable to pay 2% penal interest to the debenture holders. If the security is not
created even after 18 months, a meeting of the debenture holders will have to be called to explain
the reasons thereof. Further, the issue proceeds will be kept in escrow account until the
documents for creation of securities are executed between the Trustees and the company.
Compliances under Registration Act and Stamp Duty Act
In the case of English Mortgage, the trust deed will attract ad valorem stamp duty. After
execution, such deed will be registered with the sub registrar of Assurances. Registration charges
will have to be paid in addition to the stamp duty. While in case of an equitable mortgage, if no
document, deed etc. is signed then nothing is required to be registered with the sub registrar of
Assurances. If however, a note or letter is made then it will attract stamp duty. It is pertinent to
mention that once a mortgage is created by registration then no further stamp duty is payable on
registration.
A Listed Company, which proposes to issue debentures to the public, shall make the debentures
enlisted in a recognised Stock Exchange. It shall, before issuing the prospectus for such issue,
make the application to the Stock Exchange concerned and the permission must be obtained
before the expiry of ten weeks from the date of the closing of the subscription.
According to Section 292 of the Companies Act 1956, the proposal of a company to issue
debentures and issue the same to the public needs the prior approval of its Board of Directors
accorded by the resolution passed in the meeting of the Board. Such power cannot be exercised
by the resolution passed by the Directors by circulation, nor delegated by the Board.
other approval
In this case approval of shareholders by special resolution and of the central government
In the normal course of conversion of Debentures into equity shares of the Company, a company
is needed to follow Section 81(3)(b) of the Companies Act,1956. On the other hand, in the
● The Debentures are issued either raised through private subscription or issue of a
● A public financial institution or scheduled bank either underwrites the above issue or
subscribes to the issue of debentures, either wholly or in part or sanctions the whole or
● The right of conversion may be at par or at a premium not exceeding 25% of the nominal
Default
In the event of failure on the part of the company to redeem the debentures on the date of
maturity, the Company Law Tribunal may, on the application of any debenture holder, direct
redemption of debentures forthwith by payment of principal and interest due thereon. If a default
is made in complying with the orders of the Tribunal, every officer of the company who is in
default shall be punishable with imprisonment for a term, which may extend to three years and
shall also be liable to fine of not less than Rs.500/- for every day during which the default
continues. (Section 117C) Further this offence is not compoundable under section 621A of the
Act.
There are contradictions between the Companies Act and the SEBI regulations on issues relating
to:
a) Utilisation of Debenture Redemption Reserves. The Act provides that the Debenture
Redemption Reserve will be used towards redemption of debentures only whereas the SEBI
regulation states that these will be a part of the General Reserves, which can be utilised for the
b) Any debentures issued with a maturity period of 18 months or less is exempted from the
appointed one or more Debenture Trustees for such debentures whereas under SEBI guidelines,
months or more.
A listed company though subjected to SEBI regulations must comply with stringent norms
It is more often than naught experienced that modules, guidelines and study materials are filled
with all information relating to issue of debentures by a public company. Interestingly, one fact
is often neglected or overlooked that debentures are a documentary evidence of a loan taken by
company. A public company has an option of going to public for raising funds by way of
ownership and loans. A private company cannot contact public for raising money as loans but it
does not matter anyway that a private company is refrained from issuing debentures as a debt
instrument. Private company can very well privately place debentures to financial institutions,
commercial banks, mutual funds and board of directors of that particular company. A secretarial
professional often finds himself in a dilemma when such kind of case comes before him. In most
often cases, a Company Secretary has to resort to bare acts-, which is indeed a tedious task in its
own self. Moreover, a company secretary shall not be confused with basic functions he needs to
perform during tenure of his work. Both as a practising company secretary and as a financial
manager in a corporate, he has to take care of the fact that issuance of debentures in private
Some of the provisions that are to be followed while making issue of debentures, in case of a
(Acceptance of Deposit) Rules, 1975 “any amount raised by issue of debentures (including
convertible debentures) secured by the mortgage of any immovable property of the company and
that the market value of the immovable property secured is higher than the amount of debentures
issued” is not considered to be a Deposit. Under Section 3(1)(d) of the Act, a Private Company is
prohibited from accepting Deposit from persons other than its Directors, Members and their
relatives. Hence, the Private Company must issue Debentures only as a Secured Debenture.
2) Approvals to be taken before proceeding for the issue: The following approvals are
(Section 117B)
● Letter from Trustees Consent from the Debenture Trustees to act as Trustees.
● No approvals are required to be obtained under Section 293(1)(a) and (d) since, the
Section does not apply to Private Limited Companies, unless it is a Subsidiary of a Public
Company.
3) Allotment: Since, the Company proposes to place the Debenture privately, it is suggested
that a Letter of Offer is also made which would be circulated amongst the target buyers. The
draft letter of offer is also required to be approved by the Board. The conditions relating to the
payment for subscription, the Security, the rate of interest on the Debentures and the period by
of deposit of title deeds of the immovable property of the Company. The deposit is required to
6) Time Limit For Issue Of Debenture Certificate: The time limit for the issue of
Debenture Certificate is 3 months from the date of allotment. If the Company is of the opinion
that it might not be able to issue the Debenture Certificate within 3 months, then it is suggested
that an application is made to the CLB requesting for extending the time- limit for issue of
Debenture
Certificate.
Act, 1956, a Debenture Redemption Reserve (DRR) needs to be created. From the profits of the
Company each year, adequate amounts need to credited, which should be utilised for redemption,
8) No necessity to file form 2 for allotment of debentures: We would like to clarify
that Form 2 -`Return of Allotment’ being a requirement under Section 75 of the Companies Act
is limited to allotment of shares and it does not in its scope cover Allotment of Debentures.
10) Payment of stamp duty on the debentures: The stamp duty as prescribed under the
Stamp Act, as in force in state, required to be affixed to the Debenture Certificate on the face of
the same or in the form of attaching a separate sheet of paper and affixing the stamps on the
same. The fact that the stamps so affixed forms part of the Certificate with the Certificate
Alternative method:
Instead of affixing stamps on the debenture certificate or by attaching a separate sheet, there is
also a provision to pay consolidated stamp duty. For this purpose, intimation is needed to be
After understanding in brief some of legal compliances related with issue of debentures in public
as well as private companies, we should conclude our analysis by taking a look at current
It is very discouraging to see that debt market in India is not as organized as in other advanced
economies. Taking example of the US, where debt market (bonds) has a size, which is more that
thrice the size of equity markets. In India, companies have been issuing debentures to public as
well as to financial institutions, but the level of issue has not been as large as equity issue. Also
markets. In India, public at large averse themselves from investing in debentures issued by large
corporate bodies. Public at large is interested in investing in debentures which are issued by
financial institutions. In Indian markets there are about 8000 companies, which come up with
issues of securities. Out of them, only about 2000 are traded on stock exchanges on a regular
basis. Most often, there is a lack of liquidity in Indian stock markets that lead to a disinterest by
investors in debt instruments. This difference in Indian scenario with that of advanced economy
In this case illustration, we will take two companies from each nation: Reliance Industries
Limited from India and Wal-Mart Inc. from USA. We will see that both the companies have
significant effect on their respective economies and in a way they reflect financial structure and
pattern followed by investors in that nation. We will take into account respective contribution of
debt- bonds and debentures in total capital as well as total liabilities of these companies. After
this analysis, we will be in a position to draw conclusions of illustration as well as make our
It is shown by way of above pie chart that Wal-Mart uses about 30% of debt in total sources of
finance raised by various methods. It means that bond markets in USA are much more liquid and
organized as compared to Indian markets whose condition will be clear with help of following
illustration:
This very illustration shows that debentures and bonds have not been able to win confidence of
Conclusion of Analysis
It is not just about a single company, whole debt market of India needs reorganization and that
too at a rapid rate. In today’s context when due to recession, equity markets have fallen
drastically in India, debentures could just help in saving day for all troubled financial markets of
India. Apart from that, government should take account of SEBI’s advices when the authority
has constantly urged them to work for organization of debt market in India. This is necessary
because in an emerging economy, it is important that there is an active participation of public in
corporate world activities. Role of a Company Secretary is important because in this condition
he’s the one who has to maintain equilibrium between interest of investors, company and
government of India. This is perhaps real challenge that a Company Secretary will have to face