Debentures under Companies Act, 2013

A debenture is a long-term debt instrument that companies or governments use to raise money from the public. This financial instrument acts like a loan agreement where the public borrows an amount while promising to pay interest and retire the principal amount after a period of time. During liquidation, these securities differ from the stocks in that they do not confer ownership in the issuing company, but such owners enjoy preference rights over stockholders.

Section 2(30) of the Companies Act 2013 provides that debenture includes “debenture stock, bonds or any other instrument of a company evidencing a debt, whether constituting a charge on the assets of the company or not”.

Typically, debentures would be known as unsecured debts simply because they are secured on any physical assets and thus rely only on the ability of the issuer to pay his commitments. While other debentures may actually be secured on some particular asset as a form of security, debentures can be otherwise classified as convertible debentures, which may be later traded for equity shares, compared to non-convertible debentures, classified solely as debt securities.

The reason is its great flexibility and low level of risks; therefore, it attracts the interest of both issuers and investors. A corporation raises the needed cash without having to sell a portion of its ownership; the investor enjoys regular income and some tax benefits. This is the last one, as debenture financing is corporate finance that taps the most out of equity and secures loans. However, as is with any investment, debenture investing involves risks, in particular, the risk of a default, which is why, before making an investment, a thorough analysis of the issuer’s financial health is needed.

Some important features of debentures include:

1. Debentures are financial securities that pay interest at regular periods, semi-annually, or annually, whether the company makes any profit or not.
2. Debenture holders are the creditors of the company and do not hold a right to vote unlike the shareholders of the company.
3. Debentures are usually long-term funding for the corporation that would last from five to twenty years or even more.
4. Debentures can be described as secured, secured against particular company assets or unsecured, depending upon the credibility of the issuer.
5. Returns on debentures issued are also usually lower because the issuer is legally obligated to return the principal amount at maturity. That is, he has to return the money accepted irrespective of profit or loss.
6. Debenture securities are transferable securities and can be sold in the secondary market.
7. At the time of liquidation, the repayment of debentures is given priority before any payment to shareholders from the company assets of the company.
8. Convertible debentures can be converted into equity shares, and other remaining debt instruments are termed non-convertible debentures.
9. Debentures are also a cheap mode of capital acquisition because tax deductions are allowed on interest payments by the issuer.
10. Due care toward a comprehensive debenture investment requires considerable study because screening of the issuer’s creditworthiness assumes its prime importance since risks such as the variations in interest and potential default by the issuer might be related to them.

Types of Debentures

The issuers of debentures come into various classifications to facilitate their ability to address numerous tastes among investors. Therefore, debenture types mainly result from their features and issuance conditions are classified as follows:

1. Secured Debentures – Secured Debentures are provided by the asset of the firm on account of which debenture holders make such claims of assets over the defaulters
2. Unsecured Debentures – Debentures have no assets back but rest upon only the creditworthiness of the issuers.
3. Convertible Debentures – Convertible Debentures are those that can be converted into equity shares of the company after a certain period of time.
4. Non-Convertible Debentures or NCDs – These debentures are not issued with the intention of being converted into equity shares but to remain as a debt instrument. In other words, they cannot be converted into equity at any point in time.
5. Partly or Partially Convertible Debentures (PCDs) – The issue of these types of debentures specifies how many debentures to be issued can be converted into equity shares either on a proportional basis or percentage, provided such conditions will have been made at the time of issue.
6. Redeemable debentures – Debentures which the company repays after a specified time period of lock-in are redeemable debentures.
7. Irredeemable (or Perpetual) Debentures – which neither have a maturity date nor can be redeemed except at the discretion of the issuing company.
8. First (senior) debentures – Such debentures have a preference in the case of liquidation repayment over all other debentures.
9. Second (subordinated) debentures – These debentures shall be paid off only after the senior debentures are satisfied.
10.  Registered debentures – These debentures are issued to a certain person and can be transferred only when they are duly registered.
11. Bearer or unregistered debentures – These debentures can be transferred without registration by delivery, as ownership details are not recorded.
12.  Zero Coupon Debentures – These types of debentures are issued at a discount and also do not carry any interest rate through the year. Therefore, the investor receives the full face value after maturity.

Issue of Debentures Under the Company Law

Debentures issued in India by companies are dealt with by the Companies Act, 2013, as well as the Companies (Share Capital and Debentures) Rules, 2014. The Acts and Rules provide an authoritative guide regarding the issue and rights as well as other obligations involved with debentures. Firms following this law remain within the boundaries of the law and protect the interests of debenture holders besides other stakeholders.

1. Firstly, there should be an authorisation by the Articles of Association of the company to issue debentures, if there is no AoA authorisation then the same need to be amended under Section 14 of the Act.
2. A valuation report needs to be prepared at the price of the debentures to be issued.
3. A separate bank account needs to be opened in a scheduled commercial bank for the monies received on applications of the debenture issue.
4. Call for a board meeting to approve:

• The offer letter for the debenture issue,
• Appointment of debenture trustee and debenture trustee agreement,
• Approval of debenture subscription agreement,
• Authorisation the creation of charges on the assets of the company in case of secured debentures,
• Date and time for the extraordinary general meeting,

5. Issue the notice for the general meeting to and obtain the approval for the issue of debentures by passing the resolution.
6. File Form MGT-14 for resolutions passed by the shareholders approving the debenture issue.
7. Send the offer letter in Form PAS-4 to the identified group of debenture holders and duly record the same in Form PAS-5.
8. After the allotment money is received in the separate bank account maintained specifically for the said debenture issue, another board meeting needs to be convened for the allotment of debentures, debenture certificates, creation of debenture redemption reserve and debenture deed.
9. Return of allotment is required to be filed with the RoC in Form PAS-3.
10. Issue the debenture certificates to the debenture holders and make their entries in the Register of Debenture Holders.

Redemption of Debentures

Redemption of debentures is the return of the principal amount to the debenture holder at maturity or before the same date, as specified in terms under the issue. It denotes the end of the company’s liability to the debenture holders. Under this procedure, a company must comply with the terms of the issue along with other parts of the Companies Act 2013. The redemption process entails a corporation fulfilling its obligations to its debenture holders and, hence, the integrity and position it has in the financial markets. The redemption process helps the company preserve its reputation and position in the financial markets, and it simultaneously protects the interests and confidence of the debenture holders.

1. Convene a board meeting to approve the process of redemption of debentures by passing a resolution to that effect.
2. Intimate the debenture holders about the redemption process along with all the details, forms and timelines.
3. Coordinate and synchronise with the banks to issue monies as refunds to the debenture holders.
4. Changes in the Register of Debenture Holders and Register of Charges, accordingly.

Conclusion

The Companies Act of 2013 provides a holistic module for the issue, management and redemption of debentures with an adequate balance between corporate borrowing and the need for investor protection. It has control over long-term money borrowing by companies without diluting the control over the ownership thereof to realise a major funding source without dilution, thereby making it stand very much in favour of financial structuring. Provisions are made under the Act to ensure transparency, accountability, and protection of the rights of debenture holders through the regulatory and compliance framework.

The setting up of, among other things, Debenture Redemption Reserve, appointment of Debenture Trustees and conditions under which charges can be created on secured debentures aptly reflect the concern of the Act towards creditor protection along with a corporate discipline. Timely redemption along with the reserve fund forms the pursuit of the financial preparedness of companies to meet obligations.

Debentures do have many positive points, such as fixed interest rates or priority in repayment, but the risks associated must be explored through the financial health of the issuer and the terms prevailing in the debenture itself. With the ability to classify debentures as secured and unsecured, convertible and nonconvertible, redeemable or perpetual issuers would be able to customise the products according to their goals of financing, while lending creditors a wider horizon of investments to select from.

The Companies Act of 2013 is a strengthened legislation that acts as a comprehensive structure of rules and regulations for debenture financing in India. Once the rules are followed, it will help companies maintain their reputation, attract investors and lead to a sustaining economy. Investors also gain the assurance and security associated with returns. This type of mutual benefit underscores the fact that compliance and financially strong backing for keeping debentures as the cornerstone of corporate lending in India is what is required.