Debentures

• Company formation / Compliances
• ||
• September 29, 2020

It is very often found that the involvement of the public issue of equity and preference shares in the stock exchange is very popular. Issuing shares is the most common method of raising long-term capital because there are numerous investors who are ready to invest in the capital market. Therefore, shares are used to finance ventures having long growth period.

Raising of funds by issue of debentures or bonds is also a source of long-term capital for a company like share capital. Persons who contribute to the equity shares of a company are its owners while debentures holders are its creditors.

As per section 2(30) of the Companies Act, 2013 defines
“Debentures include 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”. 

In simple terms, debentures may be defined as an instrument acknowledging a debt by a company to some person or persons. A debenture is a type of debt instrument which is unsecured by security. Since debentures have no collateral backing, debentures must be dependent on the creditworthiness and reputation of the issuer for reliability. Both establishments and administrations commonly issue debentures to nurture capital or funds.

Debentures may pay interrupted interest payments called coupon payments. The contract stipulates structures of a debt offering, such as the maturity date, the timing of interest, the method followed for interest calculation, and other features. Corporations and governments can issue debentures. Corporations also use debentures as long-term loans.

The Regulatory framework for Debt securities

• SEBI (ICDR) Regulations 2018
• SEBI (Issues and Listing of Debt Securities) Regulations, 2008
• The Companies Act, 2013

Features of Debenture
While issuing a debenture, first trust pre-arrangement must be drafted. The first trust is an agreement between the issuing entities and the trustee that accomplishes the interest of the investors. 

Interest Rate
The determination of rate of interest that the company will pay the debenture holder or investor shall be bound under agreements. This interest rate is of two types i.e. fixed or floating. A floating rate might be knotted to a benchmark such as the production of the 10-year Treasury bond and will change as the benchmark changes. 

Credit Rating
The Company’s credit rating and eventually the debenture’s credit rating impression the interest rate that investors will receive. Credit-rating agencies quantify the creditworthiness of company and government issues. These entities provide investors with a summary of the risks involved in investing in debt. 

Maturity Date
For non-convertible debentures, the date of maturity is also a significant matter. This date commands when the company must pay back the debenture holders. The company has choices in the form the repayment which will take place. Most often, it is as redemption from the capital, where the issuer pays a lump sum amount on the maturity of the debt. Otherwise, the payment may use redemption reserve, where the company pays detailed amounts each year until full repayment at the date of maturity. 

Kinds of Debentures
The provision in the Companies Act regarding issue of shares to the public by prospectus would also mutatis mutandis apply to issue of debentures by prospectus.

Shareholders’ approval for issue of Debentures
A company may issue convertible debentures subject to the approval of shareholders by way of special resolution passed at a general meeting. 

Requirement of the General Meeting to borrow in excess of the paid-up capital and free reserve
Where the amount of a proposed issue of debentures of a company together with its existing borrowings will exceed its paid-up capital and free reserves, the company proposed issue cannot be made before a special resolution is passed by the company in general meeting empowering the Board to borrow in excess of the paid-up capital and free reserve of the company.

Issue of Debenture at a Discount
There is no prohibition to issue debentures at a discount unlike the prohibition contained in section 53 of the Act for the issue of shares at a discount. But where the debentures are convertible into equity shares, the conversions shall be at par or above the nominal value of the equity shares as per the terms of issue approved by shareholders by special resolution before such issue.

Fully convertible Debentures VS Partially Convertible Debentures 

Debenture Trust Deed
When debenture are issued for public subscription, involving a considerable number of debenture holders, who do not have the time to look after their interest in the properties mortgaged or charged to them, a trustee may be appointed for the supervision of their common interest.

A trust deed is made under which some person is appointed as trustee, whereby the properties of the company are mortgaged or charged to trustee.

The trust deed also comprises provisions which deal with the rights of the debenture holders and the company in case of discrepancies; trustee ensures the benefit of the debenture holders. 

Advantage

• The trustees hold the title deeds of the mortgaged property, which prevents the company from misusing the titles for any purpose.
• The trustees are given power under the trust deed so that the property mortgaged is kept insured and is maintained in proper condition.

 Further, in case of default by the company, the trustees can take necessary steps to realize the security without the aid of the Court. 

Appointment of Debenture Trustee
The entities shall not issue prospectus to more than five hundred persons without assigning a debenture-trustee. Thus, when the entity issues prospects or makes an offer or invitation to the public or to its members beyond 500 for the subscription of its debenture, then only it is compulsory to employ a debenture trustee.

Pros to issue of Debenture

• A debenture earns a regular interest rate return to its investors.
• Convertible debentures can be transformed into equity shares after a stated period, making them more engaging to investors.
• In the event of a company’s bankruptcy, the debenture is paid before common stock shareholders.

Cons to issue of Debenture

• Fixed-rate debentures may have interest rate risk disclosure in environments where the market interest rate is rising.
• Creditworthiness is significant while considering the chance of avoidance risk from the underlying issuer’s financial feasibility.
• Debentures may have inflationary risk if the interest paid does not retain up with the rate of inflation.

At AJSH, we assist our clients in dealing with various corporate matters (Company incorporations, statutory audits, ROC Compliances, Company winding up), ITR Filings, TDS Compliance, and related services by providing them adequate support and guidance from our end. If you have any questions or wish to know more about debentures, kindly contact us.