1. The last decade of the previous century witnessed upbeat of the issue of debentures by corporates for their financial needs. The versatility provided by the instrument (fully convertible debentures, partially convertible debentures, non convertible debentures, zero coupon debentures, optionally convertible debentures etc,) coupled with the ease of raising resources by companies and conducive stamp laws in certain states provided impetus to the issue of debentures. The banks and financial institutions also favoured the debenture issue by converting interest defaults or the irregular portion of the loans into debentures as a measure for restructuring of their loans and advances. The sudden spurt started waning due to the defaults committed by some of the issuers in servicing the debentures.
2. The Trustees for the debenture holders (in the case of public issue of debentures) came under the Securities and Exchange Board of India (Debenture Trustees) Regulations, 1993. There was role clarity for the debenture trustees and they were expected to play an important role of securing the interests of the debenture holders. The effectiveness of the debenture trustees fell short of expectations especially in the privately placed debenture issues, as Securities and Exchange Board of India (SEBI) could not take cognisance of the complaints due to statutory limitations. The provision of section 22 of the Sick Industrial Companies (Special Provisions) Act, 1985 conferring automatic suspension of contractual obligations upon making a reference to the Board for Industrial and Financial Reconstruction provided succour to the defaulting companies.
3. Under the current regime, the Companies Act, 2013 (the Act) and the Companies (Share Capital and Debentures) Rules, 2014 (the Rules) govern the issue of debentures by companies (other than public offer of debentures). Public issue and right issue of debentures by equity listed companies are governed by the provisions of SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009.

Meaning of debentures


4. The debenture has been defined by way of an inclusive definition. As per the Act, “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 of not. Hence it is permissible for a company to issue both secured and unsecured debentures. This definition recognises the fact that the debenture is a debt instrument.
5. Secured debentures: - Debentures secured by a charge on (i) any specific movable property of the company (not being in the nature of pledge); or (ii) any specific immovable property wherever situate, or any interest therein come under the category of secured debentures.
6. Unsecured debentures: - Unsecured debentures indicate that the issuer has not offered any kind of security to the debenture holders. Neither the Act nor the Rules elaborate the manner of issue of unsecured debentures. However, the procedural formalities for issue of unsecured debentures are almost the same except as to the appointment of debenture trustee, creation of charge on the assets of the issuer and filing charge with the Registrar of Companies (RoC).
7. Debentures are deposits? It is noteworthy that in terms of the Companies (Acceptance of Deposits) Rules, 2014 (deposit rules) the term deposit does not include: -                    

 “any amount raised by the issue of bonds or debentures secured by a first charge or a charge ranking pari passu with the first charge on any assets referred to in Schedule III of the Act excluding intangible assets of the company or bonds or debentures compulsorily convertible into shares of the company within five years:
Provided that if such bonds or debentures are secured by the charge of any assets referred to in Schedule III of the Act, excluding intangible assets, the amount of such bonds or debentures shall not exceed the market value of such assets as assessed by a registered valuer”.
Therefore, the unsecured debentures issued by a company will be reckoned for calculation of the limit for acceptance of deposits by a company.

8. The deposit rules extracted above contemplate the conversion into shares shall be completed within five years (from the date of issue of debentures). This definition of deposit is in congruous with the Act and Rule 18 (1) of the Rules. The Act permits conversion into shares at the time of redemption. The Rules provide that the redemption period may extend up to ten years from the date of issue for a company and in the case of a company engaged in setting up of infrastructure projects it may extend up to thirty years. Unless this disparity is rectified, the amount raised by issue of convertible debentures where the conversion option exceeds five years will also come under the purview of deposits and has to fulfil the requirements of the deposit rules.
9. Further, the Rules do not specifically provide for ranking of the charge for securing the debentures, except indicating that the charge on the properties or assets of the company having a value which is sufficient for the due repayment of the amount of debentures and interest thereon. If a charge created for securing the debentures is neither a first charge nor a pari passu charge, but sufficient for the meeting the redemption obligations to the debenture holders, ex facie, such debentures may fall within the definition of deposit under the deposit rules. This anomaly needs to be removed by suitably amending the deposit rules.

Types of permitted debenture issue

10. Section 71(1) of the Act specifies: -

 “A company may issue debentures with an option to convert such debentures into shares, either wholly or partly at the time of redemption.
Provided that the issue of debentures with an option to convert such debentures into shares, wholly or partly shall be approved by a special resolution passed at a general meeting”.
The expression “may issue” shall have to be construed as permissive and not mandatory or restrictive. In that sense, it accommodates structuring the debenture into various types, including non convertible debentures, optionally convertible debentures etc.

Pre-requisites for issue of debentures by private placement

11. (a) The Board of Directors of a company shall at a meeting pass a resolution for the issue debentures whether inside or outside India. The Board has to take a view regarding the terms and conditions (tenure of debentures, rate of interest to be offered, manner of redemption or conversion etc.) subject to which the debentures will be issued.

    (b) In case the issue of debentures carries an option to convert whether the whole or part of the debentures into shares of the company, it shall convene a meeting of the shareholders and get a special resolution passed approving the issue of debentures carrying a conversion option. Needless to mention that formalities connected with the convening of the general meeting, notices, explanatory statement, filing of the resolution with RoC etc. may have to be fulfilled.
    (c) The Board will have to identify the property, whether movable (other than by way of pledge) or immovable, having a value which is sufficient for the due repayment of the amount of debentures and interest thereon.
    (d) The Board shall identify and appoint a debenture trustee for protecting the interests of the debenture holders. As per section 71(5) of the Act, appointment of trustee for debenture holders has been envisaged in case the company issues a prospectus or makes an offer or invitation to the public or to its members exceeding 500 for subscription of its debentures. The debenture trustee shall have to be appointed before the issue of prospectus or letter of offer for subscription to the debentures. The consent of the debenture trustee shall have to be obtained in writing and a statement to that effect shall appear in the letter of offer issued for inviting the subscription to the debentures.

    Post issue compliance

    1. The company shall execute a debenture trust deed in Form No. SH.12 or as near thereto as possible within sixty days of allotment of debentures.
    2. It shall create the security on the identified movable or immovable properties.
    3. After creation of the security, file a return with the RoC in terms of section 77 of the Act.
    4. The company shall maintain a register and index of debenture holders.
    5. A company may close the register of debenture holders for any period or periods not exceeding 45 days in each year but not exceeding 30 days at any one time subject to giving previous notice of at least 7 days or such lesser period as may be permitted.
    6. The company shall permit inspection of the trust deed to any of its members or debenture holders and forward a copy of the trust deed to any of its members or debenture holders at his request within seven days of making the request on payment of fee.
    7. The company shall create Debenture Redemption Reserve out of its profits available for payment of dividend.

Debenture Trustee

12. It is essential to appoint one or more debenture trustees if a company issues a prospectus or makes an offer or invitation to the public or to its members exceeding 500 for subscription to the debentures. The attributes of the debenture trustee is negatively stated in the Rules. Any person or entity can be appointed as a debenture trustee provided he or it does not fall in any of the clauses mentioned in (i) to (vii) of 18 (2) (c) of the Rules. There is no requirement of registration of the person or entity willing to act as a debenture trustee with any authority or agency.
13. The following persons or entities are not qualified to be appointed as a debenture trustee. A person who: - (i) beneficially holds shares in the company; (ii) is a promoter or a key managerial personnel or any officer or an employee of the company or its holding, subsidiary or associate company; (iii) is beneficially entitled to moneys which are to be paid by the company, which does not include remuneration payable to the debenture trustee; (iv) is indebted to the company or its subsidiary or associate company or a subsidiary of such holding company; (v) is guarantor of the principal debts secured by the debentures or interest thereon; (vi) has any pecuniary relationship with the company amounting to 2% or more of its gross turnover or total income or Rs. 50 lakhs or such higher amount as may be prescribed, whichever is lower, during the two immediately preceding financial years or during the current financial year; or (vii) is a relative of the promoter or any person who is in the employment of the company as a director or KMP.
14. Appointment, filling in casual vacancy and removal of debenture trustee: - Company shall identify the person eligible to be appointed as a debenture trustee and secure his/its consent in writing. The company shall ensure that a statement to that effect appears in the letter of offer issued for inviting subscription to the debentures. The name of the debenture trustee shall be stated in all the subsequent notices or other communications sent to the debenture holders. There can be more than one debenture trustee for a debenture issue.
15.  Any casual vacancy arising in the office of the debenture trustee may be filled by the Board. The remaining trustees (where there are more than one debenture trustee) may continue and act till the vacancy is filled. However, if the vacancy is caused by resignation of the debenture trustee, such vacancy shall be filled with the written consent of the majority of the debenture holders.
16. The debenture holders are permitted to remove any debenture trustee from his office before the expiry of his term by passing a resolution at their meeting by not less than three fourth in value of the debentures outstanding.
17. Duties of debenture trustees: - The position of debenture trustee comes with several responsibilities and obligations. A debenture trustee is responsible to every debenture holder.  The role of the debenture trustee starts from the time of his appointment till the redemption in full of all the debentures issued by the company in respect of which he is appointed as a debenture trustee.
18. Duty to be performed prior to the debenture issue: - A debenture trustee shall satisfy himself that the letter of offer does not contain any matter which is inconsistent with the terms of the issue of debentures or with the trust deed. For this purpose he is expected to examine of the letter of offer and the trust deed.
19. Duties to be performed during the currency of the debentures: - The responsibilities of a debenture trustee continue till the redemption in full of all the debentures for which he was appointed as a debenture trustee. The debenture trustee shall be vigilant and constantly monitor various commitments made by the company to the debenture holders. These include: - (i) execution of the trust deed by the company in Form SH-12 containing all the covenants after satisfying himself that those covenants are not prejudicial to the interest of the debenture holders; (ii) ensuring that the stipulated security is created by the company and that the value of the properties are adequate for the due repayment of the amount of debentures and interest thereon at all times and such assets are free from any other encumbrances except those which are specifically agreed to by the debenture holders; (iii) where in the opinion of the debenture trustee that the assets of the company are insufficient or likely to become insufficient to discharge the principal amount as and when it becomes due, filing a petition before the National Company Law Tribunal for passing appropriate orders* (*this provision has not been brought into force yet); (iv) calling for reports on the utilisation of funds raised by the issue of debentures; (v) ensuring the creation of debenture redemption reserve; (vi) ensuring that the debentures have been converted or redeemed in accordance with the terms of issue of debentures; (vii) calling for periodical status or performance reports from the company (and examining them to assess the capability of the company with regard to its obligations to the debenture holders); (viii) ensuring that the company does not commit any breach of the terms of issue of debentures or covenants of the trust deed and take such reasonable steps as may be necessary to remedy any such breach; (ix)  informing the debenture holders immediately of any breach of the terms of issue of debentures or covenants of the trust deed; (x) taking steps to convene a meeting of the debenture holders in accordance with the terms of the debenture issue; (xi) performing such other acts as are necessary for the protection of the interest of the debenture holders and (xii) doing all such acts as are necessary in order to resolve the grievances of the debenture holders. 
20. Duties in the event of default in payment: - The role of the debenture trustee is more pronounced in the event of default by the company in meeting its payment obligations than during the normal circumstances. This vital role distinguishes an effective debenture trustee from others. The responsibilities in the event of default include: - (i) monitoring the payments by the company to the debenture holders and promptly communicating to the debenture holders defaults, if any, with regard to payment of interest or redemption of debentures and action taken by the trustee therefor; (ii) exercising a right to appoint a nominee director on the Board of the company in the event of – (a) two consecutive defaults in payment of interest to the debenture holders; (b) default in creation of security for debentures; or (c) default in redemption of debentures; and (iii) doing such acts as are necessary in the event the security becomes enforceable.
21. Convening meeting of debenture holders: - The debenture trustee is expected to convene a meeting of the debenture holders: - (i) on a requisition in writing signed by the debenture holders holding at least one-tenth in value of the debentures for the time being outstanding; and (ii) on the happening of any event of default, which constitutes a breach, default or which in the opinion of the debenture trustee affects the interest of the debenture holders.

Debenture Redemption Reserve (DRR)

22. DRR is a measure to mitigate the interest of the debenture holders in the event of default by the issuer in the due redemption of the debentures. DRR shall have to be exclusively applied towards redemption of debentures and to that extent it is insolvency remote (cannot be accessed by the Official Liquidator in the event of the liquidation of the company for payment of other dues).
23. Extent and manner of creation of DRR: - DRR is required to be created out of the profits of the company available for payment of dividend. The company shall create DRR equivalent to 50% of the amount raised through the debenture issue before the debenture redemption commences. In the case of partly convertible debentures, DRR shall be created in respect of the non-convertible portion of debentures. Company that has issued debentures shall, on or before 30th day of April in each year, invest or deposit a sum which shall not be less than 15% of the amount of debentures maturing during the year end on 31st day of March of the next year. It is also required to be ensured that the amount remains invested or deposited does not at any time fall below 15% of the amount of debentures maturing during the year ending on 31st March of that (financial) year.
24. The amount allocated for DRR purposes shall be invested or credited in one or more of the following methods: - (i) in deposits with any scheduled banks, free from encumbrances or lien; (ii) in unencumbered securities of the Central or of any State governments; (iii) in unencumbered securities specified in sub-clauses (a) to (d) and (ee) of section 20 of the Indian Trusts Act; or (iv) in bonds notified under sub-clause (f) of section 20 of the Indian Trusts Act.

Register and index of debenture holders

25. Company issuing debentures is required to keep and maintain a register of debenture holders. It shall include an index of the names of included therein. In case of the debentures held in dematerialised form, the register and index of the beneficial owners maintained by the depository shall be deemed to be the corresponding register and index. The register is required to be kept and maintained at the registered office of the company. It is permissible to keep the register or copies at any other place in India in which more than one-tenth of the total number of such debenture holders reside. If authorised by the articles of association, a company may keep a part of the register in any country outside India (known as foreign register) containing the names and particulars of debenture holders, index or beneficial holders residing outside India.
26. The register of debenture holders and index thereof may be kept or inspected or copies given in electronic form in such form and manner as may be prescribed.

Inspection of trust deed and obtaining a copy thereof

27. Company shall permit inspection of the trust deed to any of its debenture holders, except during the period when the register is closed, without payment of any fees and by other person on payment of prescribed fees. Any debenture holder may take an extract from the register of debenture holders or index or return without payment of fee. If they require a copy of the register or entries therein or return, the company shall forward a copy of the trust deed to any of its debenture holders at his request within seven days of making the request on payment of fee. Refusal to permit inspection will be visited with penalty. The Central Government has the power to direct by an order immediate inspection of the document or direct that extract required shall be forthwith be taken by the person requiring it.  
28. The register, the index and copy of the annual return maintained by a company shall be prima facie evidence of any matter directed or authorised to be inserted therein by or under the Act.

Responsibility of the Board of Directors  

29. The directors are required to ensure that the company redeems the debentures on the due date or pay interest thereon as per the offer document. In case of failure of the company to redeem the debentures or pay interest thereon and the failure to pay or redeem continues for one year or more, the director shall not be eligible to be re-appointed as a director of that company or appointed in other company for a period of five years from the date on which the company fails to do so.
30. SEBI in the revised Clause 49 of the Equity Listing Agreement has specified that the Audit Committee shall have, inter alia, the power to look into the reasons for substantial defaults in the payment to debenture holders. Though this is the responsibility of the Audit Committee, yet it is incumbent on the directors of the company to satisfy that the redemption of debentures and payment of interest thereon have been made by the company, lest they may face the disqualification of their directorship in other companies and eligibility to be re-appointed as a director in the company in case of default if the same exceeds the permitted time limit.

Right of the debenture trustee to copies of audited financial statement

31. A copy of the financial statement including consolidated financial statements, if any, auditor’s report and every other document required by law to be annexed or attached to the financial statements, which are to be laid before a company in its general meeting shall also be sent to every trustee for the debenture holder of any debentures issued by the company 21 days before the date of the meeting. Exception has been made in the case of listed companies from furnishing copies of the aforesaid documents if the company makes the documents available for inspection at its registered office during the working hours for a period of 21 days before the date of the meeting and a statement containing the salient features of such documents in the prescribed form or copies of them is sent to every trustee for the holders of debentures issued by the company.
32. It is laid down in section 71(2) of the Act that no company shall issue any debentures carrying voting rights. The Act is silent about the presence of the debenture trustee at the general meeting. These documents may be useful to carry out an analysis of the financial position of the company and assist in taking preventive measures for protecting interest of debenture holders.

Miscellaneous

33. Nomination facility: The debenture holders can avail nomination facility as per the provision of section 72 of the Act.
34. Annual return: The annual return to be prepared and filed shall contain the particulars as they stood at the close of the financial year also of debentures and the changes therein since the close of the previous financial year.
35. Rate of interest payable on debentures: The Act and the Rules do not specify the rate of interest payable by a company on the debentures issued by it. It is left to the company and the subscribers to firm up the interest rates. Normally the rate of interest is close to the borrowing rate; however it is seen in some cases the rates vary widely.
36. Redemption schedule: The Rules specify the tenure for the issue of debentures and it is left to the company to determine the redemption schedule. It may vary from bullet redemption to staggered redemption, including moratorium period for commencement of redemption. Considering the obligation to create DRR up to 50% before commencing redemption of debentures, it is for the company to structure the redemption schedule taking into account the cash flow and financing plans.
37. Contract to take up and pay for the debentures: A contract with the company to take up and pay for any debentures of it may be enforced by a decree for specific performance.  

Conclusion

38. How far effective is the provision relating to appointment of a nominee director? The Rules contemplate certain situations under which the debenture trustee can nominate a director on the Board of the company. In reality it may be a non-existent power. Under the special statutes, the nominees were insulated against prosecution for any offence by the company, if he proves that he had acted in good faith and without any mala fide intentions. Appointment of nominee directors became effective upon issue of a letter from the concerned institution. The nominee directors now (unless their appointments are still governed by special statutes) do not enjoy any immunity. Further, it is for the company to give effect to the nomination. Reluctance or delay on the part of the company to give effect to the nomination will act counter to the power. There shall be immunity to such nominee directors from prosecution for the defaults of the company and from the disqualification provision contained in the Act. Otherwise there may not be any willing candidates for appointment as a nominee director.   
39. Debenture trustees do not act on their own volition. They tend to call for a meeting and seek their approval. Even for enforcing the security for recovery of the dues of the debenture holders, the trustees call for funding the expenses. If the trustees collect from the issuer companies an amount sufficient to convene meeting of the debenture holders or initiating legal actions, their effectiveness will improve considerably.  
40. It would be better if powers are given to National Company Law Tribunal suo motu or on the application of the debenture trustee or any of the debenture holders to appoint a nominee director in the circumstances specified in the Rules.  
41. DRR: DRR creation up to 50% of the amount raised through the debenture issue before redemption commences may tend the issuers to postpone the redemption. The Rules are silent regarding annual contribution to DRR, if no part of the debentures issued matures for payment in any financial year. The issuers will be put to loss to the extent of interest payable on debentures vis-à-vis interest earned on funds invested or deposited. This will be more pronounced in the case where the debentures will become due for redemption in later years; resulting in cost of funds by issuing debentures becoming uncompetitive.
42. Debenture Trustee: There is some divergence between the Act and the Rules relating to the provision for appointment of debenture trustee. Section 71(5) envisages appointment of debenture trustee if the offer is made to 500 or more persons. Rule 18(1) (c) specifies the appointment of debenture trustee as one of the pre-requisites for issue of secured debentures by a company. It will be worthwhile in small sized issues to dispense with or give an option to the issuer regarding the appointment of debenture trustee.
43. The provisions relating to issue of debentures are tailored to protect the interests of the subscribers. In the present context, issue of debentures can be resorted to by companies that are financially sound. Such companies may find it easy to borrow funds from banks and financial institutions instead of resorting to the issue of debentures. Earlier the companies were resorting to debenture issue towards project financing and meeting the gap in the working capital requirements.
44. Debentures are attractive instruments for subscription by mutual funds as they are debt instruments. They provide periodic revenue for a long tenure and enable the mutual funds to declare dividend and their active trading in the stock market. The usefulness of the provisions relating to issue of debentures will be known only over the period of time.

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