This article is written by Sambit Rath, a B.A. LL.B. student of Dr. Ram Manohar Lohiya National Law University, Lucknow. In this article, the author aims to discuss bearer debentures, which is a type of debenture, in detail and compares them to other types of debentures to bring more clarity.
It has been published by Rachit Garg.
Table of Contents
Introduction
Every organisation whether small or large requires funds in order to operate and survive in the market. In accounting terms, these funds form the capital of the organisation. There’s a lot that goes into deciding on the amount of capital required, the source to finance it, and whether that source is feasible for the organisation. Suppose the organisation does not take into account the apparent risks associated with a particular source of financing. In that case, it could get into both financial as well as legal trouble when it fails to manage these funds properly. There are various types of organisations that can be distinguished based on their size, industry, etc. To cater to the diverse needs of these organisations, a country’s financial sector provides different financing sources. Some of these include the issue of shares, debentures, loans, retained earnings, working capital loans, etc.
In this article, we will be dealing with debentures as a source of finance for a business and particularly with bearer debentures. In order to understand what this sub-type of debentures means, we will need to first understand what a debenture is, the types of debentures, and their purpose.
What are debentures
A debenture is a debt instrument used by businesses to raise capital for various purposes. It is issued for a medium to long-term period by organisations which are fixed and are paid back at a fixed rate of interest. Repayments can be made either in instalments or in a lump sum. Debentures are basically a type of long-term loan that the company borrows from entities. A debenture is different from shares, which form the equity of the company. Since it is a type of loan, it is recorded under the liabilities head of the balance sheet. Depending on the period after which it is redeemable, it is recorded under current liabilities or non-current liabilities.
Now that we know what are debentures, let’s see how they are issued. Debentures are issued in the form of a physical document by the company. The person who purchases debentures is called a debenture holder and he becomes a creditor of the company. The document is issued to the debenture holder which he has to keep with him safely. In this document, the details of redemption and repayment are mentioned. Hence, this document/certificate acts as proof of the company’s liability to repay the loan with interest.
It is also important to note that the interest payable on these debentures is a charge against profit; which means the company has to pay the interest amount even if it doesn’t profit for that financial year. Because debentures are loans, they may or may not carry a charge on the company’s assets. This means, depending on the type of debenture, the company may or may not have to sell off its assets in order to make the repayment.
Debentures under the Companies Act, 2013
Section 2(30) of the Companies Act, 2013 defines debentures. It states that a debenture includes debenture stock, bonds, and any other instrument of a company that acts as evidence of a debt, irrespective of the fact that it constitutes a charge against the assets of the company or not. Section 71 provides that a company may issue convertible debentures and various other guidelines regarding it. The power of the Board of Directors to issue debentures on behalf of the company is provided by Section 179(3) of the Act.
Types of debentures
Based on the company’s requirements, various types of debentures can be issued:
- On the basis of the convertibility of debentures into equity shares, debentures can be divided into non-convertible, partly convertible, and fully convertible debentures.
- It can also be divided into secured and unsecured debentures based on security. As the name suggests, secured debentures are secured against assets of the company and unsecured are not.
- Some debentures can be redeemable and some irredeemable. Redeemable debentures can be redeemed on demand but perpetual/irredeemable debentures have no fixed period of time and hence cannot be redeemed on demand.
- Lastly, on the basis of registration, debentures can be issued as registered debentures or bearer debentures. Let’s look at bearer debentures in detail.
Bearer Debentures
Bearer debentures are those that can be transferred by mere delivery. Anyone who carries the certificate can claim the payment. This is due to the fact that this kind of debenture is not recorded in the register of debenture holders. This is why when a transfer of bearer debenture takes place, it is not recorded. These are also called unregistered debentures because of this feature. So in short, bearer debentures are unsecured and unregistered debentures that anyone can hold.
Features of Bearer Debentures
The features of bearer debentures are as follows:
Unregistered Debentures
Bearer debentures are unregistered debentures as they are not recorded in the register of debenture holders. This makes the transfer of bearer debentures easy and convenient. It is due to this fact that anyone who bears the debentures becomes the owner of those.
Issued physically
Bearer debentures are issued physically on paper to the debenture holder.
Redemption of Bearer Debentures
These debentures can be redeemed within a period of 30 days from the date of maturity.
Interest payment received through coupon –
In order to receive interest payments, the bearer needs to submit the coupons that are attached to the security to the issuing company.
No third party involved
Since the bearer debentures are unregistered, they can be sold without the involvement of any third party. It can also be transferred to someone else by mere delivery.
Advantages of Bearer Debentures
- One of the biggest advantages that make bearer debentures favourable for companies is the lack of requirement of diluting equity. As debentures are debt instruments, they do not affect the shareholding of the company. Hence, debenture holders cannot participate in the management of the organisation.
- The interest paid on debentures is a charge against profit. This factor makes it favourable for the company as tax is calculated on the profit of the company. A charge against it reduces the profit, which equates to a lesser tax deduction.
- Debentures are considered to be a cheaper source of finance compared to other types of loans. This encourages long-term planning.
- Bearer debentures are favourable for the holders as it is easy to transfer or sell. Since they are unregistered, there is no involvement of third-party during the transfer or sale of bearer debentures.
Disadvantages of Bearer Debentures
- There is a huge risk for the holder of bearer debentures as physical documents can get damaged, destroyed, misplaced, or stolen. In such a scenario, it becomes extremely difficult to replace such a certificate as the issuer does not record the details of the holder.
- If the debentures are detached and sent through the mail, the coupons can get lost and that would lead to losing interest payments.
- Bearer debentures can be used for money laundering and this has led to many countries placing a ban on these.
- Any person who possesses the certificates could claim the final payment. Hence, if it is stolen, there is no way to stop that person from claiming payment.
- In case of any rise in the interest rates, the issuing company is under no obligation and can call back the bearer’s debentures anytime.
Comparison of bearer debentures with other types of debentures
As we have seen earlier, debentures are of different varieties which serve a specific purpose. Let’s compare bearer debentures with the others.
Registered vs. Bearer debentures
| S.no | Basis | Bearer debentures | Registered debentures |
| 1 | Meaning | Bearer debentures are those that are not registered and anyone who possesses the certificate becomes the owner. | Registered debentures are those that are registered in the debenture holders’ register. |
| 2 | Purpose | These are used by people who want to stay anonymous with their purchases. | These are used by people who desire a sense of safety with their purchases. |
| 3 | Security | It is not secure at all because if it is lost then the payment cannot be claimed. | It is more secure as the owner can ask for a duplicate certificate in case the original gets lost. |
| 4 | Transfer | It is easy to transfer as it does not require the involvement of a third party. It is transferred through mere delivery. | The transfer process of registered debenture is cumbersome as it requires the involvement of a third party and it is a long process. |
| 5 | Registration | These are not registered. | These are registered in the debenture holders’ register of the company. |
| 6 | Personal details | Only the amount and rate of interest are mentioned on the certificate. Personal details of the holder are not mentioned. | The personal details of the holder are mentioned on the certificate including the amount and other relevant details. |
Bearer debentures vs. Secured debentures
| S.no | Basis | Bearer debentures | Secured debentures |
| 1 | Meaning | Bearer debentures are those that are not registered and anyone who possesses the certificate becomes the owner. | Secured debentures are those that are secured against some asset of the company. |
| 2 | Purpose | These are used by people who want to stay anonymous with their purchases. | These are bought by people who invest a larger sum and require added security for their funds. |
| 3 | Security | It is not secure at all because if it is lost then the payment cannot be claimed. | It is more secure as the owner can ask for a duplicate certificate in case the original gets lost. |
| 4 | Transfer | It is easy to transfer as it does not require the involvement of a third party. It is transferred through mere delivery. | The transfer process of registered debenture is cumbersome as it requires the involvement of a third party and it is a long process. |
| 5 | Charge against asset | It does not create a charge against the asset of the company as it is unsecured. | It creates a charge against the assets of the company. |
Frequently Asked Questions (FAQs)
What is a bearer debenture?
A bearer debenture is a type of debenture that is not registered in the register of debenture holders and is transferable through mere delivery.
What happens when a bearer debenture holder loses the certificate?
When the bearer debenture holder loses the certificate, he loses his right to claim payment from the company. This is because bearer debentures are unregistered and unsecured. As there is no registration, the name of the holder does not appear anywhere.
Are bearer debentures legal?
Bearer debentures are losing legal status in various countries like the USA and the UK due to the fact that they are unregistered. This makes it possible for criminals to launder money easily and remain anonymous.
Is bearer debenture a negotiable instrument?
A bearer debenture is a negotiable instrument as it has the qualities of a negotiable instrument which include transferability and promise of payment to the holder.
Can a company issue bearer debentures?
For the purpose of financing long-term or medium-term projects, a company can issue bearer debentures as per the Companies Act, 2013.
How is a bearer debenture beneficial for a company?
Due to the nature of bearer debentures, the issuing company does not have to maintain a register of debenture holders for bearer debentures. Also, in case the debenture certificate is lost, the holder cannot claim repayment. In this case, the company can utilise the money without repayment.
Conclusion
Debentures are debt instruments used by companies for capital-raising purposes. Being one of the popular ways of raising capital, debentures can be modified based on the issuer’s needs. Bearer debentures are one such type that is popular among investors who desire to remain anonymous. This ability makes it convenient for criminals to launder money. Thus, the advantage of being easily transferable gets outweighed by the downside of such debt security. These are getting banned in several economies like the USA and UK. Hence, the economies that still allow companies to issue bearer debentures should weigh the needs of investors and companies against the apparent downside of having them around.
References
- What is a debenture | BDC.ca
- Bearer Debentures – Meaning Features, types and benefits (vakilsearch.com)
- Bearer Debentures – an unregistered unsecured bond – Assignment Point
- Legal Concept and Provision of Debentures (taxguru.in)
- Bearer Debentures Meaning, Examples, Advantages, Disadvantages (financeplusinsurance.com)
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