In this blog post, Meghana Balan, a Bangalore-based Lawyer with an Independent Practice and a student pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, compulsorily convertible debentures and non- convertible debentures.
Debentures are debt instruments that are not secured by physical collateral but rather by the creditworthiness of the business that issues the debenture. It is a means of raising capital, one of the most common forms of long-term loans. These instruments are for a fixed period and pay out interest at a fixed rate; the interest paid on debentures takes preference over the dividends paid to the company’s shareholders.
There are two types of debentures, convertible and non-convertible debentures. As the names suggest, convertible debentures are instruments that convert into equity shares of the issuing company after a set period, in a sense, it is a kind of secured loan, due to which convertible debentures are issued at a lower rate of interest than non-convertible debentures and is preferred mode of investment by many investors. Non-convertible debentures are debt instruments that cannot be converted into equity shares and are usually issued at a higher rate of interest compared to convertible debentures.
- Companies Act, 2013
- Companies (Share Capital and Debentures) Rules, 2014
- Companies (Acceptance of Deposits) Rules, 2014
- Companies (Acceptance of Deposits) Amendment Rules, 2016
- SEBI (Debenture Trustees) Regulations, 1993 and
- SEBI (Issue and Listing of Debt Securities) Regulation, 2008
The term debenture is defined in the Companies Act, 2013 under Section 2(30), debenture includes debenture stock, bonds or any other instrument of the company evidencing a debt, whether constituting a charge on the assets of the company or not.
Section 71 of the Companies Act, 2013 along with Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014 deals with debentures.
Compulsorily Convertible Debenture
Compulsorily convertible debenture also known as CCD is a type of debenture in which the whole value of the debenture must be converted into equity by a specified time. The issuing company decides the compulsory convertible debentures’ ratio of conversion at the time of issue. CCD is a type of hybrid instrument, meaning it is neither considered a pure debit nor pure equity.
Section 71(1) permits companies to issue debentures with an option to convert such debenture into shares, either wholly or partly at the time of redemption, provided that it shall be approved by a special resolution passed at a general meeting. Companies issue CCDs through a private placement offer.
No Debenture Redemption Reserve is required to be created in case of CCDs. Further a company issuing compulsory convertible debentures, need not execute debenture trust deed or appoint a debenture trustee as it is not securing anything and no payment is to be made at the time of maturity of the CCD converts into equity and not redeemed.
However it is important to keep in mind the Companies (Acceptance of Deposits) Rules, 2014 which excludes as per clause ix of Rule 2(1)(c), 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 ten years.
Therefore all CCD have to convert within ten years, else it will be considered a deposit under the Companies Act, 2013 and therefore, the provisions relating to deposits will be applicable. This term was previously five years but has been amended to ten years with effect from 29th June 2016.
As per Reserve Bank of India guidelines, CCDs are considered as equity for all the reporting purposes and under financial statements, however, until the time of conversion into equity, CCDs are not considered as part of the share capital of a company.
Non-convertible debentures are debentures that do not convert into equity on maturity. Non-convertible debentures, also known as NCD, are used as means to raise long-term funds for companies through a public issue. Since they do not convert into equity, they are usually given a higher rate of interest compared to convertible debentures. NCDs offer various other benefits to the holder including high liquidity through stock market listing and safety since they can be issued by companies which have a good credit rating as specified in the norms laid down by RBI for the issue of NCDs.
There are two kinds of NCDs, secured non-convertible debentures, those that are secured by assets that can be liquidated at the time of redemption in the event the issuing company is unable to pay. Therefore, usually, the returns on secured NCDs are lower than unsecured NCDs.
Unsecured NCDs are NCDs not secured by any assets and like any unsecured debt will only receive payment after payments are made to entities that are secured. Therefore unsecured NCD’s have high-interest rates.
Secured NCDs are issued by companies subject to Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014, SEBI (Debenture Trustees) Regulations, 1993 and SEBI (Issue and Listing of Debt Securities) Regulation, 2008.
A company shall not issue secured debentures unless it complies with the following conditions:
- An issue of secured debentures may be made, provided the date of its redemption shall not exceed 10 years from the date of issue. This term is extended up to 30 years in the case of companies engaged in the setting up of infrastructure projects.
- An issue of debentures shall be secured by the creation of a charge, on the properties or assets of the company, having a value which is sufficient for the due repayment of some debentures and interest thereon.
- The company shall appoint a debenture trustee before the issue of prospectus or letter of offer for subscription of its debentures and not later than 60 days after the allotment of the debentures, execute a debenture trust deed to protect the interest of the debenture holders.
- The security for the debentures by way of a charge or mortgage shall be created for the debenture trustee on-
- Any specific movable property of the company (not being like pledge); or
- Any specific immovable property wherever situate, or any interest therein.
- The company shall appoint debenture trustees under sub-section (5) of section 71, after complying with the following conditions, namely-
- the names of the debenture trustees shall be stated in letter of offer inviting subscription for debentures and also in all the subsequent notices or other communications sent to the debenture holders;
- before the appointment of debenture trustee or trustees, a written consent shall be obtained from such debenture trustee or trustees proposed to be appointed, and a statement to that effect shall appear in the letter of offer issued for inviting the subscription of the debentures;
- A person shall not be appointed as a debenture trustee if he-
- Beneficially holdsshares in the company;
- Is a promoter, director or KMP or any other officer or an employee of the company or its holding, subsidiary or associate company;
- Is beneficially entitled to money which is to be paid by the company otherwise than as remuneration payable to the debenture trustee;
- Is indebted to the company, or its subsidiary or its holding or associate company or a subsidiary of such holding company;
- Has furnished any guarantee in respect of the principal debts secured by the debentures or interest thereon;
- Has any pecuniary relationship with the company amounting to two percent or more of its gross turnover or total income or fifty lakh rupees or such higher amount as may be prescribed, whichever is lower, during the two immediately preceding financial years or during the current financial year;
- Is a relative of any promoter or any person who is in the employment of the company as a director or KMP.
9. The Board may fill any casual vacancy in the office of the trusteebut while any such vacancy continues, the remaining trustee or trustees, if any, may act. Provided that where such vacancy is caused by the resignation of the debenture trustee, the vacancy shall only be filled with the written consent of the majority of the debenture holders.
10. Any debenture trustee may be removed from office before the expiryof his term only if it is approved by the holders of not less three-fourth in value of the debentures outstanding, at their meeting.
The duties of the debenture trustee are enumerated in Rule 18(3) of the Companies (Share Capital and Debentures) Rules, 2014 and the details of the procedure for debenture holders meeting under Rule 18(4) of the Companies (Share Capital and Debentures) Rules, 2014.
The company shall create a Debenture Redemption Reserve for the purpose of redemption of debentures, in accordance with the conditions given in Rule 18(7) below:
- the Debenture Redemption Reserve shall be created out of the profits of the company available for payment of dividend;
- the company shall create Debenture Redemption Reserve equivalent to at least twenty-five percent of the amount raised through the debenture issue before debenture redemption commences
- every company required to create Debenture Redemption Reserve shall on or before the 30th day of April in each year, invest or deposit, as the case may be, a sum which shall not be less than fifteen percent of the amount of its debentures maturing during the year ending on the 31st day of March of the next year, in any one or more of the following methods, namely:-
- in deposits with any scheduled bank, free of any charge or lien;
- in unencumbered securities of the Central Government or of any State Government;
- in unencumbered securities mentioned in Sub-clauses (a) to (d) and (ee) of section 20 of the Indian Trusts Act, 1882;
- in unencumbered bonds issued by any other company which is notified under sub-clause (f) of section 20 of the Indian Trusts Act, 1882;
- the amount invested or deposited as above shall not be used for any purpose other than for redemption of debentures maturing during the year referred above:
Provided, that the amount remaining invested or deposited, as the case may be, shall not at any time fall below fifteen percent of the amount of the debentures maturing during the year ending on the 31st day of March of that year.
- In the case of partly convertible debentures, Debenture Redemption Reserve shall be created in respect of the non-convertible portion of debenture issue in accordance with this sub-rule.
- The company shall not utilize the amount credited to the Debenture Redemption Reserve except for the purpose of redemption of debentures.
A trust deed for securing any issue of debentures shall be open for inspection by any member or debenture holder of the company, in the same manner, to the same extent and on the payment of the same fees, as if it were the register of members of the company.
A copy of the trust deed shall be forwarded to any member or debenture holder of the company, at his request, within 7 days of the making thereof, on payment of a fee.
Compulsorily Convertible Debentures are:
- Are issued under private placement.
- Can be issued by both private and public companies.
- Have a prefixed conversion date (however cannot exceed 10 years).
- Have a fixed rate of interest which is lower than that of non-convertible debenture secured or otherwise and
- The issuer determines the conversion ratio at the time of issue.
Non-Convertible Debentures are:
- Are issued either under private placement or by public offer
- Can be issued by public companies, private companies can issue only secured non-convertible debentures.
- Redemption date cannot exceed 30 years for companies engaging in infrastructure projects and not more than 10 years for all others.
- Rate of interest is higher than CCDs
- Debenture Redemption Reserve is required to be created for secured NCDs.
- Debenture trust deed is to be executed and debenture trustee appointed to ensure compliance.
Under the provisions of Section 42 of the Companies Act, 2013
Section 71(4), Companies Act, 2013
Companies (Acceptance of Deposit) Amendment Rules, 2016
SEBI (Issue and Listing of Debt Securities) Regulation, 2008