In this article, Sneha Chawla pursuing Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata discusses whether a company can issue debentures carrying voting rights or not.
INTRODUCTION
Companies usually have to borrow large sums of money. The loan requirements of the company might not be met by a single tender, therefore a loan, in certain situations can be split into several units. One of the most convenient methods of doing so is by borrowing the issue of debentures.[1] These are one of the ways where the company borrows money and then agrees to repay the debt where there might be a charge on the company’s assets for ensuring the repayment of the company’s debt. Debentures are basically substitutes for investments in a company that is usually more secure than investment in shares as the company would have to pay interest as it will be paid before the dividend payment.
What is Debenture?
As per Companies Act, 2013, under section 2(30) defined “Debentures” which includes debenture stocks, bonds and other instruments of a company regarding debts whether they constitute a charge over the company’s assets or not.
According to Topham:”Debentures are basically documents that are given by a company as evidence of a debt to the holder that is arising out of loans and that are secured by charges.”[2]
Debentures are written promises for a debt by a company under its seal consisting of the terms and conditions regarding the amount of loan or principal, the rate of interest, maturity date, maturity value etc. Basically, debentures are considered to be a certification of acknowledgement issued with the seal of the company in favor of lender as an evidence of debt.[3] Therefore this written document grants the holder the right to receive interest and return of principal as per the terms under which debentures are issued.[4]
How are Debentures beneficial?
Debentures have no collateral. Bond buyers usually purchase the debentures based on the belief that the bond issuer would likely default on the repayment. Debentures are considered to be the most common form of long-term loans as they can be taken out by a corporation. These loans have to be repaid at a fixed rate of interest at a specific date.[5] A company generally makes these payments prior paying out dividends to the shareholders, like most debt instruments. In reference to other kinds of loans and debt instruments, debentures are advantageous as they carry a lower rate of interest and have a longer period of time to make the payments.[6]
Some of the features of Debentures
- Debentures are like shares, it is basically an investment in a company.
- Debentures are part of the total capital of the company where the debenture-holders are the creditors.
- Debenture-holders have entitled the right to receive interest on their fund invested in debenture. Generally, the rate of interest is predetermined and stated in the bond certificate. Thus, the interest is payable whether there is profit or loss.
- Debentures are primary in order to pay interest expenses by a fixed rate.
- Debentures are monumental to meet the requirement of long-term capital budgeting, as they help in maximizing earning per share.
- Debentures are usually freely transferable by the debenture holder.
- In a company’s general meetings of shareholders, debenture holders have no voting rights as they may have separate meetings or votes.
- Debentures reduce the burden of income tax, as the interest is charged against profit and loss account.
- Debentures consistently provide the way, to use leverage in the capital structure of the company.
- Further, debentures provide for payments of a specific principal sum at a specific date. But that is not important as a company may issue perpetual debentures with no undertaking to pay.
Kinds of Debentures
Generally, debentures are classified into different categories:
Debentures on the basis of Redemption
- Redeemable Debentures
Debentures are usually redeemable. This basically means the company has to pay back the debenture-holders in order to have the properties released from the mortgage or charge on the expiration of the terms of the loan. Therefore this is called redemption of debentures. Redeemed debentures can often be re-issued. If there is no provision to the in the articles, or conditions of the issue or any resolution that shows any motive to cancel the redeemed debentures, then the company shall have the power to keep the debentures active for its re-issue. Thus, the company has to re-issue the same debentures or other debentures in their place.
- Irredeemable Debentures
The debentures, that cannot be paid during the life existence of the company, are called as irredeemable debentures. As the company has no obligation to make the payment of the principal of these debentures during its lifetime. So, therefore it is also termed as perpetual debentures. The company might repay the money at the time of liquidation or on the happening of a contingency or on the expiration of a longer period or if the company breaches the terms of the issue of the debentures.
Debentures on the basis of Conversion
- Convertible Debentures
[S.71(1)] At the time of redemption, the company might issue debentures in order to convert them into shares completely or partially. Debentures with such option can be issued with the approval of a special resolution passed at a general meeting.
- Non Convertible Debentures
Non-convertible debentures are basically regular debentures that can’t be converted into equity for the issuing corporation. In order to compensate it, the investors are remunerated with a high rate of interest in comparison to convertible debentures.
On the other hand in case of non-convertible debentures, the date of maturity is essential as this date domineers as to when the issuing company has to pay back the debenture holders.
- Partly Convertible Debentures
The holders in partly convertible debentures are given an option to convert part of their debentures, after which they shall enjoy the benefit of both debenture holders as well as equity shareholders.
- Fully Convertible Debentures
These are Fully convertible debentures into Equity shares at the issuer’s notice. Issuer will decide the ratio of conversion.
Debentures on the basis of Registration
- Registered Debentures
Registered debentures are debentures that are payable to the registered debenture holders, and they aren’t transferable only through delivery. The names of the holders of these debentures with details of the number, value, and type of debenture held are registered in the records of debenture holders. Registered debentures are not negotiable instruments. Transfer of such debentures requires registration.
- Unregistered Debentures
Unregistered Debentures may refer to those debentures which are not recorded in the company’s register book. Such type of debentures are known as bearer debentures and these can be easily transferred to any other person.
Debentures on the basis of security
- Secured Debentures
These are the debentures where the assets of the company are secured by a charge over them. They are known a mortgage debentures. The debenture-holders of secured debentures have the provision recover the principal amount with the unpaid amount of interest on these debentures from the assets mortgaged by the company.
- Unsecured Debentures
The debentures, that aren’t fully secured by a charge upon the assets of the company are known as unsecured debentures. They are also referred to as Naked Debentures. They are not mortgaged. The debenture holders are treated as only unsecured creditors. The Issue of such debentures are not much popular.
Other Debentures
- Perpetual Debentures
A debenture that does not consist of any particular clause regarding any payment or that consists of a clause stating it shall not be paid back is known as perpetual debenture.
- Mortgage Debenture
These type of debentures are issued by mortgaging an asset and debenture holders can recover their dues by selling a particular asset in case the company fails to repay the claim of debenture holders.
- Fixed Debentures
A note that carries a fixed charge against the issuer’s property or assets for repayment, there charge shall remain in the company’s records until the debenture is repaid. Corporations can issue fixed debentures to finance operations in the same way they issue stock. Fixed debentures can be issued singly or in a series. They pay out a fixed rate of interest at regular intervals.
Issue of Debentures
Debentures are generally issued for cash at a particular discount or at a premium. Entries are usually similar to that of issue of shares like any premium or discount when shares are issued then the amounts are payable in installments. When the debentures are being issued the premium amount payable on redemption can be adjusted.
Debentures could be issued in the form of overdrafts from banks and as collateral securities against loans or from other institutions. Collateral Security is also referred to as additional or parallel security.
PROCEDURE TO ISSUE DEBENTURES UNDER THE COMPANIES ACT, 2013 [7]
[Applicable Provisions: Section 56, 72, of the Companies Act, 2013 read with Rule 18 and 19 of the Companies (Share Capital and Debentures) Rules, 2014]
- Call and hold the Board meeting and decide which types of the debenture will be issued by the Company.
- If the Company decides to issue secured debenture the company has to comply with the condition prescribed in the Rule 18 of the Companies (Share Capital & Debentures) Rules, 2014.
- In case appointment of Debenture Trustee, consent shall be obtained from a SEBI registered Debenture Trustee, who is proposed to be appointed. If debentures to be issued are Secured Debentures, a Debenture Trust Deed in Form No. SH – 12 or as near thereto as possible shall be executed by the Company in favour of Debenture Trustees within sixty days of allotment of Debentures.
- In the Board meeting pass resolutions for
- i) Approval of Offer letter for private placement in Form No. PAS – 4 and Application Forms (In case of private placement of debentures);
- ii) Approval of Form No. PAS – 5 (In case of private placement of debentures);
- iii) Approval of Debenture Trustee Agreement and appointment of a Debenture Trustee (In case of Secured Debentures only);
- iv) Appointment of an expert for valuation (In case of private placement of debentures);
- v) Approval of increase of borrowing powers, if required;
- vi) To authorize for creation of charge on the assets of the company;
- vii) Approve the Debenture Subscription Agreement;
- viii) To fix day, date and time for the extraordinary general meeting of shareholders.
- Prepare the draft of
- i) Debenture Subscription Agreement;
- ii) Offer Letter for private placement in Form No. PAS – 4 and Application Forms;
- iii) Records of a private placement offer in Form No. PAS – 5;
- iv) Debenture Trustee Agreement;
- v) Mortgage Agreement for the creation of charge on assets of the company.
- Issue notices of extraordinary general meeting along with the explanatory statement.
- Hold an extraordinary general meeting and pass the special resolution to issue convertible secured debentures and increase borrowing powers of the company and to authorize the Board to create the charge on the assets of the company.
- File Form No. PAS – 4 and PAS – 5 in Form No. GNL – 2 with the Registrar of Companies.
- File Offer Letter in Form No. MGT – 14 with the Registrar of the Companies.
- File copy of Board resolutions, Special Resolution, Debenture Subscription Agreement, Debenture Trustee Agreement etc in Form No. MGT – 14 with the Registrar of Companies.
- File Form No. PAS – 3 (Return of allotment) with the Registrar of Companies after making allotment of debentures.
- File Form No CHG – 9 for the creation of charge on assets of the Company.
Can a Company issue debentures carrying voting rights?
Under Section 71 (2) of the Companies Act, 2013 it has been stated that no company can issue debentures which can carry any voting rights. According to rule (1) of Companies (Share Capital and Debentures) Rules, 2014, it has been stated that the company cannot issue secured debentures unless following conditions are fulfilled. The rate of redemption cannot exceed 10 years from the date of issue. The company which has been engaged in setting up of infrastructure projects can issue security debentures crossing 10 years but cannot exceed 30 years. The issue of debentures should be secured by the creation of a charged. The security of debentures by the way of charge should be treated in the favour of debenture trustee.
The debentures can be issued by the company under the meeting of the board of directors under the provisions of Section 179 (3) of the Companies Act, 2013. The provisions of Section 71 of the Companies Act, 2013 are related to the issuance of debentures along with the penalties.
Voting Rights
Section 47 of the Act provides that every member of a company limited by shares and holding equity share capital therein, shall have a right to vote on every resolution placed before the company; and his voting right on a poll shall be in proportion to his share in the paid-up equity share capital of the company.
In case of the member of a company limited by shares and holding preference share capital, shall have a right to vote only on:
- resolutions placed before the company which directly affect the rights attached to his preference shares and, 12 Share Capital and Debentures,
- any resolution for the winding up of the company, or
- for the repayment or reduction of its share capital.
Voting right of the holder of share capital shall be in proportion to his share in the paid-up share capital of the company. The proportion of the voting rights of equity shareholders to the voting rights of the preference shareholders shall be in the same proportion as of the paid-up capital in respect of the equity shares bears to the paid-up capital in respect of the preference shares. Preference shareholders are entitled to vote on every resolution placed before the company at any meeting if the dividend due on such class of preference shares are in arrears for a period of two years or more.[8]
DEBENTURE WITH VOTING RIGHTS [S.71(2)]
The sub-section provides that no company is to issue any debentures carrying any voting rights.
What is Debenture Trust Deed?
The provision of Debenture Trust Deed is given under section 71(5-10) of the Act. The company has to appoint one or more debenture trustees where the prospectus is issued for the issue of debentures or where members of public or company’s own members exceeding 500 are invited to apply for the issue.
In other cases;
- It is for the debenture holders themselves to appoint their trustee.
- Where the debenture-holders do not have the time to look after their interest in the properties mortgaged or charged to them, they may appoint some of themselves as trustees for the supervision of their common interest.
- When a trust deed is made some of them are appointed as trustees.
- Properties of the company are usually mortgaged to the trustee in favour of the debenture-holders.
- They are bound to act with the same degree of honesty, care and diligence as is required of all trustees.
Appointment of Debenture trustees [Section 71(5)]
Appointment of debenture trustees has to be made before making a debenture issue and the fact of the appointment and their consent to act as such has to be mentioned on the face of the prospectus or letters of offer.
Persons not qualified
- A beneficial holder of shares in the company;
- Persons who are entitled to the money that is required to be paid by the company to the debenture trustee ;
- A person who has entered into a guarantee in respect of principal debts secured by debentures or interest thereon.
Duties
To make sure that the assets of the company that is issuing debentures and of the guarantors is satisfactory in order to discharge the principal amount at all time;
- To make sure that the prospectus or the offer letter does not consist of anything that is erratic to the terms of the debentures or debenture trust deed;
- To make sure that there is no breach of the covenants and provisions of the debenture trust deed on part of the company;
- To take reasonable steps against any breach of the covenants or terms of issue.[9]
Who are the Debenture Holders?
The persons, firms or companies who purchase the debentures of the other company are the Debenture Holders.
Register of Debenture Holders
- According to the Companies Act, 2013, section 88(1)(b) requires every company to keep a register of debenture holders.
- An index of the names shall be included in the register.
- There shall be prescribed particulars in the register and also shall be prescribed by the Government. Thereafter, Government shall prescribe separate register for each type of debentures.
- The Company can close the register after giving at least 7 days previous notice by advertising for a period not exceeding 45 days in a year but not exceeding 30 days at a time.
- It can be opened for inspection as per the section 94(2) by the members and debenture holders, other security holder or beneficial owner during the business hours without the payment of any fees and by any other person on payment of nominal charges.
Remedies open to Debenture Holders
- The remedies of basically depend upon the terms of their agreement with the company. A debenture-holder who wants get his money back in order to realise his security may exercise remedies given by the debenture trust deed or resort to legal proceedings to enforce his rights.[10]
- If money due on a debenture is payable on demand the debtor company is entitled, once demand is made, to the reasonable time to implement the mechanics of payment, but it is not entitled to any time to raise the money if it was not at hand. A demand under debenture need not specify the amount due.[11]
- It is not necessary to allow time to the borrowing company to enable it to engage in a commercial transaction for the purpose of raising funds for the redemption of debentures.[12]
- But one of the remedies which are always open to them as mortgagees under the Transfer of Property Act is to bring the property charged to sale.[13]
Why are Debentures advantageous for the Company?
Debentures provide the greatest security to the investors. They make a very good appeal to the conservative minds. The reasons are:
- Interests on debentures are usually tax deductible expenditures and this saves income tax.
- Generally, the cost of debentures are lower than that of preference and equity shares.
- Debentures guarantee a fixed rate of interest.
- Their prices are more stable as compared to shares because the changing monetary conditions affect the price movement of the debentures very little.
- As equity shareholders do not have any right or provision to vote or take part in the management of the company, the issue of debentures shall not result in the dilution of interests of the shareholders.
- An Issue of debentures is advantageous during times of inflation.
- Debenture holders should generally avoid bearing risks as interest on debentures is payable even at loss.
- The companies can raise money through debentures easily compared to equity and preference shares.
- The investors get fixed and regular interest, whether the company earns profit or not.
References
[1]A company may issue debentures convertible into shares either fully (FCDs) or partly (PCDs). For rules and regulations to be observed in this connection, see, Section F of SEBI Guidelines for Disclosure and Investor Protection on the issue of convertible and non-convertible debentures.
[2] TOPHAM’S COMPANY LAW(12th Edn) 168. See also, a speech of Viscount MAUGHAM in Knightsbridge Estates Ltd v Byrne, 1940 AC 613 : (1940) 2 All ER 401: 109 LJ Ch 200: 162 LT 388: 56 TLR 652(HL), where all the important definitions have been considered. See also, VYAS J in Madanlal Fakirchand Dudhediya v Changdeo Sugar Mills Ltd, AIR 1958 Bom 491, 496: (1958) 60 Bom LR 254.
[3]https://accountlearning.blogspot.in/2011/04/meaning-and-concept-of-debentures.html
[4]https://accountlearning.blogspot.in/2011/04/meaning-and-concept-of-debentures.html
[5] https://www.investopedia.com/terms/d/debenture.asp
[6] https://www.investopedia.com/terms/d/debenture.asp
[7]https://www.linkedin.com/pulse/debentures-under-companies-act-2013-law-procedure-issue-kumar
[8]https://www.icsi.edu/portals/0/SHARE%20CAPITAL%20AND%20DEBENTURES.pdf
[9] These were the provisions of S. 117-B of 1956 Act. Now they are likely to be prescribed under rules.
[10]Lloyds Bank plc v Lampert, 1999 BCC 507.
[11] Bank of Baroda v Panesar, 1987 Ch 335: (1987) 2 WLR 208: (1986) 3 All ER 751 (Ch D).
[12]Lloyds Bank plc v Lampert, 1999 BCC 507.
[13] See, Narain Singh & Co v UP Oil Industries Ltd,(1964) 1 Comp LJ 225 (All); following Parvataneni Venkata Brahmarao v Andhra Bank Ltd
