This article is written by Sukeshi Singh pursuing Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from Lawsikho.
Table of Contents
Introduction
Debentures are debt securities used by companies to raise funds through debt financing. It is essentially an acknowledgement of debt, defined in Section 2(30) of the Companies Act, 2013 to 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. There are several types/combinations of debentures, as mentioned below:Â
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Secured and unsecured debentures
When debentures are issued as against creation of charge over the assets of the Company. The charge may be fixed or floating. A fixed charge is applicable to a specifically identifiable asset, whereas a floating charge is dynamic in nature and applicable to the company as a whole and unlike a fixed charge, a floating charge comes into play only when a company goes into liquidation.Â
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Redeemable and irredeemable debentures
Redeemable debentures are securities having a specific date of redemption, on which date the company shall be bound to return the principal amount to the debenture holder. Whereas an irredeemable debenture extends till perpetuity and only becomes due in an event of liquidation of the company.Â
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Fully, partially and non-convertible debentures
As the name suggests, a fully convertible debenture is one where the security holder has a right to convert their debentures into equity shares of the company at a future date, at the option of the debenture holders. The ratio of conversion, post-conversion rights given to the security holder and date of conversion are decided at the time of issue of the debentures. A partially convertible debenture is divided into two parts, compulsorily convertible debentures which are convertible into equity shares and the second being non-convertible debentures which are redeemed at the expiry of its tenure.Â
According to the Companies Act, 2013, no company shall issue debentures carrying any voting rights. The company issuing such debentures is also required to create a debenture redemption reserve account out of the profits of the company available for payment of dividend and the amount credited to such account shall not be utilised by the company for any other purposes except for the purpose of redemption of debentures. For unlisted companies, the amount to be kept in the debenture redemption reserve has been reduced from 25% (twenty-five per cent) to 10% (ten per cent) and such requirement has been waived off for listening to companies by the Ministry of Corporate Affairs as on 19 August, 2019. Â
Issuance of compulsorily convertible debentures
Issuance of debentures is categorized as acceptance of deposits under the provisions of the Companies Act, 2013. Section 73 of Companies Act, 2013 along with Companies (Acceptance of Deposit) Rules, 2014, prohibits private companies from accepting deposits from the public.Â
Deposit is defined under Section 2 (31) of the Companies Act, 2013. The definition includes any receipt of money by way of deposit or loan or in any other form by a company. However, certain categories of amount, as prescribed by RBI may be excluded.Â
Accordingly, Rule 2 (1) (c) (ix) Companies (Acceptance of Deposits) Rules, 2014 states that issue of debentures, compulsorily convertible within 10 (ten) years shall not be considered as deposit and issue of the same will not have to abase by the Companies (Acceptance of Deposit) Rules, 2014.
Procedure for issuing compulsorily convertible debentures
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No. |
Particulars |
Action items |
Reference Statute/ Rules |
|  1. |
Notice for holding a board meeting |
A notice has to be issued to convene a meeting of the board of directors which shall be in accordance with secretarial standards 1. Provided the articles of association of the company state otherwise, such meeting may be convened by giving a notice of 7 (seven) days. |
 |
| Â 2. |
Convening meeting of Company’s board of directors |
The following actions have to be taken in the board meeting:Â
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Rule 14 (1) (d) of Companies (Prospectus and Allotment of Securities) Rules, 2018 states that the proposal, for private placements of securities, has to be approved by the shareholders and in the explanatory statement the disclosure regarding the name and address of the valuer has to be made. Section 247 of the Companies Act, 2013 requires valuation of the issue by registered valuers. However, if the debentures are being issued to a person resident outside India, the valuation must be done in accordance with FEMA (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2017 by an internationally accepted pricing methodology for valuation on an arm’s length basis duly certified by a chartered accountant, a SEBI registered merchant banker or a practising cost accountant. |
| 3.  |
Hold extraordinary general meeting & Filing of MGT-14 |
The notice for an extraordinary general meeting (EGM) has to be given at least 21 (twenty-one) days clear before the meeting and can be called on a shorter notice, if at least 95% (ninety-five per cent) of the members entitled to vote in the meeting agree to the shorter notice, along with an explanatory statement for all the items which are to be transacted. Approval of private placement offered by the shareholders by a special resolution is to be done at the EGM. The special resolution has to be filed with the Registrar along with MGT-14 and attached with the offer letter, valuation report and certified true copy of special resolution along with the explanatory statement added with the notice of the EGM, within 30 (thirty) days from such resolution being passed. |
Rule 14 (8) Companies (Prospectus and Allotment of Securities) Rules, 2018 states that a company shall issue a private placement offer or the application letter special board resolution has been filed with the Registrar of Companies. Section 71 of Companies Act, 2013. |
|  4. |
Circulate offer letter |
The offer letter accompanied by an application form serially numbered and addressed specifically to the proposed allottees has to be sent to the proposed allottees, within 30 (thirty) days of recording the name of such person by the Board. |
Rule 14 (3) of Companies (Prospectus and Allotment of Securities) Rules, 2018 states that a private placement offer cum application letter shall be in the form of an application in Form PAS-4 and shall be sent to the proposed allottees, either in writing or in electronic mode. |
| Â |
Open a separate bank account. |
A separate bank account has to be opened to receive application money within the offer period as per the offer letter. |
Section 42 (5) of Companies Ac, 2013. |
|  5. |
Filing of GNL -2 |
Pursuant to Rule (3) of The Companies (Prospectus and Allotment of Securities) Rules, 2014, PAS-4 and record of private placement offers in PAS-5 have to be filed with the Registrar of Companies along with GNL-2 within a period of 30 (thirty) days of the circulation of the offer letter. |
Certain documents for which no particular e-form is prescribed is filed in e-form GNL-2. |
|  6. |
Convening meeting of company board of directors after receiving of application money |
The following actions have to be taken in the board meeting:Â
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|  7. |
Filing with the registrar of companies |
A return of allotment in Form- PAS-3 within 30 (thirty) days of the allotment has to be filed with the registrar of companies. Attachments:
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Rule 14 (6) of Companies (Prospectus and Allotment of Securities) Rules, 2018. |
|  8. |
Entry in the register maintained under Section 88 of the Companies Act, 2013. |
Entry has to be made in the company’s register of debenture holders, within 7 (seven) days after the board of directors approve the allotment of debentures. |
Rule 5 (1) of Companies (Management and Administration Rules, 2014). |
|  9. |
Issue of certificate |
The company has to issue the certificates to the allottees within 60 (sixty) days from the date of allotment of convertible debentures. |
Section 42 (6) of the Companies Act, 2013 states that the company shall a lot of securities within 60 (sixty) days. |
Issue of CCDs to non-residents under FEMAÂ
Foreign investors can invest in convertible debentures through the foreign direct investment route. To maintain/ monitor foreign exchange such investments have to comply with the following conditions.Â
(a). As per RBI guidelines, the conversion formula has to be determined at the time of the issuance of such debentures and it is to be noted that the price (at the time of conversion) is not lower than the fair market value.Â
(b). The agreement pertaining to the issue of convertible debentures should not contain optionality clauses (like put options) or if such clauses are present, then it must ensure compliance with RBI guidelines, i.e., minimum lock-in of 1 (one) year and investor exit at prevailing market price. The intention is that there should be no guaranteed exit price or assured returns in lieu of such investment.Â
Conclusion
Compulsorily convertible debentures are very lucrative investment options. Being a long term debt instrument, it attracts tax savings. Convertible debentures do not have any underlying collateral service as security. However, it must be noted that convertible debentures yield a lower interest as compared to pure debt instruments, like non-convertible debentures owing to the less risk associated with it.Â
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