INTRODUCTION TO DEBENTURE AND BORROWING POWER

 

UNIT STRUCTURE

1. Learning Objectives
2. Introduction
3. Meaning and Types of Debenture
4. Features and Rules Relating to Debenture
5. Advantages and Disadvantages of Debenture
6. SEBI Guidelines in Issue of Debenture
7. Borrowing Powers of Company and Ultra-Vires Borrowings
8. Debenture Trust Deed
9. Let Us Sum Up
10.. Answers to check your progress
11. Further readings
12. Possible Questions.

LEARNING OBJECTIVES

 
After going through this unit, you will be able to:
define the meaning and types of debenture
explain the various features and methods of extinction of debenture
discuss the advantages and disadvantages to debenture
state the SEBI guidelines in issue of debenture

INTRODUCTION


In this unit, we will discuss debenture and its various important aspects along with borrowing powers of company. Debenture is a long-term agreement between the company and the debenture holders and a deed is executed to set the terms of borrowing. Such a deed is known as “trust deed”. Borrowing is incidental to trading. The power of a company to borrow is exercised by the directors. The issue of debenture is a particular mode of borrowing money by companies. The Companies Act does not contain any section expressly empowering companies to borrow. In some cases, the memorandum and the articles provide that the company shall be entitled to borrow. Sometimes, the power of borrowing is entrusted subject to certain limitations. Through this unit, learners can understand all the necessary aspects of debenture and the important provisions relating to borrowing powers of companies.

Meaning and Types of Debenture

Debenture is a written instrument signed by the company under its common seal acknowledging the debt due by it to its holders. Through this instrument the company promises to pay a specific amount of money as stated therein at a fixed date in future together with periodic payment of interest to compensate the holders for the use of funds.
According to Palmar “Debenture is any instrument under seal evidencing a deed, the essence of it being the admission of indebtedness.”

According to the Section 2(12) of the Companies Act, a debenture includes debenture stock, bonds and any other securities of a company, whether constituting a charge on the assets of the company or not. In simple words, it is a document which either creates a debt or acknowledge it. Debentures are commonly issued by the companies in the similar manner as issue of shares through prospectus.

Types of Debenture :-
Following are the different types of debentures -
(1) Bearer or unregistered debentures :- These are debentures which are payable to bearer. These are regarded as negotiable instruments and are transferable by delivery.
(2) Registered Debentures :- These are debentures which are payable to the registered holders whose names appear both on the debenture certificate and the company’s register of debenture holders. A debenture holder can transfer the debenture by following a prescribed procedure.

(3) Secured Debentures :- These debentures which create some charge on the property of the company are known as secured debenture.
(4) Unsecued debenture or naked debenture :- Debenture which do not have any charge on the assets of the company are known as unsecured or naked debentures and the holders of such debentures like unsecured creditors may sue the company for the recovery of the debt.

5) Redeemable Debenture :- These Debenture are usually issued on the condition that they shall be redeemed after a certain period of time.

(6) Perpetual Debentures :- When debentures are irredeemable they are called perpetual debentures. A debentures will be treated as irredeemable where either there is no fixed time for repayment of the principal amount or repayment of it is made conditional on the happening of an event which may not happen for an indefinite period or may happen only in certain specified and contingent events. e.g. the winding up of the company.

(7) Convertible Debentures :- The debenture holders may given an option to convert them into preference or equity shares after a certain period. If the holders excreise the right of conversion, they cease to be the lenders of the company and become the members of the company.


Features and rules relating to debenture


Following are the features of Debentures -
(1) Debenture has no maturely date. The principal amount of bond must be repaid at a definite time stipulated in bond and debenture, otherwise creditors may sue the company.

(2) Each debenture is numbered.

(3) Debenture is issued by a company and is usually in the form of a certificate which is an acknowledgement of indebtedness.

(4) Debenture is issued under the company seal.

(5) Debenture holders have claim over the assets of the company. They have legal recourse for enforcing their rights. For protecting their claims and assuring return, they may even put restriction on dividend payment.

(6) Each debenture contains a printed statement of the terms and conditions, such as the rate of interest, the time of payment of interest, the security against which the debenture is issued and what steps the debenture holder can take in case of non-payment of his dues.

(7) Debenture holders are creditors of the company. They do not have controlling power because they have no right to vote for the election of directors and for the determination of important managerial policies.

(8) Generally a debenture creates a floating charge on the assets of the company. e.g. charge which is enforceable upon nonpayment of the interest or principal on the due dates.

Rules relating to Debentures : -
Under various sections of the Companies Act, 1956, various important rules are provided relating to debenture which are mentioned below -

(1) Under Section 117, no debenture holder is to have any voting rights in company meetings. This applies to debentures issued after the commencement of the Act of 1956.

(2) Under Section 118, if there is a trust deed securing the issue of debentures, every debenture holder can have a copy of it on payment of a small fee.

(3) Under Section 119, the trustees in a trust deed securing the issue of debenture must exercise due care and diligence in the performance of their duties. Any provision in the deed exempting them from liability on this account is void.

(4) Under Section 120, debenture may be irredeemable or redemable on the happening of a contingency.

(5) Under Section 121, redeemed debentures can be reissued unless there is any provision to the contrary, whether express or implied in the articles or in the conditions of the issue of the debentures or in any contract entered into by the company or when the company has passed a resolution to that effect.

(6) Under Section 122, an agreement to take a debenture can be specificaly enforced.

(7) Under Section 123, debts of the company shall have priority over the claime of the share holders, which by the act receive preferential payment in case of winding up.
(8) Under Section 128, full particulars regarding the issue of debenture in series must be sent to the Registrar of Companies.

(9) Under Section 129, the particulars must include a statement of the commission paid.

(10) Under Section 482, there are certain limits on the amount of commission and brokerage that can be paid for the sale of debenture.

(11) Under Section 108-113, necessary rules pertaining to the transfer of debentures and share certificates are provided.

(12) Under Section 152 (1) every company shall keep a register of debenture holders entering therein particulars regarding the name, address and occupation of the debenture holders and dates on which the holding commenced or ceased.

(13) Under Section 152 (2) every company having more than 50 debenture holders shall keep an index of debenture holders unless the register of debenture holders is itself kept in the form of an index.

(14) Under Section 153, no notice of any trust express or implied or constructive shall be entered in the registar of debenture holders.

(15) Under Section 154, the register of debenture holders may be closed for not more than 45 days in the year and not more than 30 days at a time by giving at least 7 days notice through a local newspaper.

(16) Under Section 157 and 158, there may be a foreign register of debenture holders analogonus to the foreign register of members.


Advantages and Disadvantages of Debenture



Debentures are equal parts of the loan raised by the company just as share on equal parts of share capital. Debenture as a long-term finance plays a significant role in financial aspect of a company. The advatnages of debentures can be discussed as under -

Advantages to the Comapny :- Following are various advantages of debenture for the company.

(1) Lower Rate of Interest :- As compared to the rate of dividend to be paid for share, the rate of interest for the debenture is less. So, debenture is a cheaper source of finance for the company.

(2) Trading on Equity :- By issuing debenture a company can do trading on equity. Because the rate of interest on debenture is lower than the rate of dividend. So by issuing debenture, company can declare a high rate of dividend on equity shares.

(3) Freedom in Management :- Debenture holders are not given any right to control the affairs of the company. So, the company can raise the finance without surrendering control to the debentureholders.

(4) Tax Benefits :- The payment of interest on debentures is charged against profits of the company as per income tax rules whereas the payment of dividend is an appropriation of profit, hence no charge against profits. The profits of the company are reduced by the amount of interest paid to debentureholders which results in reducing the tax liability.

(5) Certainty of Finance : - Debentures are issued for a fairly long period. According to the new guidelines issued by the Government of India in 1982, the secured debentures shall not be redemmable before a period of seven years. Hence there is a certainty of finance for that specific period and the company may adjust its financial plans accordingly.

(6) Capital from Moderate Investors :- Company can collect the finance from such investors who prefer fixed income with-minimum risk rather than high rate of dividend with more risk

(7) During Depression :- During depression a company can easily collect the finance through the issue of debentures because the psychology of investors is affected by the trends in the stock market. During depression a company is not expected to earn high profits. Therefore investors are not willing to invest their funds in shares of the company.
(8) Controlling over-capitalisation :- The state of over capitalisation can be easily controlled by redeeming the redeemable debentures. In this way, it provides flexibility in the capital structure.

(B) Advantages to Investors :- Following are the advantages of debentures to the investors -

(1) Fixed and Stable Income :- Debentures carry a fixed rate of interest. An investor can estimate the income well in advance. Thus debentures provides a fixed, regular and stable source of income to debentureholders.

(2) Safety Investment :- Debentureholders have specific or general charge on the assets of the company and thus investment is quite safe.
(3) Liquidity :- Debentures are more liquid investment and have more ready market because they are safe and can be used as collateral security in taking loan from any financial institution.

(4) Conversion of Loan :- Debenture holders can convert their holdings in shares at appropriate time in case of convertible debentures.

Disadvantages of Debentures :- Following are the disadvantages of debentures ---

(A) Disadvantages to Companies :
(1) Fixed charges on Assets :- Debentures carry a fixed change on the assets of the company . Hence the company cannot raise further loan on such assets.
(2) Fixed Burden :- Interest payable on debentures is a change on the profits of the company. It will be paid even if their is no profit. Thus, it is a burden on the company especially when there is no profits or inadequate profits.
(3) Risk of Winding Up :- The debenture holders have a right to claim winding up of the company, in case, the interest on debenture are not paid by the company. So, issue of debenture is risky for the company.

(B) Disadvantages to Investors :-
(1) No Control :- Debentureholders are creditors and not the owners of the company and hence get no controlling authority over the affairs of the company.
(2) No extra profits :- Debenturesholders get a fixed income as interest irrespective of the quantum of profits earned by the company. They cannot claim more interest even if the company earns huge amount as profits.

LET Us Know
(i) The term debenture has come from the Latin word “debere”, which means “to owe”.
(ii) A private comapny cannot issue debenture to the public, have regard to Section 3 of the Capital Issue (Control) Act, 1947.
(iii) Section 292 of the Capital Issue (Control) Act. 1947, requires that the power to issue debentures must be exercised only at a meeting of the Board of Directors.

CHECK YOUR PROGRESS


A. Fill in the blanks -
(i) The power of a company to borrow is exercised by the .........
(ii) The name of registered debentureholders are mentioned both in the debenture ........... and company’s ............ of debenture.
(iii) When debentures are irredeemable they are called ................... debentures.


 

SEBI Guidelines in Issue of debenture


SEBI (Securities and Exchange Board of India) has issued several guidelines pertaining to issue of various kinds of debentures.
Under SEBI guidelines following points are laid down relating to issue of various kinds of debentures.
Section F : Fully Converfibte, Partially

Convertible and Non-convertible Debentures :-

(a) Issue of FCD. (Fully Convertiable Debeture) having a conversion period of more than 36 months will not be permissible, unless coversion is made optional with “put” and “call” option.

(b) Compulsory credit rating will be required if conversion is made for FCDs after 18 months.

(c) Premium amount on conversion and time of conversion shall be predetermined and stated in the prospectus. The interest rate of above mentioned debenture will be determined at the time of issue.

(d) Issues of debentures with maturity of 18 months or less are exempted from the requirement of appointment of debenture trustee or creating a Denbentures Redeemption Reserve (DRR).

(e) Any conversion in part or whole of the debenture will be optional at the hands of the debenture holder, if the conversion takes place at or after 18 months from the date of allotment, but before 36 months.

(f) In case of NCDs/PCDc, credit rating is compulsory where maturity exceeds 18 months.

(g) Premium amount at the time of conversion for PCD (Partially Convertible Debenture) shall be pre-determined and stated in the prospectus. Maturity amount, period of redeemption, on redeemption for the PCDs/NCDs shall be indicated in the prospectus.

(h) In case, the non-covertible portion of PCD/NCD one to be rolled over with or without changes in the interest rate, a compulsory option should be given to those debentureholders who want to withdraw and encash from the debenture programme.

(i) Before roll over of any NCDs or non-covertible portion of the PCDs, fresh credit rating shall be obtained within a period of six months prior to the due date of redeemption and communicated to debentureholders before roll over and fresh trust deed shall be made.

(j) Letter of information regarding roll over shall be vetted by SEBI with regard to the credit rating debenture holder resolution, option for conversion and such other items which SEBI may prescribe from time to time.

(k) SEBI may prescribe additional disclosure requirement from time to time after due notice.


Borrowing Powers of Company and Uitra-Vires Borrowings

Generally borrowing powers of a company are determined by the memorandum and the articles of association. That is why, depending upon the provisions of these two documents, a company, can borrow money. The memorandum and articles of a company may impose some restrictions on borrowing power of the company. In such a case, the company is to strictly observe these restrictions. Because, borrowing in excess of the limits laid down by the articles is ultra vires the company and not binding on it.

As because, the commercial transactions necessarily involve the giving and taking of credit, so a trading company has an implied power to borrow. Of course, such type of implied power is not entrusted to any non-trading company. In case of non-trading company, if their memorandum and atricles do not permit to borrow money, then their provisions of memorandum and articles should be altered before taking any step to borrow money.

Unless any of the following ways of borrowing money is prohibited, the company can take any one of them as a way of borrowing money, subject to power given by the memorandum and articles to borrow money.

i) Mortgage of immovable properties of the company.

ii) Hypothetication on mortgage of movable goods, including stock in trade and furniture, charge on uncalled capital, floating charge on all the assets of the company, mortgage of book debts, promissory notes, hundies and bill of exchanges, debentures and debenture stock, charge on patents, licences and copyrights and goodwill etc.

A company cannot borrow money on the security of its books of account because of the fact that these books of account are to be kept in the registered office and they are open for inspection. Besides on the security of the reserve capital, no company can borrow money.

Debenture Trust Deed


Generally debentures are secured by the trustees, conveying the property of the company to trustees, acting on behalf of debenture holders called debenture trustees. Besides changing the property, the Debenture Trust Deed contains provisions which set out the respective rights of the company and the debenture holders and the right interest between the debenture trustees and other parties in whose favour the charges may exist. It is customary to appoint a Bank Executor Trustee Company instead of individuals as trustees. As because such trust deed has some advantages, it is customary to execute a trust deed. On the basis of trust deed, the trustees are charged with the duty of looking after the rights and interests of debentureholders. In addition to that, the appointment of an agency facilitates the transactions relating to debentures such as the sale of the mortgaged property if necessary. The contract between the company and the debentureholder is contained in the Debenture Trust Deed. By executing the trust deed, the charges can be created. Moreover, the property forming the security can also be charged by way of mortgage in favour of the trustees on the basis of the Debenture Trust Deed. The terms and conditions of holding and enforcing security are also contained in the Debenture Trust Deed.

By the way of executing a trust deed between the trustees and the company, the company can create a trust by appointing trustees for debenture holders. A trust deed is created when debentures are supported with a floating charge or when the debenture stock is issued. In case of the total value of debenture or debenture stock is large, the creation of a trust is necessary. The Debenture Trust Deed sets out the respective rights of the company and debenture holders and their relations inter-se. The trust deed is an original contract which binds the company to the debenture holders. The Debenture Trust Deed contains the rights of debenture holders as well as the obligations of company.

Generally following provisions are included by the Debeenture Trust Deed:-
(i) Description of the properties pledged as security for debentures
(ii) Particular covenants of the borrowing corporations
(a) To preserve its continued existence and properties
(b) To insure property
(c) To arrange for the payment of taxes and stock assessments.
(d) To comply with all the legal provisions and
(e) To take action to resrtrict the increasing indebtedness of corporation
(iii) Description of redemption rights and procedure.
(iv) Description of conversion privileges and procedues in regard to convertible bonds
(v) Remedies for the trustees and debentureholders in the event of the corporation’s default in the payment of interest, principal and sinking fund installments or the event of a re-organisation and reconstruction
(vi) Enumeration of events on the happening of which the security will be enforceable. These are usually -

(a) Default in the payment of principal or interest.
(b) Winding up of the company.
(c) Breach of any terms by the company and
(d) Appointment of a receiver
(vii) The number of debenture holders necessary for approving any proposal relaing to them.

Let us Know
(i) Where the number of debenturesholders exceeds fifty, the company shall maintain index of debentureholders. However, if a depository keeps a register of beneficiary holders of debentures and the index thereto it shall be deemed to be a register of debenturholders and the index thereto.
(ii) Where the debenture to be issued are redeemable after 18 months from the date of issue, they must be rated by any recognised agency such as CRISIL or CARE. This rating should be disclosed in the prospectus.

CHECK YOUR PROGRESS


A. State whether the following statements are true or false -
(i) Issue of debentures with maturily of 18 months or less are exempled from the requriment of appointment of debenture trustee. (True or False)
(ii) Borrowing power of a comapny is determined by the memorandum and articles of the company. (True or False)
(iii) Debenture trustees act on behalf of debentureholders. (True or False)




LET US SUM UP


Debenture is an instrument issued by the company to raise funds. Diffenent types of debentures are Bearer debenture, Registered Debenture, Secured debenture, Unsecured debenture, Redeemable debenture, Perpetual debenture, Convertible debenture etc.

Regarding features of debentures, it can be mentioned that unlike stock debenture has no maturity date. Each debenture is numbered and debenture is issued by the company only under its own seal. Debenture holders have priority. Each debenture contains a printed statement of the terms and conditions. Debenture holders are the creditors of the company. Debenture creates a floating charge on the assets of the company. Debenture holders have no voting right.

Companies Act, 1956, provides various rules relating to debentures. Under Section 117, no debentureholder is to have any voting right in company meetings. Under Section 118, if there is a trust deed securing the issue of debenture, every debenture holder can have a copy of it on payment of a small fees. Under Section 119, the trustees in a trust deed securing the issue of debenture must exercise due care. Under Section 120 debenture may be irredeemable or redeemable on the happening of a contingency.
There are several advantages of debenture to company. Such as - Lower rate of interest, Trading on Equity, Freedom in management, Tax Benefits, Certainly of Finance, Capital from Moderate Investors, controlling over capitalisation, Consolidation of debt etc. The advantages of debenture to the inverstors are fixed and stable income, safety investment, liquidity etc.

Disadvantages of debenture to the compaines are - Fixed charges on assets, Fixed Burden, Risk of winding up etc. Disadvantages of debenture to the investors are no control, no extra profits etc.

Generally borrowing power of a company is determined by the memorandum and the articles of association. The memorandum and articles of a company may impose some restrictions on borrowing by fixing limilations on borrowing. Borrowing in excess of the limits is ultravires the company and not binding on it.

The Debenture Truest Deed contains provisions which set out the respective rights of the company and the debentureholders and the right inter se between the debenture trustees and other parties in whose favour the charges may exist.

ANSWERS TO CHECK YOUR PROGRESS


Answer To Check Your Progress1
A. (i) director (ii) certificate, register (iii) perpetual

Answer To Check Your Progress2
A. (i) True (ii) True (iii) True


FURTHER READINGS


(i) Commercial Law (Including Company Law and Industrial Law)
By Arun Kumar Sen and Jitendra Kumar Mitra
 

POSSIBLE QUESTIONS



1. Define Debenture ? What are the various types of Debentures.
2. Explain the important features of debentures. State the necessary rules relating to debenture.
3. Discuss the advantages and disadvantages of debenture.
4. Write short Note : (a) Borrowing power of a company
(b) Debenture Trust Deed.

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