Introduction to Debentures
Debenture: If a company needs funds for extension and development purposes without increasing its share capital, it can borrow from the general public by issuing certificates for a fixed period of time and at a fixed rate of interest. Such a loan certificate is called a debenture. But there is one more hidden benefit is there that a debenture can be issued at a Zero 0% interest rate.
In the realm of finance and investment, where interest rates often dictate the allure of securities, a fascinating avenue emerges – the issuance of debentures at a 0% rate of interest. This concept challenges traditional norms, sparking intrigue among investors and financial enthusiasts alike. In this article, we delve into the intriguing world of zero-interest debentures, unraveling their mechanics, implications, and the broader economic landscape they navigate. As we traverse this financial terrain, we’ll uncover the reasons behind their issuance, their potential benefits, and the impact they wield in a realm shaped by interest rates and investment strategies.
In the dynamic world of the stock market, debenture is an essential financial instrument that plays a crucial role in the capital structure of a company. For beginners looking to navigate the complexities of the stock market, understanding debentures is imperative. This essay aims to provide a comprehensive overview of debentures, including their definition, types, benefits, and guidelines for their issuance.
Debentures are offered to the public for subscription in the same way as for issue of equity shares. The Companies act does not provide for an exhaustive definition of debentures but an inclusive definition. Let get started for a simplified understanding of debentures.
Table of Contents
Governing Laws:
As per the definition of debenture given in Section 2(30) of the Companies Act 2013 “Debenture includes debenture stocks, bonds or any other instruments of a Company evidencing a debt, whether constituting a charge on the assets of the Company or not”.
This section proves that the company has right to issue bonds or debenture which are instruments as a debt, which can be both secured or unsecured by the way of creating a charge on the assets of the company.
In India, debentures, which are debt instruments issued by companies to raise capital, are governed by a comprehensive regulatory framework that ensures transparency, accountability, and protection for both issuers and investors. The primary laws and regulations governing debentures in India include:
- Companies Act, 2013: The Companies Act is a cornerstone of corporate law in India. It lays down the legal framework for the issuance, redemption, and terms of debentures. It specifies the procedures companies must follow while issuing debentures, the types of debentures that can be issued, and the rights and obligations of debenture holders.
- SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015: The Securities and Exchange Board of India (SEBI) regulates the securities market, including debentures. These regulations mandate that companies seeking to list their debentures on stock exchanges must adhere to disclosure norms, corporate governance practices, and provide regular updates to the investors.
- SEBI (Issue and Listing of Debt Securities) Regulations, 2008: These regulations specifically pertain to the issuance and listing of debt securities, including debentures. They outline the eligibility criteria for companies to issue debentures, the procedures for issuance, and the disclosure requirements.
- SEBI (Debenture Trustees) Regulations, 1993: These regulations establish the role of debenture trustees, who act as intermediaries between the issuer and debenture holders to safeguard the interests of the debentureholders. They set forth the qualifications and responsibilities of debenture trustees.
- Indian Contract Act, 1872: The provisions of the Indian Contract Act are relevant in determining the enforceability of the terms and conditions mentioned in the debenture trust deed between the issuer and the debenture holders.
- Depositories Act, 1996: If debentures are issued in dematerialized form (electronic form), the provisions of this act come into play. It provides for the establishment of depositories to facilitate electronic holding and transfer of securities.
- Income Tax Act, 1961: The Income Tax Act governs the taxation aspects related to debentures, including the tax treatment of interest income earned by debenture holders and the tax implications of capital gains arising from the transfer of debentures.
- RBI Guidelines: The Reserve Bank of India (RBI) also issues guidelines related to the issuance of debentures, especially for non-banking financial companies (NBFCs) and other financial institutions.
Section 71 of the Companies Act, 2013 permits a company to issue debentures with an option to convert such debentures into shares, either wholly or partly at the time of redemption; Provided that, the issue of debentures with an option to convert such debentures into shares, wholly or partly, shall be approved by a special resolution passed at a general meeting.
Defining Debentures
A debenture is a long-term debt instrument issued by a company to raise capital. Essentially, when an entity issues debentures, it is borrowing money from investors and promising to repay the principal amount along with interest at a predetermined future date. Unlike shares, which represent ownership in a company, debentures represent a creditor’s stake, entitling the holder to interest payments and the return of the principal amount.
Some Hit-shots about Debenture:
| Debenture is a movable property. It is in the form of a certificate of indebtedness of the company and issued by the company itself. It generally creates a charge on the undertaking or undertakings of the company. There is usually a specific date of redemption. |
| The debenture holders are creditors to the company and they don’t have any claim of ownership of the company unlike shareholders. The company is only under debt of the debenture holders. |
| The debenture holder need not be concerned with the profits or loss of the company, they have a fixed rate of interest on the principal amount which they get every year irrespective of the financial condition of the company. |
| As the debenture holders are not the owner of the company so they are not entitled with the administration and management of the company. |
| Debentures usually have a charge on the assets of the company, which means that if the company on liquidation is not able to repay the amount the debenture holders can sell of property of the company to recover money. |
| The debenture holders cannot claim the privilege to vote in any meeting of the company. |
| There is an undertaking given by the company to repay debenture holders the principal amount along with the interest at the state time. |
| When the company is winding up, the first priority of the company is to repay to the debenture holders of the company hence, there is no risk involved of loss of money of the debenture holders. (Subject to certain Condition) |
| There is a series with pari passu clause which is usually a part of the debentures being issued and it would be equal as security and if the security is being enforced, the amount shall be discharged relate ably. If there is deficiency of assets, the division will be proportionately. |
Kinds of Debenture:
Debentures are generally classified into different categories on the basis of:
| (1) Convertibility of the instrument | (2) Security of the instrument | (3) Redemption ability | (4) Registration of Instrument |
| Fully Convertible Partly Convertible Optionally Convertible Non-Convertible | Secured Unsecured | Redeemable Perpetua Redeemable. | Registered Bearer |
Guidelines for Issue of Debentures:
The manner of issuing of debentures is usually similar to that of issuing share, it is through prospectus inviting applications for debentures, the money is to be paid in installments on application, allotment and on specific dates.
Debentures can, be issued in the following three ways.
| AT PAR | AT PREMIUM | AT DISCOUNT |
| When the amount collected for it is equal to the nominal value of debentures, it is said to have been issued at par. e.g. the issue of debentures of Rs. 100/- for Rs. 100/- | A debenture is said to be issued at a premium, when the price charged is more than its nominal value. e.g., issue of debentures of Rs. 300 each for Rs. 320, the excess amount over the nominal value i.e., Rs. 20 is the premium on issue of debentures. | When the amount collected is less than the nominal value, debenture is said to have been issued at discount. For e.g., issue of debentures of Rs. 300/- for Rs. 270/-. The difference of Rs. 30/- is the discount and is called discount on issue of Debentures. |
Note: The debentures issued on discount will amount to Capital loss and issue of debentures at Premium is Capital gain.
Guidelines for the Issuance of Debentures
The manner of issuing debentures is similar to that of issuing shares. The process involves the following steps:
- Preparation of Prospectus: The company must create a detailed prospectus that outlines the terms and conditions of the debentures being offered. This includes information about the company, its financials, and the purpose for which the funds will be utilized.
- Inviting Applications: The prospectus is then made available to the public, inviting applications from potential debenture holders.
- Payment in Installments: The application money for debentures is typically paid in installments. This includes an initial amount on application, followed by allotment and on specific dates as outlined in the prospectus.
- Allotment of Debentures: After the application period, the company allocates the debentures to successful applicants.
- Listing on Stock Exchange: If the debentures are to be traded on a stock exchange, the company must apply for listing.
Steps to Issue Debentures:
| Convene Board Meeting to approve type of debentures and Calling of EGM. And in case of Private Placement of Debentures approval of PAS 4 offer letter and Approval of PAS 5 record of private placement. |
| Drafting and Approval of Debenture Subscription Agreement. According to the agreement, the company shall create a Debenture Redemption Reserve account from the profits of the company available for payment of dividend. Also, the amount credited to such account should be utilized only for the redemption of Debentures. |
| Dispatch Notice of General Meeting to the members of the company. The Notice period should be of at least 21 clear days in accordance with Section 101(1) of the Companies Act and Secretarial Standard -2. |
| In case of secured debentures, following additional approvals shall also be required to be taken: Consent of Debenture Trustee to act as a debenture trustee. Approval of Terms and conditions for appointment of Debenture Trustee and agreement thereof. Authorise creation of charge to secure debentures. |
| Convene General Meeting of Shareholders for approval of the issue of Debentures. |
| In case, the money to be borrowed, together with the money already borrowed, exceeds the limits specified under section 180(1)(c), approval to increase the said limit shall also be taken. |
| Dispatch Letter of Offer and Opening of Bank account to receive subscription money from investors to the debenture issue. |
| Forms to be submitted with the Registrar of Companies: PAS 4 And PAS 5 to be submitted by attaching it to GNL 2 MGT-14 for Filing Special Resolution. CHG 9 for creation of charge in case of issue of secured debentures. |
| Convene and hold a Board meeting to consider and approve the following items: The Board shall make allotment of debentures issued to the applicants and file return of allotment with the Registrar of Companies, in PAS-3. |
Benefits of Debentures
- Fixed Returns: Debenture holders receive a fixed interest rate, providing a predictable stream of income.
- Lower Risk: Compared to investing in equities, debentures are considered lower risk since they are backed by the company’s assets.
- Diversification: Including debentures in an investment portfolio can help spread risk and balance overall returns.
- Liquidity: Depending on market conditions, debentures can often be bought or sold on the secondary market.
Time Limit to Issue Debenture Certificate:
As per Section 56(4) of the Companies Act, 2013 debenture certificate must be issued within a period of 6 months from the date of allotment.
As per Section 56 (6) If a Company failed to issue Debenture Certificate withing prescribed time limit then it shall be made liable to pay a fine minimum of 25,000 rupees which may extend to 5,00,000 rupees. The officer who is in default shall by punished with a fine which is 10,000 rupees minimum and extending to 1,00,000 rupees.
Conclusion
With a wide array of specifications in this form of security while investing in such security investors should take the precaution of background check of the company as there are a number of shell companies that issues debenture collect the amount and withdraw the same.
The investor is left with no option except NCLT but that may not guarantee of Complete return on investment, this generally happens when a company fails to pay the interest rates at the initial stage.