TOPIC: DEBENTURES – AN INTRODUCTION

Corporate Funding – Debt Capital

• Debt capital is an important source of funding for the corporates. Debentures are the most

popular form of debt capital. he provisions to issue debentures are covered under Section

71 of the Companies Act, 2013 and Rule 18 of the Companies (Share Capital and

Debentures) Rules, 2014.

• Deposits are also one of the sources available to a company to raise funds to meet the

short term or long term requirements of the company.

• Funding is crucial for corporates to invest and to expand and also to operate their daily

business. Some corporates rely more intensively on internal funds, while others rely more

intensively on external funding. The never-ending requirement for funds germinates from

the continuous business expansion undertaken by corporates.

• Funds could be in the form of equity or debt. Equity would mean the money provided by

shareholders, without any repayment clause or charge creation on the assets, whereas

debt would come along with repayment clauses, security for the loan and high finance

costs. Unlike Equity Financing, Debt Financing does not result in dilution of ownership;

but has higher costs associated with it.

• According to Section 2(30) of Companies Act, 2013, “debenture” includes 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. • Further it is provided that – (a) the instruments referred to in Chapter III-D of the Reserve

Bank of India Act, 1934; and (b) such other instrument, as may be prescribed by the

Central Government in consultation with the Reserve Bank of India, issued by a

company, shall not be treated as debenture

Types of Debentures

• Non Convertible Debentures (NCD): These instruments retain the debt character and

cannot be converted into equity shares.

• Partly Convertible Debentures (PCD): A part of these instruments are converted into

Equity shares in the future at notice of the issuer. The issuer decides the ratio for

conversion. This is normally decided at the time of subscription.

• Fully convertible Debentures (FCD): These are fully convertible into Equity shares at

the issuer’s notice. The ratio of conversion is decided by the issuer. Upon conversion the

investors enjoy the same status as ordinary shareholders of the company.

• Optionally Convertible Debentures (OCD): The investor has the option to either

convert these debentures into shares at price decided by the issuer/agreed upon at the time

of issue.

• Secured Debentures: These instruments are secured by a charge on the fixed assets of

the issuer company. So if the issuer fails on payment of the principal or interest amount,

his assets can be sold to repay the liability to the investors. Section 71(3) of the Companies Act, 2013 provides that secured debentures may be issued by a company

subject to such terms and conditions as may be prescribed by the Central Government

through rules.

• Unsecured Debentures: These instrument are unsecured in the sense that if the issuer

defaults on payment of the interest or principal amount, the investor has to be along with

other unsecured creditors of the company, they are also said to be naked debentures.

Unlike secured debentures ,unsecured debentures are issued by the Company without

creation of charge over the assets of the Company .In case a Company is unable to pay

the principal or interest on due date, these debentures do not offer any protection to the

debenture holders.

• Redeemable Debentures: It refers to the debentures which are issued with a condition

that the debentures will be redeemed at a fixed date or upon demand, or after notice, or

under a system of periodical drawings. Debentures are generally redeemable and on

redemption these can be reissued or cancelled. The person who has been re-issued the

debentures shall have the same rights and priorities as if the debentures had never been

redeemed.

• Irredeemable Debentures: A Debenture, in which no time is fixed for the company to

pay back the money, is an irredeemable debenture. The debenture holder cannot demand

payment as long as the company is a going concern and does not make default in making

payment of the interest. But all debentures, whether redeemable or irredeemable become

payable on the company going into liquidation. However, after the commencement of the Companies Act, 2013, now a company cannot issue perpetual or irredeemable debentures.