07 Sep 2023
Debentures are a type of debt instrument issued by corporations, governments, or other entities to raise capital. They are essentially a form of borrowing where the issuer promises to repay the principal amount along with interest to the debenture holders on a predetermined date. Debentures are not backed by any specific collateral or assets; instead, they are backed by the general creditworthiness and reputation of the issuer.
There are several types/combinations of Debentures!
Secured and Unsecured Debentures
Secured and unsecured debentures are two different types of debentures based on the presence or absence of collateral that backs the debt.
- Secured debentures are backed by specific assets or collateral provided by the issuing company. In case the company defaults on its payments, the debenture holders have a claim on the designated assets that secure the debenture.
- Unsecured debentures, also known as “naked” debentures, are not backed by any specific collateral. If the company defaults on its payments, debenture holders do not have a specific asset to claim for repayment. They become part of the pool of unsecured creditors seeking repayment from the company’s available assets.
Redeemable and Irredeemable Debentures
Redeemable and irredeemable debentures are two types of debentures based on the repayment terms and maturity of the debt.
Redeemable debentures, also known as callable debentures, are debt instruments with a fixed maturity date. Irredeemable debentures, also known as perpetual debentures, do not have fixed maturity date and only becomes due in an event of the liquidation of the company.
Fully, Partially and Non-Convertible Debentures
Convertible debentures and non-convertible debentures are two main categories, while fully convertible, partially convertible, and non-convertible debentures are subcategories within these categories.
Convertible debentures are a type of debt instruments that can be converted into a pre-determined number of equity shares of the issuing company at a future date, as specified in the debenture agreement.
Fully convertible debentures are convertible into equity shares in their entirety while partially convertible debentures allow for the conversion of only a portion of the principal amount into equity shares.
Non-Convertible Debentures: Non-convertible debentures are debt instruments that cannot be converted into equity shares. These debentures do not offer the option for conversion into ownership in the company. They are purely debt instruments.
According to the Companies Act, 2013, any company shall not issue debentures carrying any voting rights. In case of issuing such debentures, company is supposed to create a debenture redemption reserve account from the profits of the company solely available for payment of dividends. This profit shall not be utilised by the company for any other purposes except for redemption of debentures.
Issuance of Compulsory Convertible Debentures
Compulsory Convertible Debentures (CCD’s) are a specific type of debentures that companies can issue, and they have unique characteristics compared to traditional debentures. These debentures must be converted into equity shares a per the terms and conditions specifies in the debenture agreement.
The issuance of CCD’s is subject to regulatory norms and approval processes prescribed by regulatory authorities such as the Securities and Exchange Board in India (SEBI) in the case of India. Companies must adhere to rules and regulations related to the issuance of CCDs to ensure compliance.
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.
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.
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
|Reference Statute/ Rules
|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.
|Convening meeting of Company’s board of directors
The following actions have to be taken in the board meeting:
- Approval of draft offer letter to be privately placed in Form no. PAS-4
- Approval of draft for private placement offer in Form No. PAS- 5.
- Consider the valuation report by a registered valuer for setting out conversion rate for CCDs to equity shares of a company.
- Open a separate bank account for receiving subscription money for issues of CCDs.
- To authorize directors of a company to complete all filings with relevant government authorities.
- To pass a resolution for the approval of notice for calling a general meeting of company shareholders and authorizing company secretary or directors of the company to issue the same.
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
|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.
|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.
|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.
|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.
|Convening meeting of company board of directors after receiving of application money
|The following actions have to be taken in the board meeting:
- Pass special resolution for increasing the borrowing limit of the company to issue debentures (if applicable).
- Pass special resolution for the allotment of CCDs.
- Pass resolution for issue of letter of allotment/certificates to the allottees.
- Authorise two directors of the company to sign the certificates
- Obtain approval for filing Form- PAS-3.
- Obtain approval for filing Form- FC-GPR (Foreign Collaboration- General Permission Route) (if debentures are issued to a person resident outside India).
- Obtain approval for filing FIRC (Foreign Inward Remittance Certificate) (if debentures are issued to persons resident outside India).
|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.
- List of allottees
- Board resolution for allotment
- Valuation report
- Copy of special resolution passed.
Rule 14 (6) of Companies (Prospectus and Allotment of Securities) Rules, 2018.
|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).
|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 FEMA
The Reserve Bank of India (RBI) is the regulatory authority responsible for overseeing foreign exchange transactions in India, including the issuance of securities to non-residents.
- As per RBI guidelines, at the time of issuance of CCDs to non-residents, conversion formula has to be determined to make sure that at the time of conversion price of debentures is not lower than the fair market value.
- The agreement made at the time of issuance of CCD should not have any optionality cause. If such clause is present then it should be in compliance with the RBI guidelines. The investor should have minimum lock-in period of one year and shall exit at a prevailing market price. These conditions are put with an intention of ensuring no guaranteed exit price or assured returns in lieu of such investments.
CCDs are a lucrative investment option. For the issuing company, CCDs provide a way to raise capital in the form of debt while ensuring that the debt eventually converts into equity, thereby strengthening the company’s equity base. CCDs can be attractive to investors as they offer the potential for capital appreciation through equity ownership while providing some downside protection in the form of debt.