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Debentures**

Meaning of Debenture (Section 2(30))

A debenture is a commonly used financial instrument issued by companies to raise long-term funds. It essentially represents a document acknowledging a debt owed by the company to the holder of the debenture. Unlike shares, which represent ownership, debentures represent a loan given to the company.

A debt instrument

A debenture is fundamentally a **debt instrument**. This means that the company issuing the debenture is borrowing money from the debenture holders. The debenture certificate serves as proof of this debt. The company is obligated to repay the principal amount to the debenture holders on a specified future date (or dates) and usually pay interest periodically until the principal is repaid.

Issued by a company acknowledging debt

When a company needs funds, it can issue debentures to the public or to specific investors. The debenture itself is a formal acknowledgement by the company that it owes a specified sum of money to the debenture holder. The terms and conditions of the loan, such as the principal amount, interest rate, date of repayment, and security (if any), are usually specified in the debenture certificate or a related document.

According to **Section 2(30) of the Companies Act, 2013**, the term debenture includes debenture stock, bonds and any other instrument of a company evidencing a debt, whether constituting a charge on the assets of the company or not. However, it specifically excludes:

In simpler terms, a debenture is a certificate issued by a company stating that the company has borrowed a certain amount of money from the holder of the certificate, and promises to repay the amount on a specified date and usually pay interest at a fixed rate periodically.


Types of Debentures

Debentures can be classified into various types based on different criteria. Understanding these types helps in appreciating the characteristics and risks associated with different debenture issues.

Secured vs. Unsecured

Secured Debentures:

These debentures are secured by a **charge** on the assets of the company. If the company fails to repay the principal amount or interest, the debenture holders have the right to recover their dues from the specified assets. The charge can be a **fixed charge** (on specific assets like land or building) or a **floating charge** (on assets which change in the ordinary course of business, like stock-in-trade or debtors). In India, as per the Companies Act, companies cannot issue debentures with a charge on its assets or undertaking unless it is created in favour of a Debenture Trustee.

Unsecured Debentures:

Also known as **Naked Debentures**, these debentures are not secured by any charge on the company's assets. Their repayment depends solely on the financial strength and creditworthiness of the company. In case of liquidation, unsecured debenture holders are treated as ordinary unsecured creditors, ranking below secured creditors (including secured debenture holders) but usually above preference shareholders and equity shareholders.

Convertible vs. Non-Convertible

Convertible Debentures:

These debentures give the holder the right to **convert** their debentures into equity shares of the company at a predetermined price or ratio after a specified period. This feature offers the debenture holder potential participation in the growth of the company's equity value. They can be fully convertible (the entire debenture amount is convertible) or partly convertible (only a portion is convertible, the rest remains as a debenture).

Non-Convertible Debentures (NCDs):

These debentures **do not** give the holder the right to convert them into equity shares. They remain as debt instruments throughout their tenure and are redeemed on maturity by repaying the principal amount. NCDs are a pure debt instrument, offering only fixed interest payments and principal repayment.

Redeemable vs. Irredeemable

Redeemable Debentures:

These are debentures which are repayable by the company on a specified future date or after a certain period, either in a lump sum or in instalments. Most debentures issued by companies are redeemable debentures.

Irredeemable Debentures:

Also known as **Perpetual Debentures**, these debentures are not repayable during the lifetime of the company. They are repayable only when the company goes into liquidation or when the company decides to repay them (if the terms allow). Such debentures are rarely issued now, particularly in India, as regulations often require a maturity period.

Other Classifications:

Registered vs. Bearer Debentures:

Registered Debentures: The names, addresses, and particulars of holdings of the debenture holders are recorded in a register maintained by the company. Transfer of these debentures requires registration with the company.

Bearer Debentures: These debentures are transferable by mere delivery. The company does not maintain a register of debenture holders. Interest and principal are payable to the person who produces the debenture certificate or interest coupon.

Specific Coupon Rate vs. Zero Coupon Rate Debentures:

Specific Coupon Rate Debentures: These debentures carry a fixed or floating rate of interest which is paid periodically (e.g., half-yearly or annually).

Zero Coupon Rate Debentures: These debentures do not carry a specific rate of interest. Instead, they are issued at a significant discount to their face value and redeemed at par. The difference between the issue price and the redemption value represents the interest to the debenture holder.


Debenture Trust Deed

When a company issues debentures to the public, especially secured debentures, it involves a large number of investors. It becomes impractical for the company to deal with each debenture holder individually regarding matters like enforcing security, ensuring compliance with terms, or managing redemption.

To address this, a **Debenture Trust Deed** is executed between the company and a **Debenture Trustee** (or Trustees). This deed is a legal document that contains the terms and conditions governing the debenture issue and defines the rights and responsibilities of the company, the debenture holders, and the debenture trustee.

Role of Debenture Trustee:

The Debenture Trustee acts on behalf of all debenture holders as a protector of their interests. Their main functions include:

The Companies Act, 2013, in India mandates the appointment of Debenture Trustees for public issues of debentures or private placement offers made to more than 50 persons. The provisions related to debenture trustees are primarily contained in **Section 71** of the Act and rules made thereunder.

The Debenture Trust Deed specifies details such as:

The appointment of a Debenture Trustee and the execution of a Debenture Trust Deed provide an added layer of security and protection for the debenture holders, especially small investors, ensuring their rights are safeguarded.


Debenture Redemption Reserve

The Debenture Redemption Reserve (DRR) is a reserve created out of the profits of the company for the purpose of redeeming debentures. The primary objective of creating a DRR is to ensure that sufficient funds are available with the company at the time of maturity of debentures to repay the principal amount to the debenture holders. It prevents the company from distributing all its profits as dividends, thereby safeguarding the interests of debenture holders.

Creation of DRR is a statutory requirement for certain classes of companies issuing debentures, as per the rules framed under the Companies Act, 2013. These rules specify the amount of DRR to be created, which is usually a percentage of the value of outstanding debentures. For example, historically, it was 25% of the value of debentures issued, but the specific rules have been revised over time for different types of companies (like listed companies, unlisted companies, banks, financial institutions, housing finance companies). It's crucial to refer to the latest rules for the exact percentage and applicability.

Purpose and Utilisation:

The amount transferred to DRR is essentially a portion of distributable profits that is retained in the business. This reserve is specifically meant for the redemption of debentures. The funds represented by the DRR can be used for:

Important Note: The amount in DRR cannot be used for distributing dividends or for any other purpose other than debenture redemption.

Investment of DRR Amount:

Companies are also required to invest or deposit a certain percentage (historically 15%) of the amount of debentures maturing in the coming financial year into specific liquid assets like bank deposits, government securities, or other approved securities. This ensures that readily available cash is there for redemption when debentures fall due.

Once the debentures are redeemed, the amount standing in the DRR can be transferred back to the General Reserve or Surplus (Profit and Loss Account).

Accounting Treatment:

The creation of DRR involves transferring a portion of profits from the Surplus (Balance in Statement of Profit and Loss) to the Debenture Redemption Reserve account. The journal entry typically is:

$ \text{Surplus (Balance in Statement of Profit and Loss)} \quad \text{Dr.} $
$ \quad \quad \quad \quad \text{To Debenture Redemption Reserve} $
$ (\text{Being amount transferred to DRR as per rules}) $

When debentures are redeemed, the entry to utilise DRR is:

$ \text{Debenture Redemption Reserve} \quad \text{Dr.} $
$ \quad \quad \quad \quad \text{To Debentures Account} $
$ (\text{Being amount of DRR utilised for redemption}) $

(Note: This entry is a simplification; the actual redemption entries involve Debenture Holders account and Bank account).

After redemption, the balance in DRR is transferred:

$ \text{Debenture Redemption Reserve} \quad \text{Dr.} $
$ \quad \quad \quad \quad \text{To General Reserve/Surplus} $
$ (\text{Being balance in DRR transferred after redemption}) $

Compliance with DRR requirements is essential for companies issuing debentures, as non-compliance can attract penalties.

Charges**

Meaning of Charge

In the context of company law and finance, a **charge** is a right created by a company over its assets or property in favour of a creditor (like a bank, financial institution, or debenture holder) to secure the repayment of a debt or the performance of an obligation. It essentially provides the creditor with a claim on specific assets of the company, which can be enforced if the company defaults on its debt.

The creation of a charge provides the creditor with a higher level of security compared to being an unsecured creditor. In the event of the company's liquidation or inability to repay, a charge holder has priority over unsecured creditors to recover their dues from the charged assets.

According to **Section 2(16) of the Companies Act, 2013**, "charge" means an interest or lien created on the property or assets of a company or any of its undertakings or both as security and includes a mortgage.

Security for debt owed by the company

This subheading precisely captures the core purpose of a charge. When a company borrows money or takes on other obligations, it can offer one or more of its assets as security. Creating a charge over these assets means that the creditor has a legally recognised right to sell or take possession of those assets to recover the outstanding debt if the company fails to pay. It reduces the risk for the lender, making it easier for the company to raise funds, often at lower interest rates compared to unsecured loans.

The assets that can be charged include tangible assets like land, buildings, plant and machinery, inventory, and intangible assets like book debts, goodwill, or intellectual property rights.


Types of Charges

Charges created by companies can be broadly classified into two main types based on the nature of the assets charged and the creditor's rights over those assets:

Fixed Charge

A **fixed charge** is a charge on a **specific, identifiable asset** of the company. The company cannot dispose of this asset without the permission of the charge holder (the creditor). The asset is clearly identified and defined at the time the charge is created.

Definition and Characteristics:

Assets Covered:

Typical assets covered by a fixed charge include:

Floating Charge

A **floating charge** is a charge on a **class of assets**, present and future, which in the ordinary course of the company's business, is constantly changing. Unlike a fixed charge, a floating charge does not attach to any specific asset within the class at the time it is created. The company is free to deal with these assets (buy, sell, consume, or charge them in the ordinary course of business) without needing the charge holder's permission.

Definition and Characteristics:

Assets Covered:

Typical assets covered by a floating charge include:

Crystallization of Floating Charge:

A floating charge becomes a fixed charge when an event occurs that triggers its conversion. This process is called **crystallization**. Upon crystallization, the charge attaches to the specific assets within the class that exist at that moment. Common events that trigger crystallization include:

Once a floating charge crystallizes, the company can no longer deal with the charged assets without the creditor's permission.

Comparison between Fixed and Floating Charge:

Feature Fixed Charge Floating Charge
**Attachment to Asset** Attaches to specific assets from creation. Floats over a class of assets; does not attach to specific assets until crystallization.
**Dealing with Asset** Company cannot deal with the asset without permission. Company can deal with assets in ordinary course of business until crystallization.
**Nature of Security** Static and specific. Fluid and general (over a class).
**Priority** Generally ranks ahead of a floating charge (unless the floating charge is created earlier and prohibits subsequent fixed charges, and the fixed charge holder has notice). Ranks below fixed charges and certain preferential payments (like employee wages) upon crystallization.
**Examples** Land, building, specific machinery, fixed deposits. Stock-in-trade, raw materials, book debts.

Registration of Charges (Section 77-87)

In India, the Companies Act, 2013, mandates the registration of certain charges created by a company with the Registrar of Companies (RoC). This is a crucial requirement to make the charge valid and effective against the liquidator and creditors of the company. Registration provides public notice of the charge, so anyone dealing with the company's assets is aware of the existing encumbrance.

**Section 77 of the Companies Act, 2013**, requires every company creating a charge on its property or assets situated within or outside India, on tangible or intangible assets, to register the particulars of the charge signed by the company and the charge holder together with the instruments, if any, creating such charge with the Registrar within a specified time.

Creation and modification of charges

Requirement and Time Limit:

When a company creates a charge, it is required to register it with the RoC within **30 days** of its creation using **Form CHG-1** (for charges other than those created by banks/FIs on working capital) or **Form CHG-9** (for creation/modification of charge for debentures) along with the necessary fees. The charge holder (creditor) can also file for registration if the company fails to do so.

If the registration is not done within 30 days, an application can be made to the Registrar for condonation of delay. The Act provides extended timelines for registration subject to payment of additional fees, which depend on the period of delay. As per the recent amendments and rules:

Forms and Procedure:

Registration involves filing the prescribed e-forms (CHG-1 or CHG-9) electronically with the RoC, attaching copies of the charge instrument (e.g., mortgage deed, debenture trust deed). The forms require details such as the date of creation, amount secured, description of assets charged, and particulars of the charge holder.

Once the RoC is satisfied that the forms and particulars are correct, it issues a **Certificate of Registration of Charge** in **Form CHG-2**. This certificate is conclusive evidence that the requirements of registration have been complied with.

Modification of Charge:

Any modification of the terms or conditions of a registered charge, such as changes in the amount secured, interest rate, or assets covered, must also be registered with the RoC using **Form CHG-3** within **30 days** of such modification. Similar provisions for condonation of delay apply to modification as well.

Consequences of non-registration

The registration of a charge is not merely a formality; it has significant legal implications. **Section 77(3) of the Companies Act, 2013**, states the primary consequence of non-registration:

Charge Void Against Liquidator and Creditors:

If a charge required to be registered under Section 77 is not registered within the prescribed time limit with the RoC, it becomes **void against the liquidator and any creditor of the company**. This means that if the company goes into liquidation, or if other creditors have claims, the unregistered charge holder will lose their priority and will be treated as an unsecured creditor. They will rank below secured creditors (whose charges are registered) and potentially even other unsecured creditors in some cases, making recovery of their debt difficult or impossible from the charged assets.

Charge Still Valid Against the Company:

It's important to note that while the unregistered charge is void against the liquidator and other creditors, it is **still valid as a contract of loan between the company and the charge holder**. The company is still obligated to repay the debt. However, the charge holder cannot rely on the security to recover the debt in priority over other creditors if the company faces financial distress or liquidation.

Penalty:

**Section 86** of the Act prescribes penalties for non-compliance. If a company fails to register a charge or its modification within the specified time, the company and every officer in default are liable to a penalty. Similarly, if a charge holder fails to file the charge after giving notice to the company, they are also liable to a penalty.

Furthermore, when a charge is satisfied (debt is repaid) or released, the company must inform the RoC by filing **Form CHG-4** within **30 days** of the satisfaction or release. The RoC then issues a Certificate of Satisfaction of Charge in **Form CHG-5**. Failure to register satisfaction can incorrectly show a charge exists on the company's assets, affecting its creditworthiness.

In summary, the registration of charges is a critical aspect of company finance and law. It ensures transparency, protects the interests of charge holders by giving them priority over charged assets, and provides public notice of encumbrances on the company's property.