Long Note on Debentures

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What Is a Debenture?

A debenture is a type of bond or other debt instrument that is unsecured by collateral. Since debentures have no collateral backing, debentures must rely on the creditworthiness and reputation of the issuer for support. Both corporations and governments frequently issue debentures to raise capital or funds.

  • A debenture is a type of debt instrument that is not backed by any collateral and usually has a term greater than 10 years.
  • Debentures are backed only by the creditworthiness and reputation of the issuer.
  • Both corporations and governments frequently issue debentures to raise capital or funds.
  • Some debentures can convert to equity shares while others cannot.  

 

What are the Different Types of Debenture?

Two main types of debentures can be issued:

  1.  Convertible debentures:
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Interest-bearing bonds can be converted from debt into equity shares after a specific period. This is a special feature that corporations take advantage of because it can attract lenders and usually carries a lower interest rate for the issuing company.

2. Non-convertible debentures: 
Regular debt instruments that are not convertible into equity shares. However, to attract lenders and investors, these come with higher interest rates.

Debenture Trustee:

  • A debenture trustee is a person who safeguards the interest of debenture holders and serves as a liaison between the issuer company and the debenture holders.
  • Debenture trustee, in simple terms, means any person who is given the responsibility for issuing and distributing debentures. If any company is looking for raising the capital, then they can choose the option of issuing the stocks as a form of debt with a condition that the debt had to be repaid at a specific interest rate.
  • The debenture trustees keep in contact with different groups. They act as a middleman between the company that issued debentures and also those debenture holders who are collecting interest payments.
  • In Indian laws, the concept of a debenture trustee was introduced in the SEBI (Debenture Trustees) Regulations, 1993 (“Regulations“), which inter alia govern the eligibility criteria for registration with SEBI, code of conduct, and other regulations to monitor and review the working of debenture trustees. Later, the concept of debenture trustees and trust deed was also introduced in the Companies Act, 1956, by way of the Companies (Amendment) Act, 2000, only for the public issue of debentures.
  

 

Debenture Trustee’s Appointment: 

A company is required to appoint a debenture trustee when it issues a prospectus or makes a public offer. Also, an appointment is required when any company makes an offer to its members exceeding the number of 500 or more to subscribe for the debentures.

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If the issue of debentures is for a maturity less than 18 months then it is not necessary to appoint a debenture trustee. Now, the entities that can be appointed as a debenture trustee

are a scheduled commercial bank that carries any commercial activity, an insurance company, any financial institution, or a body corporate. These entities are required to be registered with SEBI.

Eligibility For Being  a Debenture Trustee:

  1. No person shall be entitled to act as a debenture trustee unless he is either—

(a) a scheduled bank carrying on commercial activity; or

(b) a public financial institution within the meaning of section 4A of the Companies Act, 1956; or

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(c) an insurance company; or

(d) body corporate.

Debenture Trustee’s Rights

All appointments to be made of the debenture trustee should be made under s. 71of the companies act,2013

  • Section-18 (c) of a company in no cases can issue dentures before the appointment of a debenture trustee.
  • The company cannot issue dentures before obtaining the consent of a debenture trustee.
  • The company as to specify the name of the denture trustee in the offer later.
  • The debenture trustee can call for a periodical performance report of the company.
  • The trustee can call for the reports regarding the use of funds raised through the issue of debentures.
  • The trustee can communicate promptly to the debenture holders’ defaults in any with regards to payment of interest or redemption of debentures and action taken by the trustee, therefore.
  • The trustee can appoint a nominee of the board of directors of the company.

Courts in India in case of Debenture Trustee’s Role:

Case 1: Central Bank of India v. Tadepalli Padmaja and others – In this case, the national consumer dispute forum on July 4, 2008, held that the petitioner bank failed to discharge its fiduciary duty with special care and skill as is expected from a professional corporate trustee and had not taken appropriate steps as contemplated under the SEBI regulations.

 

Case 2:  Baroda Rayon corporation ltd. V. ICICI ltd. – In this case, the Bombay high court upheld the right of the debenture trustee that ICICI ltd. to sell off a unit of Baroda rayon for the benefit of the debenture holder in respect of the certain debentures. 

 

Case 3: Canara Bank v. Apple finance ltd. – In this case, the suit was filed by the Canara Bank as a debenture trustee for amounts due and payable by the defendant Apple finance ltd (AFL)in respect of 7500 14% secured redeemable Rated Non-Convertible Debentures series (AAAII) for Rs 75 crores together with interests, cost, charges thereon. AFL failed to redeem the debentures and pay off the various loans granted by the debenture holder. Consequently, the plaintiff sued to obtain interim relief including the appointment of the court receiver. The Bombay High court held Canara’s bank right to sell AFL’S mortgaged property in the interest of the debenture holder.

Conclusion: Author’s viewpoint 

Issue of Debentures, whether redeemable or convertible, involves compliance with the substantive and procedural aspects of the law. Documentation is really important. the benefit of raising loan capital lies in the fact that it does not disturb the equity structure of the company and consequently the existing management. However, the success of a debenture issue be they private or public issue, depends, to a large extent, on the goodwill and rapport built up by the company with the investing public. Another aspect of the matter is the protection of interest of debenture holders. This is sought to be achieved by an independent debenture trustee who is required to be appointed by listed companies concerning the public issue or further issue of capital as the number of debenture holders is considerably large. The creation of DRR which is a statutory obligation is intended to provide liquid resources built out of the profit of a company for the redemption of debentures. In fine, as debenture has remained an easy source of finance for companies, the pace of their accountability has increased concomitantly. 

References:

  • https://www.sebi.gov.in/sebi_data/faqfiles/dec-2016/1482144051182.pdf
  • https://www.caclubindia.com/articles/debenture-trustee-27207.asp
  • https://www.slideshare.net/shantanu_leo/debenture-trustees
  • https://economictimes.indiatimes.com/markets/stocks/news/sebi-amends-debenture-trustee-regulations/articleshow/59596918.cms
  • https://www.sebi.gov.in/sebi_data/faqfiles/dec-2016/1482144051182.pdf

 

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