India: Secured NCD's Under Companies Act , 2013

A debenture is an instrument of debt executed by the company acknowledging its obligation to repay the sum at a specified rate and also carrying an interest. It is one of the methods of raising the loan capital by the company. A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the company's capital structure, it does not become share capital.

In general debentures are classified into various types such as redeemable, irredeemable, convertible, non convertible, fully, partly, secured, unsecured, tenure, redemption, mode of redemption, convertibility, security, transferability, type of interest rate, etc. In order to understand non convertible debentures, it would be better to understand the meaning of convertible debentures first. The convertible debentures as the name suggests are those debentures which are converted to equity shares of a company after a specified term. Such debenture earns regular income in form of interest up to the period they are converted to equity shares of the company. Hence non convertible debentures ('NCDs') can be regarded as those debentures which are not convertible to equity shares of the company after the expiry of a certain period.

Hence Secured NCDs are the ones which are backed up by some assets which can be liquidated for paying off the debenture holders in case the company issuing the same is not able to redeem them. For this reason, the returns on secured NCDs are lower than unsecured NCDs.

PROVISIONS UNDER ACT

Debentures as defined under the Companies Act, 2013 ('2013 Act') 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. The power to issue debentures can be exercised on behalf of the company at a meeting of the Board of Directors under the provisions of section 179(3) of 2013 Act.

Section 71 of Chapter IV of the 2013 Act deals with the provisions relating to the issuance of debentures along with the penalties for the non compliance of the same and can be read as follows:-

  1. A company may issue debentures with an option to convert such debentures into shares, either wholly or partly at the time of redemption:
  2. 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.
  3. No company shall issue any debentures carrying any voting rights.
  4. Secured debentures may be issued by a company subject to such terms and conditions as may be prescribed.
  5. Where debentures are issued by a company under this section, the company shall create a debenture redemption reserve account out of the profits of the company available for payment of dividend and the amount credited to such account shall not be utilised by the company except for the redemption of debentures.
  6. No company shall issue a prospectus or make an offer or invitation to the public or to its members exceeding five hundred for the subscription of its debentures, unless the company has, before such issue or offer, appointed one or more debenture trustees and the conditions governing the appointment of such trustees shall be such as may be prescribed.
  7. A debenture trustee shall take steps to protect the interests of the debenture holders and redress their grievances in accordance with such rules as may be prescribed.
  8. Any provision contained in a trust deed for securing the issue of debentures, or in any contract with the debenture-holders secured by a trust deed, shall be void in so far as it would have the effect of exempting a trustee thereof from, or indemnifying him against, any liability for breach of trust, where he fails to show the degree of care and due diligence required of him as a trustee, having regard to the provisions of the trust deed conferring on him any power, authority or discretion:
  9. Provided that the liability of the debenture trustee shall be subject to such exemptions as may be agreed upon by a majority of debenture-holders holding not less than three fourths in value of the total debentures at a meeting held for the purpose.
  10. A company shall pay interest and redeem the debentures in accordance with the terms and conditions of their issue.
  11. Where at any time the debenture trustee comes to a conclusion that the assets of the company are insufficient or are likely to become insufficient to discharge the principal amount as and when it becomes due, the debenture trustee may file a petition before the Tribunal and the Tribunal may, after hearing the company and any other person interested in the matter, by order, impose such restrictions on the incurring of any further liabilities by the company as the Tribunal may consider necessary in the interests of the debenture-holders.
  12. Where a company fails to redeem the debentures on the date of their maturity or fails to pay interest on the debentures when it is due, the Tribunal may, on the application of any or all of the debenture-holders, or debenture trustee and, after hearing the parties concerned, direct, by order, the company to redeem the debentures forthwith on payment of principal and interest due thereon.
  13. If any default is made in complying with the order of the Tribunal under this section, every officer of the company who is in default shall be punishable with imprisonment for a term which may extend to three years or with fine which shall not be less than two lakh rupees but which may extend to five lakh rupees, or with both.
  14. A contract with the company to take up and pay for any debentures of the company may be enforced by a decree for specific performance.
  15. The Central Government may prescribe the procedure, for securing the issue of debentures, the form of debenture trust deed, the procedure for the debenture-holders to inspect the trust deed and to obtain copies thereof, quantum of debenture redemption reserve required to be created and such other matters.

PROVISIONS UNDER RULES

The above mentioned section has to be read along with Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014 ('2014 Rules') which prescribes certain conditions to be fulfilled by a company in order to issue secured debentures and can be read as follows:-

  1. The company shall not issue secured debentures, unless it complies with the following conditions, namely:-

    1. An issue of secured debentures may be made, provided the date of its redemption shall not exceed ten years from the date of issue. Provided that a company engaged in the setting up of infrastructure projects may issue secured debentures for a period exceeding ten years but not exceeding thirty years;
    2. such an issue of debentures shall be secured by the creation of a charge, on the properties or assets of the company, having a value which is sufficient for the due repayment of the amount of debentures and interest thereon;
    3. the company shall appoint a debenture trustee before the issue of prospectus or letter of offer for subscription of its debentures and not later than sixty days after the allotment of the debentures, execute a debenture trust deed to protect the interest of the debenture holders ; and
    4. the security for the debentures by way of a charge or mortgage shall be created in favour of the debenture trustee on-

      1. any specific movable property of the company (not being in the nature of pledge); or
      2. (ii) any specific immovable property wherever situate, or any interest therein.

KEY CHANGES IN 2013 ACT

The provisions of section 71 of 2013 Act has replaced the provisions of sections 117, 117A, 117B, 117C, 118, 119 & 122 of Companies 1956 Act ('1956 Act'). While comparing the provisions with respect to the issuance of debentures under the Companies Act 2013 Act & Companies Act, 1956 following can be concluded:-

  1. The 2013 Act mandates a company to approve the issue of debentures with an option to convert the same into shares wholly or partly at the time of redemption by way of special resolution passed a general meeting. However there was no such provision under the 1956 Act.
  2. Company under the 2013 Act is allowed to issue secured debentures, if it fulfills the prescribed terms & conditions. However under 1956 Act, no such terms & conditions were prescribed.
  3. The 1956 Act mandates the appointment of debenture trustee in every public offer of debentures regardless of the number of the persons to whom the offer was made. However relaxation with respect to the same is provided under the 2013 Act by making the appointment of denture trustee compulsory only in the case when prospectus is issued to more than 500 persons for subscription of debentures.
  4. In case debenture trustee comes to the conclusion that the assets of the company are insufficient or likely to become insufficient then he or she may file petition before the Tribunal under the 2013 Act as compared to Company Law Board ('CLB') in 1956 Act.
  5. The penalty with respect to failure to comply with the orders of the Tribunal has been increased in the 2013 Act as compared to penalty prescribed under 1956 Act.
  6. Under 2013 Act, the provisions with respect to the re-issue of the debentures has been dispensed with.
  7. The 2013 Act, permits that a contract with the company to take up and pay for any debentures of the company can be enforced by a decree for specific performance.

CONCLUSION

The 2013 Act, permits a company to issue secured debentures by securing the issue of the same by way of creation of charge or mortgage on the property or assets (movable or immovable) of the company. However it is pertinent to note that the said Act restricts to secure such issue of debentures by way of creation of charge or mortgage in favor of the debenture trustee on any specific movable property of the company in the nature of pledge which means a company cannot pledge its movable property to secure its issue. It can be concluded from the above that the provisions relating to the issuance of secured debentures have became more stringent in the 2013 Act in respect to the compliance & disclosure requirements along with the impositions of strict penal provisions against the company in case of any default as compared to the 1956 Act meaning thereby a company has to be more cautious while planning to issue of secured debentures so that a it may not attract any penal provisions with respect to the same which can put the company in more trouble.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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