Company Law: Understanding Debentures and Their Types 

By Anushi Mandlecha 12 Minutes Read

Introduction  

Corporate organization requires funds to fulfil its need. Funding is crucial for corporations to invest, expand and operate their daily business. Some corporations 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 corporations. A capital can be issued by raising funds from the public in the form of Equity Shares. The person who holds these shares is known as Shareholder and is the owner of the company. As Equity funds most of the times are not adequate and the organization is resorted to external resources for arranging capital that is External Commercial Borrowing, Debentures, Bank Loan etc. The loans are raised by the corporate sector by the way of issuance of debentures. The Amount of loan can be divided into units of small denominations and the company can sell them to the public. Each unit is called a Debenture and the holder of such units is called a ‘Debenture holder’. The amount raised is a loan for the company. 

Debenture is an acknowledgment of the funds received by the company equal to the nominal value of the debenture. It includes the payment of interest at a fixed rate till the time the principal sum becomes repayable.  

The company Act 2013 does not provide Exhaustive definition of Debentures but provides inclusive definition. According to Section 2(30) of Companies Act 2013 Debentures 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 company normally pays interest to debenture 

holders at the end of each year before maturity, but if it is unable to pay either the interest or the principal amount of the loan, the creditors of the company have the right to request the competent authority that the company be liquidated to recover their money by selling the company’s properties. 

Characteristics of Debenture

1. Debentures of the Company are movable property which will be transferable as per the provisions given in the Articles of Association of the company. 
2. The debenture holders are creditors to the company and they do not have any claim of ownership of the company unlike shareholders. The company is only under debt of the debenture holders. 
3. Debentures usually have a charge on the assets of the company, which means that if the company on liquidation is not able to repay the amount the debenture holders can sell off property of the company to recover money. 
4. The company has committed to repay the principal amount along with interest to debenture holders at a specified time. 
5. Debenture holders cannot claim the special right to vote in any meeting of the company. 
6. When the company is winding up, the priority of the company is to repay the debenture holders of the company as per the applicable law hence, there is no risk involved in loss of money of the debenture holders. 

Types Of Debentures  

On The Basis of Convertibility of Instrument 

1.  Non-Convertible Debentures (NCD) – These instruments retain the debt character and cannot be converted into equity shares. In other words these are basic kinds of debentures which can never be converted into stocks after they have been issued and till the time they exist.
2. Partly Convertible Debentures (PCD) –A part of these instruments is 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. 

3. 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. In the case of Canning Industries Cochin Ltd. V. Securities and Exchange Board of India¹, it was held that 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.

4. 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. 

On the basis of Security of Instrument 

1. Secured Debenture – 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 specified by the government. 

             This security on debentures may be of two types: 

1. Fixed Charge    
2.  Floating Charge.

1. Fixed Charge – It refers to specific assets of the company.
2. Floating Charge- It refers to all the assets of the company.

2. Unsecured Debentures – These instruments 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. 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 the due date, these debentures do not offer any protection to the debenture holders. 

             These are very risky for the investors as they do not carry any security or charge as the company only promises to pay the debt amount and interest and does not create a liability on assets by way of  attachments in case of default.

On the basis of Redemption ability

1. Redeemable Debentures – The debentures which are issued with the option of redemption on demand or after serving notice or at a fixed date or through a system of periodical drawing. Usually, debentures are of redeemable nature and after redemption they can either be cancelled or can be reissued. The priorities and rights of the person who is reissued the debentures shall be same as the debentures were never redeemed. 

For example – If the debenture’s maturity period is 7 years it will be redeemable on the expiry of 7 years. 

2. Perpetual or 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. 

On the basis of Registration of Instrument

1. Registered Debentures –Registered debentures are made out in the name of a particular person, whose name appears on the debenture certificate and who is registered by the company as holder on the Register of debenture holders. Such debentures are transferable in the same manner as shares by means of a proper instrument of transfer duly stamped and executed and satisfying the other requirements.  

2. Bearer debentures – Bearer debentures on the other hand, are made out to bearer, and are negotiable instruments, and so transferable by mere delivery like share warrants. The person to whom a bearer debenture is transferred becomes a “holder in due course” and unless contrary is shown, is entitled to receive and recover the principal and the interest accrued thereon. In a case Calcutta safe deposit Co. ltd vs Ranjit Mathuradas Sampat² the Calcutta High Court observed that the debenture holder is entitled to recover the principal and interest in case of due. 

Conclusion

Therefore, it could be concluded that Debentures is a medium- to long-term debt instrument used by large companies to borrow money, at a fixed rate of interest. A debenture is thus like a certificate of loan or a loan bond evidencing the company’s liability to pay a specified amount with interest. According to 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. There are various types of debentures such as Secured Debentures, Unsecured Debentures, Redeemable debentures, Irredeemable Debentures, Convertible Debentures, Non-Convertible Debentures, Partly Convertible Debentures, Registered Debentures, Bearer Debentures etc.  

1. Appeal No.115 of 2019 ↩︎
2. AIR1971CAL78, [1971]41COMPCAS1063(CAL), AIR 1971 CALCUTTA 78 ↩︎

Anushi Mandlecha