CHAPTER 8: DEBENTURE

DEFINITION AND MEANING OF DEBENTURE: Section 2 (30) of the Companies Act, 2013 defines a
debenture as "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".

In simple terms, a debenture may be defined as an instrument acknowledging a debt by a company to

some person or persons.

FEATURES/ CHARACTERISTICS OF DEBENTURE: The usual features of a debenture are as follows :-

1. A debenture is usually in the form of a certificate (like a share certificate) issued under the
common seal of the company.
2. The certificate is an acknowledgement by the company of indebtedness to a holder.
3. A debenture usually provides for the payment of a specified sum at a specified date.
4. A debenture usually provides for payment of interest until the principal sum is paid back. But
again, this is not essential. Interest may be made payable subject to contingencies of uncertain
nature.
5. A company shall not issue any debentures carrying voting rights. [Sec. 71(2)]
6. 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. [Sec. 71(12)]

KINDS OF DEBENTURE

Debenture may be of different kinds as follows :-

1. Redeemable Debentures: Debentures are generally redeemable, that is to say, they are issued on the
terms that the company is bound to repay the amount of debentures, either at a fixed date, or upon
demand, or after notice, or under a system of periodical drawings.

2. Secured and Unsecured/ Naked Debentures: Where debentures are secured by a mortgage or a
charge on the property of the company, they are called secured debentures. Where they are not secured
by any mortgage or charge on any property of the company, they are said to be naked or unsecured.

A company shall not issue secured debentures, unless it complies with the following conditions, namely;-
(a) An issue of secured debentures may be made, provided the date of its redemption shall not
exceed ten years from the date of issue. However, 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;
(b) Such an issue of debentures shall be secured by the creation of a charge on the assets of the
company, by way of either mortgage or hypothecation only, having a value which is sufficient for
the due repayment of the amount of debentures and interest thereon;
(c) The company shall appoint a debenture trustee before the issue of prospectus or letter of offer
for subscription of its debentures; and
(d) The company shall execute a debenture trust deed in Form No. SH.12 or as near thereto as
possible, within sixty days from the date of allotment of the debentures.

3. Convertible Debentures: Convertible debentures are those in which an option is given to the
Debenture holders to exchange a part or whole of their debentures for shares in the company under
certain conditions and limitations imposed regarding the period during which the option may be
exercised. This enables the investor to change his position from a debenture holder to a shareholder when
he finds that company is in a sound position financially and begins to make profit.

It may be noted that a company may issue convertible debentures subject to the approval of shareholders
by way of special resolution passed at a general meeting.

DEBENTURE TRUST DEED & DEBENTURE TRUSTEE [SECTION 71]

Meaning of Debenture Trust Deed: When debentures are issued for public subscription, involving a
considerable number of debenture holders, who do not have the time to look after their interests in the
properties mortgaged or charged to them, a trustee may be appointed for the supervision of their
common interest. A trust deed is made under which some person is appointed as trustee, whereby the
properties of the company are mortgaged or charged to trustee. The trust deed also contains provisions
dealing with the rights of the Debenture holders and the company. The trustees act as watchdogs to
ensure that company's obligations under the trust deed are carried out and they can act expeditiously and
effectively to safeguard the interests of the Debenture holders.

Advantages of a Trust Deed: There are several advantages of having a trust deed, some of which are as
follows :-
1. The trustees hold the title deeds of the mortgaged property, which prevents the company from
misusing the title deeds for any purpose.
2. The trustees are given, power under the trust deed so that the property mortgaged is kept insured
and is maintained in proper condition.
3. The company can, with the consent of the trustees, enjoy a number of powers over the property
charged, e.g., by way of sale, exchange or lease, thus enabling the company to put the property to
advantageous use without jeopardizing the interest of debenture holders.
4. In case of default by the company, the trustees can take necessary steps to realise the security
without the aid of the Court.

Appointment of Debenture Trustee: The company shall not issue prospectus to more than five hundred
persons without appointing a debenture-trustee. Thus, when the company issues prospectus or make an
offer or invitation to the public or to its members exceeding 500 for the subscription of its debentures,
then only it is required to appoint a debenture trustee.

The company shall appoint debenture trustees, after complying with the following conditions namely:-
 The names of the debenture trustees shall be stated in letter of offer inviting subscription for
debentures and also in all the subsequent notices or other communications sent to the
debenture holders;
 Before the appointment of debenture trustee or trustees, a written consent shall be obtained from
such debenture trustee or trustees proposed to be appointed and a statement to that effect shall
appear in the letter of offer issued for inviting the subscription of the debentures;

Disqualification of Debenture Trustee: A person shall not be appointed as a debenture trustee, if he—
(a) Beneficially holds shares in the company;
(b) Is a promoter, director or key managerial personnel or any other officer or an employee of the
company or its holding, subsidiary or associate company;
(c) Is beneficially entitled to moneys which are to be paid by the company otherwise than as
remuneration payable to the debenture trustee;
(d) Is indebted to the company, or its subsidiary or its holding or associate company or a subsidiary of
such holding company;
(e) Has furnished any guarantee in respect of the principal debts secured by the debentures or
interest thereon;
(f) Has any pecuniary relationship with the company amounting to two per cent, or more of its gross
turnover or total income or fifty lakh rupees or such higher amount as may be prescribed,
whichever is lower, during the two immediately preceding financial years or during the current
financial year;
(g) Is relative of any promoter or any person who is in the employment of the company as a director
or key managerial personnel;

Duties and Functions of Debenture Trustee: The functions of the debenture trustee shall generally be -
 To protect the interest of holders of debentures (including creation of securities within the
stipulated time); and
 To redress the grievances of holders of debentures effectively.

In particular, it shall be the duty of every debenture trustee to-

 Satisfy himself that the letter of offer does not contain any matter which is inconsistent with the
terms of the issue of debentures or with the trust deed;
 Satisfy himself that the covenants in the trust deed are not prejudicial to the interest of the
debenture holders;
 Call for periodical status or performance reports from the company;
 Communicate promptly to the debenture holders defaults, if any, with regard to payment of
interest or redemption of debentures and action taken by the trustee therefore;
  Appoint a nominee director on the Board of the company in the event of—
 Two consecutive defaults in payment of interest to the debenture holders; or
 Default in creation of security for debentures; or
 Default in redemption of debentures;
 Ensure that the company does not commit any breach of the terms of issue of debentures or
covenants of the trust deed and take such reasonable steps as may be necessary to remedy any
such breach;
 Inform the debenture holders immediately of any breach of the terms of issue of debentures or
covenants of the trust deed,
 Ensure the implementation of the conditions regarding creation of security for the debentures, if
any, and debenture redemption reserve;
 Ensure that the assets of the company issuing debentures and of the guarantors, if any, are
sufficient to discharge the interest and principal amount at all times and that such assets are free
from any other encumbrances except those which are specifically agreed to by the debenture
holders;
 Do such acts as are necessary in the event the security becomes enforceable;
 Call for reports on the utilization of funds raised by the issue of debentures;
 Take steps to convene a meeting of the holders of debentures as and when such meeting is
required to be held;
 Ensure that the debentures Have been converted or redeemed in accordancewith the terms of the
issue of debentures;
 Perform such acts as are necessary for the protection of the interest of the debenture holders and
do all other acts as are necessary in order to resolve the grievances of the debenture holders.

The meeting of all the debenture holders shall be convened by the debenture trustee on—
 Requisition in writing signed by debenture holders holding at least one-tenth in value of the
debentures for the time being outstanding;
 The happening of any event, which constitutes a breach, default or which in the opinion of the
debenture trustees affects the interest of the debenture holders.

Right to obtain copies of, and inspection of Trust Deed: Any member or debenture holder of the
company may inspect the debenture trust deed and take the extracts thereof, during business hours being
not less than two hours on every working day, without any fees.

Further, a copy of the trust deed shall be forwarded to every member or debenture holder of the company,
at his request, within 7 days of the making of the request, on payment of such fee as may be specified in
the articles of association of the company but not exceeding ten rupees for each page.

Liability of Trustee to Debenture holders: In general, a debenture trustee is liable to Debenture holders
for any type of breach of trust. However, he may escape the liability in the following cases : -
(i) Where the trustee can show that he took such care and diligence as required of him as a trustee
having regard to the powers, authorities and discretions conferred on him by the trust deed;
(ii) Where a majority of, not less than 3/4th in value, Debenture holders, present and voting in person
agree, at a meeting summoned for the purpose, with respect to specific acts or omissions of the
trustee.

REDEMPTION OF DEBENTURES [SECTION 71]

Debenture Redemption Reserve (DRR): The company shall create a Debenture Redemption Reserve for
the purpose of redemption of debentures, in accordance with the conditions given below—
(a) The Debenture Redemption Reserve shall be created out of the profits of the company
available for payment of dividend;
(b) The company shall create Debenture Redemption Reserve equivalent to at least fifty percent of
the amount raised through the debenture issue before debenture redemption commences.
(c) Every company required to create Debenture Redemption Reserve shall on or before the 30th
day of April in each year, invest or deposit, as the case may be, a sum which shall not be less than
fifteen percent, of the amount of its debentures maturing during the year ending on the 31st day
of March of the next year, in any one or more of the following methods, namely:—
 In deposits with any scheduled bank, free from any charge or lien;
 In unencumbered securities of the Central Government or of any State Government;
 In unencumbered securities/bonds mentioned in Indian Trusts Act, 1882;
 (d) The amount remaining invested or deposited, as the case may be, shall not at any time fall below
fifteen percent of the amount of the debentures maturing during the year ending on the 31st day
of March of that year;
(e) In case of partly convertible debentures, Debenture Redemption Reserve shall be created in
respect of non-convertible portion of debenture issue in accordance with this sub-rule.
(f) The amount credited to the Debenture Redemption Reserve shall not be utilised by the company
except for the purpose of redemption of debentures.

Failure in Redemption of Debentures: A company shall pay interest and redeem the debentures in
accordance with the-terms and conditions of their issue. 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 amounts as and when it becomes due, the debenture-trustee may file a petition
before the Tribunal and the Tribunal may by order, impose such restrictions as may consider necessary in
the interests of the debenture-holders.

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.

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.

REMEDIES TO DEBENTURE HOLDERS: The remedies to debenture holders vary according to whether he
is secured or unsecured.

If debentures are unsecured and the principal or any interest due in respect of a debenture is in arrears,
the debenture holder may :
 Sue the company according to the terms of issue as an unsecured creditor; and / or
 Present a petition for winding up of the company and prove his debt in the winding up as an
unsecured creditor for the amount due.

If debentures are secured on the assets of the company and the principal or any interest due in respect of
a debenture is in arrears, the debenture holder may :
(i) Sue, on behalf of himself and all other debenture holders,, to obtain payment or to enforce his
security by sale. The Court will appoint a receiver and order the sale of a property;
(ii) Present a petition for the winding up of the company, this is so even if the debentures are bearer
debentures;
(iii) Sell the assets charged as security, if an express power to do so is contained in the issue of
debentures;
(iv) Appoint a Receiver, if the conditions of the issue of debentures give him power to do so. The
Receiver will sell the property charged and the sale proceeds will be utilized for the payment of
the debentures;
(v) Apply to the Court for a foreclosure order. The effect of the order is to terminate the company's
interest in the assets charged, the debenture holders becoming the owners of them;
(vi) Have the property sold by the trustee, if the debenture trust deed permits such sale.

If debenture holder owes a debt to the company which is unable to pay its debentures in full, the
debenture holder cannot set off his debt against the liability he owes to the company. The rule of law is
that a person who claims a share of a fund must first pay everything he owes to the fund.

NOMINATION OF SECURITIES [SECTION 72]: Section 12 of the Companies Act, 2013 provides
nomination facility to the security holders -shareholders, debenture holders, depositors, etc.,

Section 72, in a nutshell, stipulates the following :-

(i) A security holder can, at anytime, make nomination by filling in and sending Form No.SH.13 to the
company. The nomination can be made only by individuals holding securities singly or jointly. If the
securities are held jointly, all the joint holders will sign the nomination form. Non - individuals
including a society, trust, body corporate, partnership firm, Karta of HUF and holder of Power of
 Attorney cannot nominate.
(ii) Once a nomination is made, the same will qua the company, override all claims from the legal heirs
under the succession certificate or from beneficiaries / executors under a will executed by the
deceased security holder.
(iii) If the nominee is a minor, security holder can also appoint any person to receive the amount /
benefits in the event of his death during the minority of the nominee. The person so appointed is an
alternative nominee and his authority comes to an end as soon as the minor nominee attains
majority.

Claim of Rights by Nominee: Following are the important provisions in this regard :-
(i) Upon death of the security holder, the nominee would be required to furnish the following
documents for the purpose of identification :-
a) Certified true copy of death certificate of security holder.
b) Proof of dale of birth of the nominee, in case the nominee is a minor.
c) An affidavit / declaration by the nominee declaring his rights.
d) The original security certificate (s).

The company, on production of the above documents, and on being satisfied about the identity of the
nominee, will request the nominee elect either to register himself as holder of security or to transfer the
security. The nominee is then required to issue a notice of election. If the nominee elects to be registered
as a holder of security, he shall send a notice in writing to the company stating that he so elects.
(ii) A nominee is not entitled to exercise his voting right but is entitled to dividend and other benefits
before being registered as a member. However, if the Board of Directors has issued a notice to the
nominee to elect and no election either to transfer or hold the security in his name is made within
a period of 90 days, the Board may withhold the payment of the dividend, bonus or other moneys
payable/accruing to the security holder.

Variation of Nominee: A nomination may be cancelled, or varied by nominating any other person in
place of the present nominee, by the holder of securities who has made the nomination, by giving a notice
of such cancellation or variation, to the company in Form No. SH.14.

The cancellation or variation shall take effect from the date on which the notice of such variation or
cancellation is received by the company.

ANSWER THE FOLLOWING (AS PER ICSI MODULE)

1. What are the restrictions imposed on the borrowing powers of the Board of directors? If a
company borrows beyond its powers, examine the remedies open to such creditor:
(i) When the money has not been spent;
(ii) When the money has been spent to pay the debts of the company.
2. What is the difference between debenture and a loan? Is fixed deposit a Debenture or Loan?
3. What is debenture? What are the kinds of debentures?
4. What is a convertible debenture? What are the provisions of the Companies Act, 2013 regarding
Convertible debentures or loans?
5. Is it compulsory to maintain a Debenture Redemption Reserve Account? If yes, how?