Debentures and Bonds

I.            Debentures

 

Debenture is most important instrument and method of raising the loan capital by the company. A debenture is 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.

 

Section 2 (30) of the Companies Act, 2013 define inclusively 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.

 

The power to issue debentures can be exercised on behalf of the Company as a meeting of the Board under the provisions of Section 179 (3) of the Companies Act, 2013. Further Section 71 of the Companies Act, 2013 deals with the provisions relating to the issuance of debentures along with the penalties for non-compliance of the same which can be summarized as follows:

 

·         A company may issue debentures with an option to convert such debentures into shares, either wholly or partly at the time of redemption. Provided that the issue of debentures with an option to convert such debentures into shares shall be approved by a special resolution passed by the shareholders in a duly convened general meeting of the company.

 

·         Company can issue secured and unsecured debentures. Secured debentures may be issued by a company subject to such terms and conditions as may be prescribed. Further Company cannot issue any kind of debentures carrying any voting rights.

 

·         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 utilized by the company except for the redemption of debentures.

 

·         Company cannot 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 it has, before such issue or offer, appointed one or more debenture trustees.

 

·         A company shall pay interest and redeem the debentures in accordance with the terms and conditions of their issue.

·         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.

 

·         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.

 

Work required to done before calling of Meeting (for passing resolution):

·         Identify the person to whom you will issue Debentures.

·         Prepare the list of such persons to whom offer to subscribe debenture will give.

·         Prepare Draft offer letter under PAS-4.

·         Identify the debenture trustee (in case of offer for subscription is for more than 500 persons).

·         If there is requirement to appoint Debenture Trustee, then obtain the consent of such debenture trustee.

·         Ask the details from the Bank to open separate Bank Account.

·         Identify the assets of the Company on which charge will be creating (in case of issue of secured debenture).

·         Obtain the Valuation Report of the Property.

·         Obtain the valuation report of Chartered accountant for valuation of equity shares. ( In case of issue of convertible debenture)

 

II.            Bonds

Bonds, however, in India are typically issued by financial institutions, government undertakings and large companies. The interest rate is assured and is paid at a fixed interval, i.e. on an annual or semi-annual basis. On maturity, the principal is repaid. Bond is a form of loan. The holder of the bond is the lender and the issuer of the bond is the borrower.

 

There are many types of bonds, but only a few types are relevant to the Indian markets.

 

·         Deep discount bonds, also known as zero-coupon bonds, wherein there is no interest or coupon payment and the interest amount is factored in the maturity value. So, the issue price of these bonds is inversely related to their maturity period.

·         Corporate bonds are issued by companies and offer interest rates higher than bonds issued by public sector units and other financial institutions. The interest rate on these bonds is governed by their credit rating and higher the rating, lower is the interest rate offered by them.

·         Convertible bonds are another category wherein the bond holder has an option to convert the bonds into equity after a fixed tenor. These may be fully or partially convertible where only a part is converted and the other part matures.

·        Sovereign bonds which are issued by the government

Debentures and Bonds

 

Debentures and Bonds are similar except for one difference bonds are more secure than debentures. In case of both, you are paid a guaranteed interest that does not change in value irrespective of the fortunes of the company. However, bonds are more secure than debentures, but carry a lower rate. The company provides collateral for the loan. Moreover, in case of liquidation, bondholders will be paid off before debenture holders.

 

A Debenture is more secure than a stock, but not as secure as a bond. In case of bankruptcy, you have no collateral you can claim from the company. To compensate for this, companies pay higher interest rate to debenture holders. All investment, including stocks bonds or debentures carry an element of risk.

 

Both bonds and debentures get priority over shares when company is liquidated. However, if the bonds are secured, they get priority over unsecured debentures.