Debentures may be either secured or unsecured. When secured, they are backed by a charge against the property or asset of the company, or that of its holding, subsidiary, or associate companies. The value of such assets must be sufficient for the repayment of non-convertible debentures (NCDs) and the interest due on them. Creation of a security interest ensures that the debenture holder has the rights of a secured creditor, enhancing their protection in case of default.
Nature of Assets on Which Charge Is Created
The security for debentures can be created through a charge or mortgage in favor of the debenture trustee. This can be done on any specific movable property of the company or its group entities, or any specific immovable property, regardless of its location or any interest therein. In the case of non-banking financial companies (NBFCs), it is often difficult to identify specific movable properties, as their primary assets are book debts or receivables. Therefore, NBFCs may create a charge on any movable property.
Exception from Creation of Security Interest
Government companies issuing debentures that are fully guaranteed by the Central Government or one or more State Governments are not required to create a charge. Additionally, when a subsidiary company takes a loan from a bank or financial institution, the charge may be created on the assets of the holding company.
Tenure of Secured Non-Convertible Debentures
The general rule allows secured NCDs to have a tenure of up to 10 years from the date of issue. However, certain companies are permitted to issue NCDs with a maturity of up to 30 years. These include companies engaged in infrastructure projects, infrastructure finance companies, and infrastructure debt fund NBFCs. Also included are companies that are permitted by a Ministry or Department of the Central Government, or by regulatory authorities like the Reserve Bank of India or National Housing Bank, to issue debentures exceeding the standard 10-year limit.
An infrastructure finance company refers to an NBFC that allocates at least 75 percent of its total assets to infrastructure loans. An infrastructure debt fund NBFC must be a non-deposit taking NBFC with a net owned fund of INR 300 crores or more, investing only in public-private partnership and post-commencement infrastructure projects that have completed at least one year of satisfactory commercial operations and are part of a tripartite agreement.
Registration of Charge
When a security interest is created, resulting in a lien or encumbrance over the assets of a company or its undertakings, it must be registered with the Registrar of Companies by section 77(1) of the Companies Act, 2013. This requirement also applies to companies acquiring assets that are already subject to a charge. Additionally, any changes in the terms, extent, or operation of a registered charge must also be registered.
If the issuing company fails to register the charge, the charge-holder may do so under section 78 of the Companies Act. Registration provides conclusive evidence of the creation of a charge and serves as public notice of the charge-holder’s interest in the charged asset. Third parties are thus subject to the interest of the charge-holder when dealing with such assets.
Examples of Modification of Charge
Several instances may necessitate the modification of an existing charge. These include changes in the amount of NCDs raised under a shelf disclosure document, the creation of additional security over different property for the same set of NCDs, release of a particular asset due to part redemption of debentures, inclusion of another creditor as a charge-holder with or without further issuance, or adjustments in the interest rate, tenure, or other terms of the charge.
Timelines for Registration
The Companies Act sets specific timelines for registration of charges. Following amendments introduced by the Companies (Amendment) Act, 2017, effective from November 2, 2018, a company must file Form CHG-9 within 30 days of the charge’s creation or modification. If this period is exceeded, the Registrar may allow a further 30-day extension upon application and payment of additional fees. Beyond 60 days, registration is still permitted for an additional 60 days, provided an ad valorem fee is paid.
For instance, if a charge was created on February 1, 2020, and the amount secured is INR 1000 crores, the registration would follow the below fee structure. If filed within 30 days (i.e., by March 1, 2020), no extra fee applies. If delayed up to 60 days (by March 30, 2020), additional and ad valorem fees apply. If delayed up to 120 days (by May 29, 2020), higher additional and ad valorem fees are charged.
In the case of small companies and one-person companies, the ad valorem fee is 0.025 percent of the secured amount, capped at INR 1 lakh. For other companies, it is 0.05 percent, capped at INR 5 lakhs.
Filing with Registrar of Companies
The company is required to file eForm CHG-9 for the creation or modification of a charge related to NCDs. The form includes details of the charge and the appointment of the debenture trustee. It must be accompanied by a certified true copy of the board resolution authorizing the issuance and the instrument containing the charge details. Section 77 of the Companies Act mandates this filing. Notably, an application cannot be made to the Regional Director to condone a delay in filing the form for the creation or modification of a charge.
Importance of Charge Registration for Creditors
Charge registration is crucial as it ensures the public has access to information regarding encumbered assets. This public notice helps prospective creditors, investors, and other stakeholders understand the liabilities attached to a company’s assets. If a charge is not registered, it may adversely affect the substantive rights of existing or potential creditors who may be unaware of prior secured interests. Therefore, charge filing is more than a contractual obligation; it establishes legal transparency for all parties dealing with the company.
Shift in Priority from Date of Creation to Date of Filing
An important amendment introduced through the Companies (Amendment) Act, 2019, altered the principle determining the priority of charges. Under the revised provision, a subsequent registered charge may override an earlier unregistered one, even if the earlier charge agreement was executed before the registration of the new one. The date of registration now determines the priority, not the date of creation.
Accordingly, constructive notice of a charge applies from the date of its registration. This principle was upheld in the case of English and Scottish Mercantile Investment Co. Ltd. (1892) 2 QB 700 (CA). Further, under Rule 4 of the Companies (Registration of Charges) Rules, 2014, while applying for delayed filing, the company must declare that such delay will not adversely affect the rights of other creditors. This requirement reinforces the importance of timely charge registration.
Scheme for Relaxation of Time for Filing Charge-Related Forms
During the pandemic, the Ministry of Corporate Affairs issued a circular dated June 17, 2020, introducing a scheme for relaxing the timeline for filing forms related to charge creation or modification under the Companies Act. This scheme provided relief from additional fees for certain charge filings.
This scheme was separate from the Company Fresh Start Scheme of 2020. It applied only to the registration and modification of charges through eForms CHG-1 and CHG-9, excluding the satisfaction of charges since existing laws already permit condonation of delay for such filings. The relief period extended from March 1, 2020, to September 30, 2020, and was later extended to December 31, 2020.
Applicability of the Relaxation Scheme
The scheme is applied to two categories of companies. The first included those where charges were created or modified before March 1, 2020, and the timeline for filing had not expired by that date. For these companies, the exclusion period was ignored while computing the 120-day filing window, effectively extending the permissible period without incurring penalties.
The second category included companies where charges were created or modified after March 1, 2020. These companies were exempt from additional fees if they filed by December 31, 2020. The 120-day deadline for them began on January 1, 2021.
Inapplicability of the Scheme
The relaxation scheme was not available in certain cases. Companies that had already filed CHG-1 or CHG-9 before the circular’s issuance date of June 17, 2020, were not eligible. Also excluded were filings for CHG-4 related to satisfaction of charges, companies whose filing deadlines had expired before March 1, 2020, and companies whose deadlines extended beyond January 1, 2021, even after considering the exclusion period.
Impact of the Scheme
Although the Companies Act allows 120 days for charge registration, the exclusion of the ten-month pandemic period resulted in charges potentially remaining unregistered for up to fourteen months. This raised concerns about the fairness to creditors whose charges remained unregistered while subsequent charges were registered during that time. Since the doctrine of constructive notice applies only after registration, creditors whose charges are delayed may find themselves subordinated to later, registered claims.
Types of Debentures under the Companies Act
Debentures may be classified in several ways based on security, convertibility, and tenure. A thorough understanding of each type is crucial before initiating the issuance process. Based on security, debentures may be secured or unsecured. Secured debentures are backed by a charge on the assets of the company, whereas unsecured debentures do not carry any such charge. The Companies Act, 2013, and SEBI regulations (for listed entities) prescribe stricter requirements for secured debentures. Based on convertibility, debentures may be convertible or non-convertible. Convertible debentures are further classified into fully, partly, or optionally convertible debentures depending on the extent and nature of conversion into equity shares. Non-convertible debentures (NCDs) remain debt instruments throughout their tenure. Based on tenure, debentures may be perpetual (without maturity) or redeemable (to be repaid after a specific period). Redeemable debentures are the most commonly issued ones and are subject to strict regulatory scrutiny regarding redemption terms and conditions.
Regulatory Framework Governing Debenture Issuance
Issuance of debentures in India is governed primarily by the Companies Act, 2013, and the rules thereunder, especially the Companies (Share Capital and Debentures) Rules, 2014. In case of listed companies, the SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021 also apply. Section 71 of the Companies Act, 2013 permits companies to issue debentures with or without the option to convert into shares, subject to conditions. Rule 18 of the Companies (Share Capital and Debentures) Rules, 201,4, lays down conditions for issuing secured debentures, including the creation of a charge, appointment of debenture trustee, and creation of a debenture redemption reserve. Listed companies also have to comply with the listing agreement and disclosure obligations prescribed by SEBI. Further, the Depositories Act, 199,6 and RBI guidelines may apply in specific cases, especially where the debentures are issued to non-residents or financial institutions. A company must also adhere to FEMA (Foreign Exchange Management Act) guidelines if debentures are subscribed by foreign investors.
Board and Shareholder Approvals
Issuing debentures involves securing necessary approvals from the Board of Directors and, in some cases, shareholders. Section 179(3) of the Companies Act, 201,3 empowers the Board to issue debentures by passing a board resolution. If the debentures are convertible, then as per Section 62 read with Section 71(1), the company must obtain approval by passing a special resolution in the general meeting. The resolution must state the terms of issue, conversion ratio (if applicable), rate of interest, redemption terms, and other relevant features. In the case of private placement, the company must also comply with Section 42 and file the prescribed forms with the Registrar of Companies. Companies are required to maintain complete transparency and record resolutions appropriately in the minutes of meetings. Listed companies must inform stock exchanges and comply with SEBI’s disclosure norms regarding the proposed issuance.
Appointment of Debenture Trustee
As per Rule 18(1)(c) of the Companies (Share Capital and Debentures) Rules, 2014, when a company issues secured debentures for a period exceeding 18 months, it must appoint a debenture trustee before the issue opens for subscription. The trustee plays a critical role in protecting the interests of debenture holders by ensuring compliance with the terms of the debenture trust deed and monitoring the company’s obligations. Only SEBI-registered debenture trustees can be appointed. The company must enter into a written agreement with the debenture trustee in the form of a debenture trust deed, which outlines the powers and duties of the trustee, events of default, rights of debenture holders, and the process for enforcement of security. A draft of the trust deed must be vetted and filed as required under regulatory norms. The trust deed must be executed within 3 months of the closure of the issue. The trustee must continuously monitor the assets charged as security, the creation of a debenture redemption reserve, and compliance with covenants.
Creation of Debenture Redemption Reserve (DRR)
Section 71(4) read with Rule 18(7) of the Companies (Share Capital and Debentures) Rules, 2014,, mandates the creation of a debenture redemption reserve (DRR) for the redemption of debentures. However, DRR requirements vary based on the type of company. For listed companies and NBFCs (Non-Banking Financial Companies), DRR is not required for public issues of debentures. For unlisted companies issuing debentures on a private placement basis, DRR equivalent to 10% of the outstanding value must be created from the profits of the company. DRR must be created before redemption commences and must be maintained until the debentures are fully redeemed. In addition to DRR, companies are also required to invest or deposit a prescribed portion of the amount due for redemption in specified modes of investment before 30th April each year, to safeguard the interests of debenture holders. The deposit amount should not be less than 15% of the debentures maturing during the year ending on 31st March of the next year.
Allotment and Filing Requirements
Once the issue opens and subscriptions are received, the company must allot the debentures within the timelines prescribed under the Companies Act and SEBI regulations. For private placement under Section 42, allotment must be completed within 60 days from the date of receipt of application money. If not allotted within 60 days, the application money must be refunded within 15 days, failing which interest is payable at 12% p.a. The company must file a return of allotment in Form PAS-3 with the Registrar of Companies within 15 days of allotment. Along with PAS-3, necessary board resolutions, list of allottees, and valuation certificates (if applicable) must be attached. In case of secured debentures, the company must also file Form CHG-9 with the Registrar for registration of the charge within 30 days from the creation of the charge. Failure to file the charge within the timeline may lead to penalties and the charge being deemed void against the liquidator or creditors. The trust deed must be executed and filed in SH-12. If debentures are listed, companies must also submit a listing application to the stock exchange and obtain approval before allotment.
Compliance with Private Placement Process
If the debentures are issued through private placement under Section 42 of the Companies Act, strict compliance with procedural requirements is necessary. The company must issue a private placement offer letter in Form PAS-4 to identified persons, not exceeding 200 in a financial year (excluding QIBs and employees under ESOPs). A complete record of the offer must be maintained in Form PAS-5. Subscription money must be received through banking channels and not in cash. The company must ensure that the offer is not advertised or circulated to the public, failing which the offer would be deemed to be a public offer, attracting stricter compliance. A valuation report from a registered valuer may be required if the debentures are convertible. The company must also ensure that the offer complies with RBI and FEMA regulations if offered to persons resident outside India. After allotment, the company must issue debenture certificates within 6 months and maintain a register of debenture holders.
Listing and SEBI Compliance for Listed Debentures
If the company proposes to list the debentures on a stock exchange, SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021 become applicable. These regulations prescribe detailed disclosure requirements, due diligence by lead managers, appointment of debenture trustees, and creation of security. A draft offer document must be filed with the stock exchange, and in-principle approval must be obtained. Upon successful subscription, the company must file listing applications and adhere to listing norms. SEBI regulations also mandate periodic disclosures regarding interest payments, credit rating, redemption schedule, utilization of proceeds, and compliance with covenants. Listed debentures are also subject to scrutiny under SEBI LODR Regulations for continuous listing and disclosure obligations. Failure to comply with SEBI norms can attract penalties, debarment, and other enforcement actions.
Types of Debentures
Debentures can be classified into various categories based on different criteria. From a legal and accounting perspective, it is important to understand the distinctions between these categories, as they carry implications for risk, repayment obligations, and regulatory compliance.
Based on security, debentures can be secured or unsecured. Secured debentures are backed by specific assets or a floating charge on the company’s undertakings. Unsecured debentures, also known as naked debentures, are not backed by any collateral and rely solely on the creditworthiness of the issuer.
Based on convertibility, debentures are either convertible or non-convertible. Convertible debentures can be converted into equity shares after a specified period, either partially or fully. This conversion may be compulsory or optional. Non-convertible debentures, on the other hand, do not have this feature and remain debt instruments throughout their tenure.
Based on tenure, debentures may be redeemable or irredeemable (perpetual). Redeemable debentures have a fixed maturity date upon which the principal amount is repaid to the debenture holder. Irredeemable debentures are rare in India as the Companies Act, 2013 does not allow companies to issue debentures without a redemption date, effectively disallowing perpetuity.
Based on mode of redemption, they can be classified as redeemable at par, premium, or discount. Most companies issue redeemable debentures at par or premium. Redemption at a discount is rare due to implications on taxation and investor interest.
Understanding the type of debenture being issued helps determine the statutory requirements applicable and assists companies in planning their funding strategies while remaining compliant with applicable laws.
Debenture Redemption Reserve (DRR)
The concept of Debenture Redemption Reserve (DRR) was introduced to protect the interests of debenture holders and ensure the availability of funds for repayment at maturity. According to the Companies Act, companies issuing debentures were previously required to create a DRR out of their profits.
However, under the Companies (Share Capital and Debentures) Amendment Rules, 2019, the requirement to maintain a DRR has been relaxed for certain classes of companies. As per the latest provisions:
- No DRR is required for listed companies.
- Unlisted companies issuing debentures on a private placement basis also need not maintain DRR.
- NBFCs and HFCs registered with RBI are exempted from maintaining DRR for privately placed debentures.
However, companies not falling in the above categories and issuing debentures through public issue must create a DRR equivalent to at least 10% of the value of debentures. This reserve must be created out of the profits of the company before declaring dividends.
Although the DRR requirement has been relaxed, Section 71(4) still mandates that companies must deposit or invest at least 15% of the amount of debentures maturing during the year in specified instruments (e.g., bank deposits, government securities) by April 30 each year. This ensures availability of funds for redemption even if the DRR is not maintained.
Role of Debenture Trustees
Debenture trustees play a vital role in protecting the interests of debenture holders, particularly in case of secured debentures or public issues. Section 71(5) of the Companies Act, 2013 mandates the appointment of a debenture trustee before issuing a prospectus or letter of offer to the public or any class of people.
The debenture trustee must be registered with SEBI and must not have any conflict of interest with the company issuing the debentures. Their functions include:
- Ensuring that the assets of the company backing the secured debentures are adequate and properly maintained.
- Monitoring compliance with the terms of the issue.
- Taking steps to protect the rights of debenture holders in case of default.
- Initiating legal proceedings if necessary on behalf of debenture holders.
The trust deed is an essential document that outlines the powers and duties of the debenture trustee and the rights of the debenture holders. As per Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014, the trust deed must be executed within sixty days of the allotment of debentures.
Appointment of a vigilant and independent trustee ensures better governance and instills confidence among investors subscribing to debentures.
Private Placement vs. Public Issue of Debentures
Companies can issue debentures through two major routes: private placement and public issue. Each method has its regulatory framework under the Companies Act, SEBI Regulations, and other applicable laws.
Private placement involves offering debentures to a selected group of investors and is governed by Section 42 of the Companies Act, 2013. This method is preferred by companies for raising funds in a cost-effective and less regulated manner. It requires passing of a board resolution and filing of the Private Placement Offer Letter (Form PAS-4) with the Registrar of Companies. The offer can be made to a maximum of 200 persons in a financial year, excluding QIBs and employees under ESOPs.
Public issue involves offering debentures to the general public through an offer document. It is more heavily regulated, requiring compliance with SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021. A prospectus must be filed with the Registrar and SEBI. Appointment of a debenture trustee is mandatory, and credit rating is essential. This method provides access to a wider investor base but involves higher compliance costs.
The choice between private placement and public issue depends on the company’s funding needs, investor profile, cost implications, and risk appetite. Most corporate debt is raised through private placements due to flexibility and lower regulatory burden.
Allotment and Listing of Debentures
Once debentures are issued, the process of allotment and listing becomes crucial. For both public issue and private placement, the company must allot debentures within 60 days from the receipt of application money. Failure to do so requires the company to refund the money within 15 days, failing which it must pay interest at 12% per annum.
In the case of public issues, listing of debentures on a recognized stock exchange is mandatory. SEBI regulations require filing of listing application and compliance with disclosure norms. Listing ensures liquidity for investors and better price discovery.
For privately placed debentures, listing is optional but is often preferred by institutional investors. Listed privately placed debentures must comply with SEBI’s continuous listing obligations including periodic disclosures, credit rating reviews, and governance norms.
Filing of Prospectus or Private Placement Offer Letter
If the company is issuing debentures to the public, it must file a prospectus with the Registrar of Companies (ROC) and the Securities and Exchange Board of India (SEBI), if applicable. In case of private placement, the company must issue a private placement offer letter in Form PAS-4 to identified persons. This form must contain detailed disclosures about the company’s business, financial position, and the terms of the debenture issue. The offer letter must be serially numbered and specifically addressed to the identified persons to whom the offer is made.
Filing of Return of Allotment
After the allotment of debentures, the company is required to file a return of allotment with the ROC in Form PAS-3 within 15 days of the allotment. The form must be accompanied by a list of allottees, the number of debentures allotted to each, and relevant board and shareholder resolutions authorizing the issue and allotment.
Creation of Debenture Redemption Reserve (DRR)
Section 71(4) of the Companies Act, 2013 mandates the creation of a Debenture Redemption Reserve (DRR) out of the profits of the company available for payment of dividend. The DRR is to be used only to redeem the debentures. According to Rule 18(7) of the Companies (Share Capital and Debentures) Rules, 2014, the following companies are not required to create a DRR: All India Financial Institutions regulated by RBI; Banking Companies; NBFCs registered with RBI (for privately placed debentures); and other listed companies issuing debentures on a private placement basis. For companies that are required to create DRR, the minimum percentage is 10% of the value of debentures.
Deposit of Redemption Amount in Specified Account
As per Rule 18(7)(c) of the Companies (Share Capital and Debentures) Rules, 2014, companies must deposit or invest, on or before April 30th each year, a sum not less than 15% of the amount of debentures maturing during the year ending on March 31st of the next year. The amount must be deposited in a scheduled bank in a separate account called the Debenture Redemption Account or invested in specified securities. This ensures availability of funds for redemption of debentures.
Debenture Trustees and Trust Deed
For public issues or when debentures are issued to more than 500 persons, the company must appoint one or more debenture trustees. The appointment must be made before the issue opens for subscription. A debenture trust deed must be executed in Form SH-12 within 60 days of allotment. The trustees safeguard the interest of debenture holders and ensure compliance with terms and conditions of issue.
Credit Rating and Debenture Listing
If the debentures are listed, they must be rated by a credit rating agency registered with SEBI. The rating must be disclosed in the offer document. Listing of debentures on a recognized stock exchange requires the issuer to comply with SEBI (Issue and Listing of Non-Convertible Securities) Regulations. The stock exchange reviews compliance, and failure to meet requirements can result in delisting or penalties.
Register of Debenture Holders
The company must maintain a register of debenture holders in Form MGT-2. This register must contain details such as name, address, occupation, number of debentures held, date of allotment, and other relevant particulars. The register must be kept at the registered office of the company or any other place approved by a board resolution.
Debenture Certificate and Interest Payment
The company must issue debenture certificates to the holders within six months from the date of allotment. The certificates must be signed and sealed as per the provisions of the Act and Articles of Association. Interest on debentures must be paid as per the agreed terms. Delay in payment may attract penalties and interest.
Redemption of Debentures
Debentures must be redeemed as per the terms of issue. The redemption can be at par, premium, or discount, as specified. The company must ensure timely repayment of principal and interest. In case of secured debentures, the assets must be released from charge upon redemption. The redemption must also be reflected in the books of accounts and ROC filings.
Penalty for Non-Compliance
Non-compliance with provisions relating to debentures can attract penalties under the Companies Act, 2013. If a company fails to comply with the provisions of Section 71 or the rules made thereunder, the company shall be liable to a penalty of five lakh rupees and every officer in default shall be liable to a penalty of one lakh rupees.
Conclusion
Issuance of debentures requires careful compliance with the Companies Act, 2013 and related rules. The process involves planning, board and shareholder approvals, due diligence, regulatory filings, and post-issuance compliances. Non-compliance can result in financial penalties and reputational risks. Therefore, companies must follow due process and consult legal or financial advisors as necessary.