Debentures in Company Law – iPleaders

This article is written by Danish Ur Rahman. This article gives an exhaustive overview of the concept of ‘debentures’ in Company law, the uses of debentures, different types of debentures, how it is issued and what remedies are given to the debenture-holders.

It has been published by Rachit Garg.

Securities are issued by companies to acquire capital from investors. A security is a negotiable instrument issued by a company or a government which has a certain monetary value to acquire capital from the persons who invest in it. There are three types of securities in company law – a) equity securities which give the equity share value as a security to the person who is investing; b) derivatives securities which give value through another financial instrument or promise or contract and, c) the debt securities which gives the creditor a value through an instrument which comes with a charge on the assets provided as a collateral or security. 

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Debentures are a type of debt securities issued by a company and are one of the best ways for a company to acquire capital without diluting its ownership or equity values. Debenture has its own features with respect to both the companies and the debenture-holders. It is good for the company as it helps the company to acquire capital without diluting any of its ownership, and it is also good for the debenture-holders as they are secured through their right to charge. A more detailed analysis of debentures is given below in the article. 

A debenture is a type of debt instrument which is issued by a company to raise capital. Debenture is a long-term debt instrument which may be in the form of a bond or a loan which is secured by the charge upon the assets which have been provided as securities. Debentures have a fixed rate of interest and other characteristics which are described in detail later in the article.

According to Section 2(30) of the Companies Act, 2013 – the term “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 definition in the Companies Act, 2013 does not mandate the creation of a charge. So, a debenture can be issued without creating a charge on the company’s assets. For example, unsecured debentures are issued without creating a charge, where the company is not required to provide any property or asset as a security for the debt amount acquired by issuing the debentures.

Debentures are several types and each has its own features and characteristics. The different types of debentures are listed below.

  • Debentures based on security
  • Debentures based on tenure
  • Debentures based on conversion
  • Debentures based on registration

Debenture based on security

Usually, the debenture-holder has less or no risk for the amount he has lent to the company to get the debentures since he has securities to charge, upon the default of payment by the company. The debentures based on security are of two types – secured and unsecured debentures.

Secured debentures

Secured debentures are also known as mortgage debentures. They are a type of debenture that are secured by a charge either fixed, or floating, on a company’s assets. The holder of this type of debenture has the right to recover the principal amount and the interest from the assets which have been given as securities.

Unsecured debentures

In this type of debenture, the companies are not required to pledge any of their properties or assets as collateral for the debt amount. Since the unsecured debentures do not require any assets to be used as a security, the lender usually is at high risk of losing his principal amount in case the company defaults. This type of debenture has a high rate of interest.

Debentures based on tenure

Redemption of the debenture occurs when on the maturity date, the company pays back the principal amount along with the interest and releases its properties or assets from the charge given to the debenture-holder. It is divided into two types – redeemable and irredeemable debentures.

Redeemable debentures

Most of the debentures are redeemable, meaning on the expiry of the maturity date, the debenture is redeemed by the company by paying back the principal amount with interest to the debenture-holder and releasing its assets from charge.

Perpetual or Irredeemable debentures

If a debenture does not contain any clause as to the payment of the principal amount by the company and redeeming the debenture, then it is known as a perpetual or irredeemable debenture. This type of debentures, unlike redeemable debentures, does not cease on the maturity date.

Debentures based on conversion

The company has the right to convert the debentures into equity shares. There are two types of conversion of debentures – convertible and non-convertible debentures.

Convertible debentures

The company issuing debentures has the right to convert these types of debentures into equity shares. So the debenture-holder who was just a creditor to the company becomes a member of the company and enjoys ownership of the company to the extent to which he has the equity shares of the company.

Non-convertible debentures

This type of debenture cannot be converted into equity shares of the company. So the debentures will always be redeemed and will never have the characteristics of equity shares of the company. 

Debentures based on registration

As most of the important deeds and instruments of a company are usually registered in the company, debentures are no exception. There are two types – registered and unregistered debentures.

Registered debentures

If debentures are issued by the company, the company is required to maintain a register of its debenture-holders as Section 88 of the Companies Act, 2013 provides that every company shall register the holders of its debentures. Both, the debenture certificate and the company’s register, shall have the name of the debenture holder.

Unregistered or Bearer debentures 

The company can avoid the registration of the debenture-holders if it issues the debentures to the bearer. Such types of debentures are transferable, like negotiable instruments, by way of simple delivery and are also called debentures payable to the bearer.

Debentures are financial instruments distributed by companies to raise their capital. There are various sources through which a company can raise its capital such as – retained earnings, equity capital and debt capital.

Retained Earnings – a leftover profit after paying all the direct and indirect costs, all the interests to the lenders and the payment of dividends to the shareholders. The retained earnings of the company are used for further investment in the company.

Equity Capital – It is a source of capital generated by giving out the equity of a certain part of ownership to the person who invests in the company. For example, shares.

Debt Capital – It is a source of capital generated through debt which is lent by banks and other lenders who get a fixed rate of interest. For example, loans and debentures.

Of all the sources available to the company, one of the most efficient capital sources for a company’s capital are the debentures.

Advantages of debentures

Debentures have several advantages and they are characterised in two kinds as given below:

  • Advantages of debentures to the company
  • Advantages of debentures to the debenture-holder

Advantages of debentures to the company 

  1. Secure way of raising money: Debentures are one of the most effective and safer ways for a company to raise funds when compared to equity or shares. Issuing debentures is safer because it can be paid back by the company.
  2. Less authoritative: Since the debenture-holders do not have any voting rights as mentioned in Section 71(2) of the Companies Act, 2013, the company is not under the authority of so many persons and can function more independently. 
  3. Less risk of dilution: The company has less risk towards diluting its equity as the company does not provide any ownership to the debenture-holders.
  4. Option of redemption: Since the debentures can be paid back by the company when they have surplus funds, there is no limitation to the company for the perpetual obligation that they would have to give security to the debenture-holders once they pay back their debt to the debenture-holders.

Advantages of debentures to the debenture-holder

  1. A secured way to invest money: There is very minimal or no risk to the amount invested by the debenture-holder in the debentures. Irrespective of the market’s fluctuation or the company’s performance, the amount invested by the debenture-holder is always secured even if the company winds up.
  2. Fixed-rate of Interest: The debenture-holder gets a fixed amount of interest no matter how the company is performing or the company is in loss.
  3. Right to charge: The debenture-holder has the right to charge against the properties or assets of the company which have been given as security for the amount lent by the debenture-holders.

Disadvantages of debentures

Debentures have some disadvantages as well and they are characterised as two types and they are:

  • Disadvantages of debentures to the company
  • Disadvantages of debentures to the debenture-holder

Disadvantages of debentures to the company 

  1. Expensive during depression: In times of depression of a company, there may be a chance that the debentures can become expensive, but since the rate of interest would be the same and hence the company would suffer a loss by paying more interest.
  2. Burden of Interest Payment: Since the performance of the company and the trends of the market does not affect the payment of interest to the debenture-holder by the company, the interest payment is generally a burden on the company when it is not performing well.
  3. Imbalance of debt-equity ratio: Though the debentures do not affect the company’s equity, it would force the company to depend on debt, and the financial feasibility of the company would be disturbed by the imbalanced debt-equity ratio.
  4. Major cash outflow: When in the times of redeeming debentures, a major cash is transferred to the debenture-holders from the company which would result in the imbalance of a company’s in-hand capital.

Disadvantages of debentures to the debenture-holder

  1. No ownership: Though the debenture-holders help a company to acquire capital by issuing debentures, they cannot be given ownership of the company to any extent. 
  2. Fixed interest: Unlike shares, where the dividends may be high when the company is performing well, in debentures, there is a fixed interest irrespective of how bad the company is doing. 
  3. Not always secured: Though debentures are more secure than shares, all types of debentures are not secured, unsecured debentures have more risk than the secured debentures. 

There are various rules and regulations that have to be followed while issuing debentures by a company. The essential requirements are listed under Section 71 of the Companies Act, 2013.

Rules for issuing debentures under the Companies Act, 2013

The issuance of debentures can be made by a company with an option to convert such debentures into shares, such conversions may be done wholly or partly. For the purpose of converting debentures into shares, there must be a special resolution passed at a general meeting of the company. 

The issuance of debentures along with the voting rights in any activities of the company is prohibited by Section 71(2). A company may issue secured debentures subject to the prescribed terms and conditions under section 71(3). Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014 gives various rules for the issuance of debentures, which 

Rules as regards to debenture Redemption Reserve (DRR) 

If a company issues debentures under Section 71, a debenture redemption reserve account has to be created by the company from the profit of the company available for the payment of the dividend. Under Sec 71(4) the amount credited to such a reserve account shall not be used for any purpose other than the redemption of debentures.

The objective of a Debenture Redemption Reserve (DRR) is to reduce the risk of the debenture holder in case of default of repayment by the company. The debenture redemption reserve contains a certain earmarked (designated) amount of profit of the company each year. Only such profit is contributed to DRR that is eligible for the payment of dividends. 

Sometimes a company may suffer from a lack of profit or from a liquidity shortage that may cause them to default in repayment of the debentures. In the year 2000, the government developed the idea of a debenture redemption reserve to reduce such defaults from the companies.

Companies that are exempted from creating a DRR

  1. As of 16 August 2019, the companies listed in the National Stock Exchange (NSE), the Calcutta Stock Exchange (CSE) or the Bombay Stock Exchange (BSE) are exempted from maintaining a debenture redemption reserve.
  2. Public financial institutions, whose paid-up shareholdings are held by the Central Government to an extent of 51% or more and the public financial institutions that are governed by the Reserve Bank of India (RBI) are exempted from the obligations to maintain the DRR.
  3. All Banks are scheduled under the second schedule of the Reserve Bank of India Act, 1934.

Rules as regards to debenture trustee

  1. According to Section 71(5) & 71(6) of the Companies Act, 2013, no company shall make an offer, or an invitation or publish a prospectus to the public or the members of the company whose number exceeds 500 for the subscription of debentures, without appointing one or more debenture trustees. 
  2. The conditions that govern the appointment of such trustees shall be subject to prescribed rules. The role of the debenture trustee is to take steps to redress the grievances of the debenture-holders and protect their interests.
  3. The Securities and Exchange Board of India (SEBI) issued the SEBI (debenture Trustee) Regulations, 1993 for the purpose of regulating debenture trustees.  Also Rule 18 (1) (c) of the Companies (Share Capital and Debentures) Rules, 2014, mandates the company to appoint a debenture trustee before the issue of offer for subscription of debentures.
  4. According to Section 71(7), any provision contained in either the trust deed or in any contract with the debenture-holders secured by a trust deed is void, 
  • if such provision exempts the debenture trustee from any liability of breach of trust, where he fails to show the due care and diligence as required by him as a trustee.
  • if such provision indemnifies the debenture trustee for any liability of breach of trust, where he fails to show the due care and diligence as required by him as a trustee.
  1. According to Section 71(9) of the Act, if at any time the debenture trustee feels that the assets of the company are not sufficient to fulfil the principal amount and when it becomes due, the trustee may file a petition before the national company law tribunal and by order restrict the company from incurring any further liability.
  2. Another important duty of the debenture trustee is to keep the company’s assets charged against the debentures. Rule 18 (3) of the Companies (Share Capital and Debentures) Rules, 2014, provides various other functions of the debentures trustee, that the letter of offer to issue debentures are consistent with the debenture deed, to request periodic status and performance of the company and inform the debenture-holders in case if there is a default.

Other general rules while issuing debentures

  1. The creation of a charge is mandatory on the properties or assets of the company or its subsidiary company, its holding company or its associates company for the purpose of issuing debentures.
  2. If a company fails to redeem the debenture-holders on the date of the maturity or on the due date the company fails to pay the interest, then by application of one or all the debenture-holders or by the application of the debenture trustee the Tribunal may by order direct the company to redeem the debentures.
  3. The Central Government has the power to prescribe the procedures, for securing the interest of the debenture-holders, for the form of debenture trust deed and for the debenture-holders to inspect the trust deed.

Charge is defined under Section 2(16) of the Companies Act, 2013. A charge is the concept of control over the company’s properties or assets which have been given as securities for the amount lent by the creditors in the case of debentures of the debenture-holders. A charge may arise upon the properties given as securities when there is a default on the repayment of the money lent. The debenture-holder can take the charge to sell the property secured to satisfy his debt amount. There are two types of charges:

  1. Fixed Charge.
  2. Floating Charge.

Fixed charge

This is a normal concept of charge which is created on some specific properties or assets. As a result, the assets which have been charged have a fixed nature, which restricts the companies from selling such assets freely. If the company wants to sell the assets, it will either have to get the debenture holder’s permission to do so or repay the debt amount to release the asset in order to sell them. Even if they sell a new charge has to be created for the new assets which would hinder business. So that gives rise to the concept of floating charge.

Characteristics of fixed charge

  1. The company cannot sell the assets which are provided as a security to the debenture-holders, without the permission of the debenture-holders, thus making them more secure.
  2. Big businesses use the fixed charge more often than small businesses. Bigger businesses have many assets that are immovable and constant, such as machinery.
  3. The businesses have little say in the matters of fixed charge, the fixed charge on a company’s assets puts restrictions on the company’s borrowings through the sale of their assets.

Floating charge

The floating charge is linked to all the assets of the company either present or future. The charge on the assets keeps on changing as the company buys or sells assets at its convenience. This type of charge gives an opportunity to the companies to freely continue trading the assets or selling them when there is a necessity to do so, without repaying the debt amount to the debenture-holders.

This type of charge created, however, is not to be fixed immediately, it is floating among all the assets of the company which the company may acquire from time to time.

When the time comes when the lender wants to enforce his security to realise his debt, the charge on the assets which is in the hands of the company at that time becomes fixed. Now, the debenture-holder takes charge of the assets which are present in the hands of the company at that time and gets back his principal amount and interest. 

Characteristics of floating charge

  1. It should be a charge upon a class of both, present and future assets.
  2. The class of assets which is to be charged must be one which in the ordinary course of business of the company would be generally changing from time to time.
  3. It should be communicated by the charge until the debenture-holder takes any step, the company shall have the right to use the assets comprising such charge.

Crystallisation of floating charge

The process of converting a floating charge into a fixed charge in the time of enforcing the security by the debenture-holder is known as the crystallisation of a floating charge. The floating charge remains dormant till it becomes fixed when the securities are enforced by the debenture-holder.

In the case of Government Stock and Other Securities Investment Co Ltd v. Manila Railway Co Ltd (1897), it was held that it is of the essence of a floating charge that it remains dormant until the undertaking charges cease to be a going concern, or until the person in whose favour the charge is created intervenes. Thus, a crystallisation of floating charge occurs when the company is winding up or when the charge-holder intervenes i.e., the debenture-holder intervenes.

Procedure for issuing debentures 

Part B of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 provides the requirement of a due diligence certificate from the debenture trustee. Various other procedures which have to be followed by companies while issuing debentures are explained in detail below in this heading. It is essential for every company that decides to acquire capital through debentures to follow the below mentioned steps.

Call and convene a general meeting 

A notice for board meeting shall be issued, at least seven days before the meeting to all the directors of the company to their address. The notice shall be attached with the agenda, notes to the agenda and draft resolution. 

The board meeting shall pass the necessary board resolution like approval of debentures through private placement, approval of private placement offer letter, approval of members to whom private placement be made and authorise the director to sign and issue notice of the general meeting

Filing of form MGT – 14 with ROC 

The company shall file form MGT – 14 with the Registrar Of Companies (ROC) along with the fee as specified in the Companies (Registration offices and fees) Rules,2014 within 30 days of passing the special resolution in the general meeting. The certified true copies of the resolution along with an explanatory statement and general meeting documents shall be submitted while filing the form.

Private placement offer letter

Section 42 of the Companies Act, 2013 directs that the company shall record all the names of the persons to whom the debenture shall be offered through private placement. PAS – 4 forms shall be used to make a private placement offer letter.

The company has to send these offer letters either in writing or in electronic mode within 30 days of recording the names of persons to whom the debenture is offered. The company shall maintain a register using the form PAS – 5 of the person to whom the debentures have been offered through the offer letter.

Open a separate bank account

A separate bank account shall be created in a bank which has been scheduled in Schedule II of the Reserve Bank of India Act, 1934, for keeping the monies which have been received on the application.

Debenture certificate 

If there is any allotment of debentures to the debenture-holders, the certificate of debenture shall be issued to debenture-holders within 6 months of the date of allocation.

Debentures are fixed security income and work like a loan and in return, the company pays a fixed interest with a certain interest rate per annum and after the maturity date the principal amount is paid back. If the person buys debentures by opting for cumulative interest, then all the cumulative interest along with the principal amount would be paid back at the maturity date.

There are two methods for investing in debentures which are listed above and they are characterised as the direct method and the Indirect method.

Indirect method

Indirect method of buying the debentures is a concept of purchasing the debentures wherein the investor can buy debentures outside the company’s physical selling point. In an indirect method, the person need not buy debentures directly from the company, he can buy them through a third source. 

A person can invest in debentures indirectly by investing in mutual funds, there is an option to invest in known debt mutual funds which includes debentures. The concept of mutual funds is that the mutual funds would mutually collect funds from the investors and will invest in different types of funds. The different types of funds may include corporate funds or government funds. Those debt mutual funds would play the role of debentures by raising corporate funds or government funds.

The most important benefit of buying debentures in an indirect method is its convenience. The person investing is not required to physically go anywhere to buy debentures. The major drawback of mutual funds is its fees, any mutual fund would charge the investors with 1% or 2% of total money invested as fees per year. If a person wants to save such fees, he must invest in a direct method.

Direct method

The direct method of investing in debentures is where a person can buy the debentures directly from the company either physically or online. The direct method is used to buy government debentures, corporate debentures and tax-saving debentures. The methods to buy or invest in debentures through direct methods are explained in detail below.

Corporate debentures:

Corporate debentures can be bought or traded in stock markets. If a person wants to buy debentures he has the option to buy debentures in his trading or demat account. Several debentures would be listed in the stock markets from which the investors can choose to buy debentures as per their convenience. 

Other options to buy corporate debentures of private companies are through multiple commercial banks, like State Bank of India, HDFC Bank, ICICI Bank etc. A person can also directly visit a company’s website and buy debentures from them or a person can directly visit any of the company’s physical branches to buy debentures. The debentures will be received in the form of either a physical certificate or in demat form which is reflected in the demat account.

If a person wants to invest in corporate debentures, he will be entitled to receive a fixed rate of interest from the company. The interest provided by any company directly depends on its credit rating. If a company gives the investors less risk, then the rate of interest given by such a company would be less. If a company has a strong balance sheet then the company is considered to give its investors less risk and hence, the debenture-holder would be entitled to a lower rate of interest for their debentures. If the company has a low credit rating and a weak balance sheet, then such a company would pay a higher rate of interest.

Another criterion where the interest rate has fluctuated is based on its security. The unsecured debentures promise to pay more interest rates of up to 14% per annum compared to the interest paid by the secured debentures.

Government debentures:

Government debentures are one type of sovereign bonds which is issued by the government to support public spending, which includes a payment of periodic interest by the government. Government debentures cannot be bought from trading or demat accounts, because brokers are not registered with RBI. Only financial institutions, commercial banks or primary dealers can purchase government debentures, a retail investor cannot purchase government debentures.

A retail investor can buy government debentures by investing through commercial banks, a range of 7-8% interest rate per annum can be expected from government debentures. If the investment is short term then the interest rate would be 7% and if it is of a long term of 20-30 years, then it will be 8%. Government debentures cannot be bought online; a person has to physically visit the commercial banks to buy them.

The demat account is mandatory even if a person wants to invest in government debentures, the debenture certificate can be either in the form of physical or demat. Since the government debentures cannot be traded in stock markets, only after the maturity date, the principal amount be paid back, so the government debentures are slightly illiquid assets.

Tax Saving debentures or bonds:

Tax-saving debentures or bonds are issued by the government or its authorised entities or its infrastructure companies which payback long-term gains with very little interest on them. Organisations like the National Highway Authority of India (NHAI), Rural Electrification Corporation (REC), Power Finance Corporation (PFC) etc., provide tax-saving debentures or bonds. An individual has to buy such debentures or bonds by physically visiting those organisations’ financial institutions or through commercial banks which are registered with these organisations. Since these types of investments help an individual to save long-term capital gains, the interest rate here is considerably low, it is generally 5 – 5.5% per annum.

Normally the debentures are registered under the company’s registry under Section 88 of the Companies Act, 2013. Since the debenture-holders are secured and registered under the company’s registry, they enjoy priority over other contributors of the company’s capital like shareholders, unsecured creditors etc. The registration of debentures under the company’s registry is limited to determining the priority of debenture-holders in a company. Whereas, the registration under the Registration Act, 1908 determines the priority of all the creditors to the company and their priority over the immovable assets of the company. 

K. Roy & Bros vs. Ramanath Das and Ors. (1943) 

Facts of the case

The appellants are the building contractors and they agreed to build a sugar mill for the company. The appellants were not paid for their work and the materials required for building the sugar mill, so they eventually went to arbitration and secured for themselves an award for their debt. The defendant was a director and one of the managing agents of the company, and he bought 151 debentures in the company, each of them for Rs. 500. With the money raised the company built the machinery and installed it in the production sector. The company after functioning for a certain time got into financial issues and a winding-up order was ordered by the court. The liquidator appointed by the court considered that since the debentures were not registered under the Registration Act, 1908 the debentures have the charge only on the movable assets of the company. Whereas the appellants, the builders would have priority over the immovable assets of the company.

Issue of the case

Whether the registration of debentures under Section 17 of the Registration Act, 1908 is required to be done in addition to the registration of debentures under Section 88 of the Companies Act, 2013?

Judgement of the case

The Calcutta High Court held that according to the conditions in the debenture trust deed, the money payable to the debentures shall be charged without any preference or priority towards other debentures. The Hon’ble Court held that the priority of charge on the company’s assets is based on the registration of the debentures under the Companies Act, 2013 and is applicable only to the debenture-holders. Whereas, the registration under the Registration Act, 1908 is applicable to the assets of the company in general. So in this case, the appellants have more priority over the immovable property of the company as they have the arbitration award in their favour and the defendants only have a charge over the movable properties as they have not registered under the Registration Act, 1908.

The repayment of the debt amount of the debenture by the company to the debenture-holder at the maturity date is the redemption of debentures. Redemption of debentures allows the company to discharge from its liability as a debtor and can get back the assets which have been provided as charges. The company can redeem the debentures at a value that it decides at the time of redemption. There are three values at which a debenture can be redeemed:

  • At Par: The redemption value which is given by the company is equal to the face value of the debentures.
  • At Premium: The redemption value which is given by the company is more than the face value of the debentures.
  • At Discount: The redemption value which is given by the company is less than the face value of the debentures.

Procedure for redemption of debentures

Different companies can opt for different ways for redemption of debentures issued by them. In the process of redeeming debentures, the company usually pays back the debenture-holders the capital raised from them in the form of debentures. The Debenture Redemption Reserve (DRR) is used for the purpose of redemption of debentures by the company. Section 18(7) of the Companies (Share Capital and Debentures) Rules, 2014 lists the following procedure to be followed while redeeming the debentures:

  1. The Debenture Redemption Reserve (DRR) is to be accumulated by the profits gained by the company which is available for dividend payments.
  2. There must at least be 50% of the amount raised through debentures in the DRR to secure the payment during the redemption.
  3. For the purpose of partly converted debentures, the DRR must be created in respect of the non-convertible portion of the debentures only.
  4. The DRR funds may not be used for any other purpose than the purpose of redemption of debentures.
  5. In case of any default by the company on repayment of the debenture amount, any or all of the debenture-holders or debenture trustees can seek remedy for the same before the National Company Law Tribunal(NCTL) .

In most of the financial aspects, shares and debentures are similar in nature. Both shares and debentures are used by the company in the course of raising their capital to improve their business. In a company both the shares and debentures have certain common functions in any business transactions. 

Similarities between shares and debentures

  • Both the shareholders and the debenture-holders play the roles of investors as they invest their money in the company. 
  • Both the shareholders and the debenture-holders also get something in return from the company for the money they have invested in it. 
  • As both the shares and the debentures are the fundraising tools for the company, they can be issued to the public. Both the shares and debentures can also be sold or purchased in an open market.
  • Both the shareholders and the debenture-holders depend upon the assets of the company as securities for the money they have invested in the company.

Differences between shares and debentures

Though both the shares and the debentures are the fundraising tools for the company to raise their capital funds, there are certain differences between them which is explained in detail below.

Differences with respect to the powers of shareholders and debenture-holders

The first basic difference between the shares and debentures is the role of their holders in the company. 

Shareholders play a role of being a member of the company as they have the company’s ownership to the extent to which they have invested in it. Thus, they enjoy all the rights of the members of the company. Shareholders have voting rights in the company so they engage in the major activities of the company.

The debenture-holder cannot be a member of the company and thus they do not have the company’s ownership, a debenture-holder is simply a creditor of the company who lends money to raise their capital. Section 71(2) of the Companies Act, 2013 directs that no company shall issue debentures with voting rights to the debenture-holders in any of the meetings of the company. Majorly the debenture-holders cannot interfere in the business activities of the company.

Difference in respect to returns received  

Both the Shares and the debentures get some return for the amount invested in the company. The Shares get their return by way of dividends. Dividends are given from the profit incurred by the company, the rate of dividend is proportional to the rate of profit of the company. The more the company is in profit, the more the shareholders can get their dividends from the company.

The debentures get their return by way of a fixed rate of interest. Unlike shares the interest is not given from the profits incurred by the company, moreover, the profit or loss of a company is immaterial in respect of returns from debentures. The rates at which the interest is to be given are governed by a regulating body – the Investment Information and Credit Rating Agency (ICRA). As the rate of interest for a debenture is fixed, the rate of dividend may be much higher than the rate of interest

Difference in respect of security given by the company

The company gives securities to the investors who invest in their capital, some securities may be secure and some may be insecure.

The Securities given by the company in respect of shares are the ownership of some extent of the company to which the shareholders have invested. The securities of this type which are given to the shareholders are not secure and are of more risk when compared to the securities given to the debenture-holder. The fate of the shares depends on the market’s fluctuation and the company’s performance.

The Securities given by the company in respect of debentures is the right to charge on the assets which have been given as collaterals. The securities of this type which are given to the debenture-holders are secure and are of no risk when compared to the securities given to the shareholders. The Market’s fluctuation and the performance of the company are irrelevant in terms of debentures as the securities are secure and the debenture holder has less risk.

Other differences between shares and debentures

The company cannot pay back the shareholder and get back the equity shares without the shareholder’s consent. If the shareholder is willing to sell or transfer the shares to the company itself, he/she can do so, but the company does not have the power to pay back by itself. On the other hand, unless the debenture is a perpetual debenture, the company can always pay back the debenture-holders and get back their securities.

Since the shareholders are the members of the company and they enjoy ownership of the company to some extent, their claims to return their investments in the company in terms of winding up are not paid in priority. In case of debentures if the company is winding up, then the debenture-holder is to be paid in priority. They are the first to be paid by the company in case of it winding up because they are the creditors of the company.

Summary of the difference between debenture and shares:

Serial No. Basis of Difference Debentures Shares
1. Role in the company The debenture-holder just plays the role of creditor of the company. The shareholder acts as a member of the company.
2.   Ownership The issuing of debentures does not affect the ownership of the company. The issuing of shares dilutes the ownership of the company.
3. Risk The debentures are generally risk-free. The Shares are a risky venture of investing in a company.
4. Return The debenture-holder gets a fixed amount of interest from the company for the principal they have invested till the date of maturity The shareholder gets returns in the form of dividends, the dividends are issued when the company is in profit.
5. Transformation A debenture can be transformed into shares, which are also known as convertible debentures A share cannot be transformed into debentures 
6. Security A debenture is secured by a way of charge on the assets provided by the company as collateral A share is not as secure as a debenture as they are based on the market trends and the performance of the company 
7. Function of a company A debenture-holder cannot take part in any function of a company. A shareholder being a member of the company can take part in the functions of the company.
8. Right to vote A debenture-holder does not have the right to vote in the company meetings A shareholder has the right to vote in the company meetings.

Difference between debentures and other securities

The major difference between debentures and other securities such as derivative securities and equity securities is that it is a debt security – the company is indebted to the debentures issued i.e. the company gets a debt through issuing debentures from the debenture-holders and adds it to it’s capital. Whereas the other securities even though they too help the company to acquire capital, they are not considered as a debt to the company. Some securities may give ownership and some may give value which depends on another underlying instrument or document. There is another type of security which is known as hybrid securities, which are a combination of two or more securities.

Conversion of debentures into other form of securities

The debentures can be converted to other forms of securities of a company. The most common form of conversion is the conversion of debentures into shares, wherein a company gives an option to the debenture-holders to convert their debentures into shares, thus also giving them the right to ownership of the company. The right to ownership acquired through such conversion is limited to the extent of the converted shares. These types of debentures are called convertible debentures. 

Debentures are one of the most regulated and one of the most useful capital-earning methods for a company. They have very unique features when compared with other modes of acquiring capital. In the concept of debentures, both the company and the debenture-holder are in safer and profitable aspects with respect to each other. As the private sector’s power is increasing day by day, it is vital to follow a more secure way for both the companies and the person investing in it for the purpose of acquiring capital for the growth of the business. Debentures are the most secured form of securities given by the company and as there are different types of debentures, it will help both the companies and the debenture-holders to choose any one among them as per their convenience.

Can a company buy its own debentures?

A company can buy or purchase its own debentures in the open market. Companies do so with the motive of investing in them and at a later period of time selling them at a higher price and earning a profit thereby. According to Section 68 of the Companies Act, 2013 and Section 17 of the Companies (Share Capital and Debentures) Rules, 2014 defines the procedure for buyback of securities by a company. 

What is the time period to redeem debentures?

There is as such no time period to redeem debentures, it may vary from company to company but most of the time, the redemption happens after the maturity date. It may be a fixed number of years, any time after a stipulated number of years has passed since its issue or any time after the debenture-holder has issued a notice showing his intention to get back his principal amount through annual drawing.

What is the role of a debenture trust deed in debentures?

The debenture trust deed is an instrument which is in favour of the debenture holder and is executed by the company. The company in the trust deed defines its role and duties in the issue of debentures and protects the interest of the debenture-holders.

Are debentures and bonds the same? 

Generally speaking, all debentures are bonds, but not all bonds are debentures. When a bond is unsecured it is considered a debenture. Debentures are basically used for a specific purpose, unlike bonds. For example, a bond may be issued to raise the capital of the company in general, whereas a debenture may be issued to raise capital for any specific upcoming project of the company. Also in case of the convertible debentures, the convertible debentures can be converted into shares, but bonds can never be converted into shares.  Another major difference is that the bonds are issued for a long period of time as compared to debentures that are issued for a short period. 

Any tax liability to a debenture-holder while redeeming debentures?

If a debenture-holder has invested in bonds or debentures, then he needs to file an Income Tax Return (ITR) and pay tax on the income received when the debenture gets redeemed by him. As per the Income Tax Act, 1961, debentures are considered as securities and they can be sold, and the sale of debentures is considered as a capital gains income. In terms of listed and unlisted debentures for short term capital gains, there is a tax slab in the Act and in terms of listed and unlisted debentures for long term capital gains, the tax rate is 10% and 20% respectively without indexation under Section 112 of the Income Tax Act, 1961.

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