Debentures and convertible debentures

Raising of funds by issue of debentures or bonds is also a source of long-term capital for a company like share capital. Persons who subscribed to the shares of a company are its owners while debenture holders are its creditors. Shares and debentures are however, securities and the provisions of the companies act 1956 regulate their issue and protect the interests of the holders of shares and debentures. The issue of debentures and bonds to the public by listed companies will be accordance with SEBI.

Perpetual debentures

Although section 120 of the companies act provides for issue of irredeemable debentures, this is an outmoded concept. As a matter of fact, the guidelines of SEBI provide for redemption of debenture after a certain period of their issue and also for the protection of the interests of the debenture holders.

Debentures promote a balanced capital structure

All the moneys needed for running a company’s business is not generally provided by the owners. Good financial management implies that there must be a proper balance between the owners capital and long-term loan capital. A proper mix of outside long-term capital strengthens the interest of holders of equity shares.

Capital gearing

It is an important aspect which should be kept in view. The relation between equity shares and reserves on the one hand and preference shares and long-term loan capital is known as capital gearing. A highly geared capital is one which has a small portion of equity capital, free reserves and undistributed profits of their registration entities. If a larger portion of total capital is met by equity capital and reserves, the capital structure is said to be low geared.

Meaning of debentures

A debenture is a document which acknowledges a debt of a company. A debenture is generally secured on the assets of an registration company, but a company may also issue debenture without any security may be rare.

Floating charge or fixed charge

The security for debentures may be a floating charge or fixed charge on the assets of the company or both. A floating charge is not any specific asset. The company is free to do business with the assets subject to the floating charge and to change the structure of the assets in the ordinary course of business. A floating charge becomes fixed when the company ceases to be a going concern. However, debenture with a floating charge are not favored by investors.

Types of debentures

For a long time in the past debentures were considered to be true debt instruments. But during the last 20 years or so issue of convertible debenture has become popular. Thus the register of company can issue the following types of debentures.

Pure debentures secured by mortgage of company’s immovable property and other assets, known as non-convertible debentures.

Partly convertible debenture comprising of part of the amount of debentures convertible into equity shares and the balance amount subject to redemption at the time of maturity of the debentures.

Fully convertible debenture consisting of the full amount of debenture convertible into equity shares of the registered company.

Same provisions for public issue of shares and debentures

The provisions in the act regarding issue of shares to the public by prospectus would also mutatis mutandis apply to the issue of debenture by prospectus except that section 69 relating to minimum subscription does not apply to an issue of debentures. Thus, the act requires an offer of shares or debenture to the public to comply with the disclosure aspects in the same way. A public limited company which does no issue a prospectus, shall not allot any of its shares or debentures unless it files with ROC.

Listing of debentures as per section 73 of companies act 1956

A listed company, which prospectus to issue debenture to the public. It shall make the debenture enlisted in a recognized stock exchange. It shall, before issuing the prospectus for such issue, make the application to the stock exchange concerned. The permission must be obtained before the expiry of ten weeks from the date of the closing of the subscription. It is not a condition that only a listed company registration can make a public issue of debenture. According to SEBI guidelines it is possible to make an initial offer of debenture to the public subject to the conditions specified.

Public companies (term of issue of debentures and raising of loans with option to convert such debentures or loans into shares) rules, 1997

Pursuant to the above rules, the approval of the central government for conversion of debenture and loans into equity shares in terms of clause (a) of the proviso under section 81(3) of the company’s act 1956 will not be necessary if the terms of conversion are as follows:

The debentures are issued or loans are raised either through private company subscription or issue of a prospectus to the public.

A public financial institution or scheduled bank either underwrites the above issue or subscribe to the issue of debenture, either wholly or in part or sanctions the whole or part of the loan.

The right of conversion may be at par or at a premium not exceeding 25% of the nominal value of the shares.

Issue of convertible debenture within the above rules, will therefore, require only the approval of shareholders resolution before the issue is made and the approval of the board in terms of section 292.

Government approval when not needed

Some are of the view that when, in terms of the issue of convertible debenture, a company holds unconditional right to convert the debentures into equity shares as per the conditions of issue. The debenture-holders have no option but to accept the conversion, no approval of the central government.