What is a debenture? Discuss its characteristics. State and explain the different kinds of debentures.
Write a note
on remedies of debentures holders in case of non-payment.
Debentures are one of the frequently used methods by which a business can procure long-term funds for its initial
financial needs or for its subsequent requirements of growth and modernization. Funds acquired by means of
debentures represent debt and its holders are the company’s creditors.
In common parlance, debenture is merely a written instrument signed by the company under its common seal,
acknowledging the debt due by it to its holders. Through this instrument the company promises to pay a specific
amount of money as stated therein at a fixed date in future together with periodic payment of interest to
compensate the holders for the use of the funds.
The Companies Act, 1956 has not defined as to what debenture means. It simply states that a “debenture includes
debenture stock, bonds and any other securities of a company whether constituting a charge on the assets of the
company or not [Sec. 2 (12)]. Thus, the Act only states that it is a kind of security which constitutes a charge by way
of security on issuing debentures. In sum, debenture is a long-term promissory note which usually runs for duration
of not less than ten years”.
CHARACTERISTICS OF DEBENTURES
1. It is an instrument in writing. An oral promise in acknowledgement of a debt is not a debenture.
2. It is an acknowledgement of the indebtedness of the company to its holder for the amount stated in it.
3. It is usually under the seal of the company but it is not necessary. A certificate signed by two directors of a
company and without bearing the company’s seal is a valid debenture.
4. It is one of a series of like debentures. But a single debenture may be issued to one man.
5. It provides for the payment fixed sum with interest of a specified rate by a specified time. But this is not essential
because a company may issue perpetual debentures. Section 120 of the companies’ act 1956 expressly provides for
the issue of perpetual or irredeemable debentures w3hich are made payable only in the event of a winding up or
some serious default with the company.
6. It is generally secured by a charge, fixed or floating on any part of the company’s property or undertaking. But
this is, however, not an essential condition because section 2(12) provides that the debentures may or may not
constitute a charge on the assets of the company.
CLASSIFICATION OF DEBENTURES
1. Classification in Terms of Security
i. Secured Debentures: Secured debentures are those secured by a charge on the fixed assets of the company
issuing it. This means that if the issuer fails to pay the principal or interest amount, his assets can be sold for
repayment of the liability to the investors. Section 71(3) of the Companies Act, 2013 provides that secured
debentures may be issued by a company subject to such terms and conditions as may be prescribed by the
Central Government through rules.
ii. Unsecured Debentures: In these instruments, if the issuer defaults on payment of the interest or principal
amount, the investor has to be on the same standing as other unsecured creditors of the company waiting
for repayment. These are also called Naked Debentures.
2. Classification in Terms of Redemption:
Redeemable Debentures: These are the debentures which are issued with a condition that they will be redeemed
at a fixed date or upon demand, or after notice, or under a system of periodical drawings. Debentures, generally are
redeemable and on redemption, they can be reissued or cancelled.
Perpetual or Irredeemable Debentures: A Debenture, in which no time is fixed for the company to pay back the
money, is an irredeemable debenture. The holder of debenture cannot demand repayment till the company is a
going concern and does not make default in payment of interest. After the commencement of the Companies Act,
2013, a company cannot issue perpetual or irredeemable debentures.
3. Classification in Terms of Records Maintained: From records point of view, debentures can be classified as
registered debentures or bearer debentures. Registered debentures are those in respect of which names, addresses
and particulars of holding of the debenture holders are registered by the company. In this case, debentures can be
transferred by executing a regular transfer deed. Bearer debentures are those which are transferable by mere
delivery. In this case, the company does not keep any record of the debenture holders.
4. Classification in Terms of Priority: From priority point of view, debentures are classified as first debentures and
second debentures. First debentures are those which have to be repaid before other debentures are paid out.
Debentures which will be repaid when first debentures have been redeemed are termed as second debentures.
5. Classification in Terms of Convertibility:
i) Non-Convertible Debentures (NCD): These instruments cannot be converted into equity shares. They will retain
their debt character only.
ii) Partly Convertible Debentures (PCD): A part of these instruments can be converted into Equity shares in future
at the notice of the issuer. The issuer decides in which ratio the conversion is done, usually at the time of
subscription itself.
iii) Fully convertible Debentures (FCD): These debentures are fully convertible into Equity shares at the issuer’s
notice. The issuer decides the ratio of conversion. Upon conversion, the investors enjoy the same status as any
ordinary shareholders of the company.
iv) Optionally Convertible Debentures (OCD): The investor has an option to convert these debentures into shares at
a price decided by the issuer or agreed upon at the time of issue.
6. On the Basis of Registration
i) Registered Debentures: A company maintains a register of debenture holders. The debenture, when issued to a
specific person’s name, mentioning such name on the certificate and the register, creates a Registered Debenture. It
can only be transferred like shares by a duly stamped instrument of transfer satisfying the requirements of Section
56 of the Act.
ii) Bearer debentures: On the contrary, debentures may be made out to bearer, making them freely transferable by
delivery and entitling its bearer to the amount at the time of redemption. Bearer debentures are negotiable
instruments, and the person holding it is a ‘holder in due course’ under the Negotiable Instruments Act. He is thus
entitled to receive the principal and the interest thereon (Calcutta Safe Deposit Co. Ltd. v. Ranjit Mathuradas
Sampat
DIFFERENCES BETWEEN SHARES AND DEBENTURES
Definition of Shares: Smallest division of the company’s capital is known as shares. The shares are offered for sale in
the open market, i.e. stock market to raise capital for the company. The rate on which the shares are offered is
known as share price. It represents the portion of ownership of the shareholder in the company. The shareholders
are entitled to the dividend (if any) declared by the company on the shares.
Definition of Debentures: A long-term debt instrument issued by the company under its common seal, to the
debenture holder showing the indebtedness of the company. The capital raised by the company is the borrowed
capital; that is why the debenture holders are the creditors of the company. The debentures can be redeemable or
irredeemable in nature. They are freely transferable. The return on debentures is in the form of interest at a fixed
rate. Debentures are secured by a charge on assets, although unsecured debentures can also be issued. They do not
carry voting rights.
Key Differences Between Shares and Debentures
1. The holder of shares is known as a shareholder while the holder of debentures is known as debenture holder.
2. Share is the capital of the company, but Debenture is the debt of the company.
3. The shares represent ownership of the shareholders in the company. On the other hand, debentures represent
indebtedness of the company.
4. The income earned on shares is the dividend, but the income earned on debentures is interest.
5. The payment of dividend can be made only out of current profits of the business and not otherwise. Unlike the
interest on debentures which has to be paid by the company to debenture holders, no matter company has earned
profit or not.
6. Dividend is not a business expense and so is not allowed as deduction. On the contrary, interest on debentures is
an expense and so allowed as a deduction.
7. In the event of winding up, debentures get priority of repayment over shares.
8. Shares cannot be converted as opposed to debentures are convertible.
9. There is no security charge created for payment of shares. Conversely, security charge is created for the payment
of debentures.
10. A trust deed is not executed in case of shares whereas trust deed is executed when the debentures are issued to
the public.
11. Unlike debenture holders, shareholders have voting rights.
12. Shares are issued at a discount subject to some legal compliance. Debentures can be issued at a discount
without any legal compliance.