Basics of Debentures & Borrowing Powers of Companies
1. Introduction to Corporate Borrowing
Companies often require substantial capital to fund their operations, expansion, or new projects. While equity shares are a means of raising capital, companies also borrow money through loans or by issuing debentures. The Companies Act, 2013 governs both the manner and extent of borrowings by companies.
2. Meaning of Debentures
Definition (Section 2(30), Companies Act, 2013):
“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.
Debentures are a form of debt instrument that acknowledges a loan taken by the company from debenture holders. They do not carry ownership rights but represent a creditor relationship.
3. Features of Debentures
- Debt Instrument – Represents borrowing by the company.
- Fixed Interest – Usually carry a fixed rate of interest, paid periodically.
- No Voting Rights – Debenture holders are creditors, not owners.
- Tenure – Issued for a specific period, after which repayment is due.
- Secured/Unsecured – May be backed by company assets or not.
- Transferable – Can be traded or transferred (depending on terms).
4. Types of Debentures
| Category | Types | Description |
|---|---|---|
| Based on Security | Secured | Backed by charge on assets. |
| Unsecured (Naked) | No charge; only company’s creditworthiness. | |
| Based on Tenure | Redeemable | Repaid after a specified term. |
| Irredeemable (Perpetual) | Not repaid unless winding up (not common in India). | |
| Based on Convertibility | Convertible | Can be converted into shares. |
| Non-Convertible | Cannot be converted into shares. | |
| Based on Registration | Registered | Name of holder recorded. |
| Bearer | Transferable by delivery only. Not allowed in India under current law. |
5. Statutory Provisions on Debentures
Section 71 – Issue of Debentures
- A company may issue debentures with or without the option to convert into shares.
- No voting rights can be attached to debentures.
- Secured debentures must comply with conditions regarding creation of a Debenture Redemption Reserve (DRR) and trust deed.
- Debentures cannot be issued with a maturity exceeding 10 years, except for infrastructure companies (30 years).
Debenture Trustees
- Appointed when debentures are offered to more than 500 persons.
- They protect the interest of debenture holders and ensure the performance of obligations by the company.
6. Debenture Redemption Reserve (DRR)
- Introduced to safeguard debenture holders.
- Certain classes of companies must create a DRR out of profits before redeeming debentures.
- As per Rule 18 of Companies (Share Capital and Debentures) Rules, 2014, DRR requirements differ for NBFCs, listed companies, etc.
7. Borrowing Powers of Companies
A. Express Power in MoA & AoA
- A company can borrow funds only if authorized by its Memorandum and Articles of Association.
B. Section 179(3)(d) – Powers of Board
- The Board of Directors has the power to borrow, subject to limitations set in the company’s constitution.
C. Section 180(1)(c) – Special Resolution Requirement
If borrowings exceed the aggregate of paid-up share capital, free reserves, and securities premium, then a special resolution is required in a general meeting.
D. Ultra Vires Borrowing
- If borrowing is beyond the powers given in MoA/AoA, it is void ab initio.
- Lenders may have limited remedies under equity if money has been used for company’s benefit.
8. Registration of Charges (Sections 77–87)
- For secured borrowings (debentures or loans), a charge must be registered with the Registrar of Companies (RoC).
- Time limit: Within 30 days of creation (extendable).
- Failure to register can render the charge unenforceable against liquidator/creditors.
9. Rights of Debenture Holders
- Right to receive interest and principal on due dates.
- In case of default, may approach debenture trustee or initiate legal proceedings.
- If secured, can enforce security through appropriate forums.
10. Comparison: Shareholders vs. Debenture Holders
| Basis | Shareholders | Debenture Holders |
|---|---|---|
| Ownership | Yes | No |
| Voting Rights | Yes | No |
| Return | Dividend (not guaranteed) | Interest (fixed) |
| Risk | High | Lower |
| Security | Unsecured | Often secured |
Conclusion
Debentures are a crucial instrument for corporate finance, allowing companies to raise funds without diluting ownership. However, companies must ensure compliance with provisions of the Companies Act, 2013, especially concerning security, registration, trustee appointment, and board/shareholder approvals. Sound borrowing practices and transparent disclosures ensure both financial discipline and investor protection.