This article has been written by Ms Shubhangi Kusum, a 4th year student of ICFAI University, Jharkhand.

Abstract

Debentures are essential financial instruments used by companies to raise capital. In this article, we explore the world of debentures, their types, and the critical role played by debenture trustees under the Companies Act, 2013. The debentures are the ones who are also known as the creditors of the company as they invest in the company. If we consider the case of bankruptcy the debentures are the one who’s the company must repay payments first. The company should priorly return the amount of the debentures firstly. The debentures are the one of the main trust holders of the company which plays a pivotal role in corporate finance, and it also allows the company to raise the capital while maintaining the equity ownership. The debentures are that hands of a company which allows the company to raise the capital for their investment and makes the availability of funds easily and smoothly.

Introduction

Debentures serve as a vital financial instrument for companies seeking to raise capital. These debt instruments provide an avenue for companies to borrow funds from investors while promising to repay the principal amount along with interest. In this article, we explore the world of debentures, their types, and the crucial role played by debenture trustees under the Companies Act, 2013. The Debentures are considered as one of the main holders of the company. A debenture is an instrument of debt executed by the company acknowledging its obligation to repay the at a specified rate and carrying an interest. It is also known as the method of raising and initiating the loan or financial funds for the company. A debenture can also be considered as a certified loan promoter or a loan bond evidencing the fact that the company is liable to pay a various specified amount with the interest and although the money or the funds which are raised by the debentures of a company automatically becomes a part of the company’s capital structure, and it does not become share capital.

Understanding Debentures

What are Debentures:

In any business, the ways to raise money and capital for the working of the company is a Debenture. It can help in the collection of funds issued by the debentures. It is far different from other kinds of shares such as equity shares and other shares as both preference and equity. There is a basic difference or distinction being, as when anyone who buys the shares of the company becomes the part owner of the company, but at the same time when anyone buys debentures issued by the company then it becomes a creditor to the company. It can be said that the debenture is a kind of formal loan given to the company by another individual as a result the company is obliged to repay the loans within a specified period with interest. The main importance and the advantages of being a debenture holder is that, in case of winding-up/bankruptcy of any company, the debenture holders are the creditors of the company and the are the ones who would be paid first. 

If we consider some important sections of the Companies Act, as a result these are the sections related to the payment of loans at the time of winding up of a company. They are: –

1. Section 530:   In this, it specifies the order of payments during the winding up of a company. It highlights the pattern or sequences in which various creditors and stakeholders should be paid. Debenture holders are among the beneficiaries, but not necessarily the first to receive payments.  
2. Section 529A: This provision starts with a notwithstanding clause, which emphasize its importance. It ensures that few payments take priority over the order specified in Section 530. These overriding preferential payments may include specific obligations or liabilities that must be settled before other claims.

Debentures are essentially promissory notes issued by companies to raise funds. Unlike equity shares, where shareholders become partial owners of the company, debenture holders act as creditors. When a company issues debentures, it is essentially borrowing money from investors, promising to repay it within a specified period, along with interest. 

There are various laws under the Companies act,2013 which specifically defines that no company shall issue a prospectus or make an officer or invites to the public or to its members exceeding five hundred for the purpose of its debentures, unless the company has, before such issue or offer, appointed one or more debenture trustees and the conditions governing the appointment of such trustees shall be such as may be prescribed as “No company shall issue a prospectus or make an offer or invitation to the public or its members exceeding five hundred for a subscription of its debenture, unless the company has, before such issue or offer, appointed one or more debentures trustees and the conditions governing the appointment of such trustees  should same as prescribed.” 

Types of Debentures:       

• Convertible Debentures: These can be converted into equity shares after a specified period.
• Non-Convertible Debentures: These cannot be converted into equity shares.

Issuance of Debentures:           

• Under the Companies Act, 2013, private companies can issue debentures only through private placement.
• A company can issue debentures with an option to convert them into shares (subject to shareholder approval).
• Issuance of debentures does not grant voting rights to debenture holders.

Secured Debentures: If a company opts for secured debentures, it must meet certain conditions-

• Redemption date within 10 years (or up to 30 years for infrastructure projects).
• Creation of a charge on company assets to secure repayment.
• Appointment of a debenture trustee.

 Debenture Trustee

A debenture trustee acts as a custodian of debenture holders’ interests. In other words, it means a person is given responsibility for issuance and distribution of debentures. They act as the holder of debenture stock for the sake of another party. A company can take the alternative of issuance of the stocks as a form of debt for increasing the capital with a circumstance that the debt had to be reimburse at a determined interest rate. The debenture trustee must keep contact with distinct groups. Debenture trustee serves as a connection between the debenture holders who are collecting the interest payments and the company that issue the debentures 

Securities Exchange Board of India (SEBI) regulates the debenture trustees in India. There are rules and regulations regarding the registration, eligibility criteria, review, code of conduct etc.

As stated in SEBI Rules, 1993- “debenture trustee” means a trustee of a trust deed for securing any issue of debentures of a corporate body [section 2 (bb)]. (Applicable to public companies only)

Debenture trustee appointment and duties of debenture trustee

Section 71 (5) of the Companies act deals with the Appointment of Debenture Trustee.

Rule 18 (2) of the Companies (Share Capital and Debenture Rules),2014 states the conditions of appointment.

After adhering to the following circumstances, debenture trustee shall be appointed under sub-section (5) of section 71 by the company:

1. It states that the name of debenture trustee should be specified under the letter of offer of debenture or also the name should be mentioned in the notice, or any means of communication issued.
2. There should be a written consensual paper from the trustee which should be obtained by the company before the appointment of the debenture trustee
3. There should not be the appointment of the debenture trustee if he/she: – 

1. holds a beneficiary share in the company;
2. If he/she is the promoter of the company, director or member of the board of director or key management personnel or any other officer or a person/employee of the company or its any holding, subsidiary or associate company.
3. If that person is entitled to any monetary incomes paid by the company other than remuneration payable to them;
4. If there is any debt to the company, or its subsidiary or its holding or associate company or a subsidiary of such holding company;
5. If there is any guarantee for the debts secured by the debentures or its interest
6. If he/she is the relative of the promoter or any other person in the company 
7. has any pecuniary relation with the company, for two years preceding the financial years or during the current financial years [ the amount should be lower of 2% of turnover or total income OR Rs. 50lac]

1. If there should be decisions related to the casual vacancy, the board can fill it but while performing any such vacancies, the remaining trustee or trustees, if any, may act;

It is mentioned that such vacancy occurs after the resign of the debenture trustee, the vacancy should be filled with majority of the debenture holders with their written consent. 

If at their meeting the three fourth in the value of the debenture trustee decides to remove, they can remove the office before the expiry of his term only if it is approved by the holders of the debentures.

There is Rule 18(3) in the Companies (Share capital and debenture rules) under year 2014, which describes the duties of the debenture trustee such as;

• There is not any breach in the terms of issue of debentures which should be ensured by the trustee
•  The steps should be taken by the trustee for the remedy if there is any breach of the rules as above mentioned
• The trustee is the person who informs the debenture holders about such breach.
• The trustee can ensure that all the condition regarding creation of security for the debentures is fulfilled and trustee should take care of that also
• The trustee convenes the meeting between the company and the debenture holders

Rights:

• There are section 18(c) which states that a company in no case could issue debenture before the appointment of a debenture trustee
• The company cannot issue debentures before obtaining the consent of the debenture trustee.
• The company must specify the name of the name of the debenture trustee in the offer letter.
• They can arrange or call for a report of the company related to the performance periodically
• The debenture trustee can also ask for the report related to the use of funds through issue of debentures
• There should be proper communication in between the debenture holders and the trustee if any regarding the payment of interest or redemption of debentures and action taken by the trustee therefore
• There should be an appointment of a nominee by the trustee to board of director of the company.

Liabilities:

• There should not be any appointment as a debenture trustee if there is share of ownership in the company of that same debenture
• There should not be appointment of that if he/she is a promoter of company, employee or the manager of the company
• There is no any appointment for the creditor to the company.
• There should be consent of other trustees in filing of the vacancy of the debenture.

Case laws

In Baroda Rayon Corporation v. ICICI Ltd. (Debenture Trustees), the right of debenture trustee to sell off a unit of Baroda Rayon for the benefits of debenture holders was upheld by the Court.

In Canara Bank (Debenture Trustees) v. Apple Finance Ltd., the case was filed by Canara Bank as a debenture trustee for sum due and unsettled by the defendant Apple Finance ltd. AFL failed to recover the debentures and settle the various loans conceded by the debenture holders. Consequently, the plaintiffs sued to acquire interim relief together with the appointment of the Court receiver. To secure the said debenture, AFL mortgaged their immovable property. A file charge on the right, title and interest, inter alia of the suit property together with the plot on which it stood and the furniture, fittings and fixtures thereon came to be created in favour of debenture trustee i.e. Canara Bank who filed the case. The Bombay High Court upheld the right of debenture trustee i.e. Canara Bank to sell the immovable property which is mortgaged by the company to secure the debenture, in the interest of debenture holder as the Apple Finance Ltd. fails to redeem the debenture and pay off the various loans granted by the debenture holders.

Conclusion

In summary, debenture trustees serve as vigilant guardians, ensuring the rights and security of debenture holders. Their multifaceted responsibilities include monitoring issuer reports, enforcing security interests, and overseeing conversion and redemption processes. By maintaining transparency and acting swiftly in case of defaults, debenture trustees contribute to a robust financial ecosystem. Debenture trustees, often unsung heroes in the financial landscape, play a pivotal role in maintaining investor confidence. Their watchful eyes scrutinize issuer reports, ensuring transparency and adherence to agreed-upon terms. When defaults or breaches occur, debenture trustees act swiftly, safeguarding the interests of debenture holders. Whether overseeing the conversion of debentures into shares or enforcing security interests, they provide stability and trust. Investors can rest assured that their hard-earned capital is protected. In this intricate dance between companies and investors, debenture trustees ensure harmony, making debentures a reliable avenue for capital raising.

References

• https://incometaxindia.gov.in/Acts/Companies%20Act,%201956/102120000000000910.htm
• This article was written by anonyms published on tax guru website. The link for the same is herein.https://taxguru.in/company-law/debenture-trustees-frequently-asked-questions faqs.html#:~:text=Duties%20of%20the%20Debenture%20Trustee%20include%3A%20%28a%29%20Call,security%20in%20the%20interest%20of%20the%20debenture%20holders.
• This article was originally written by Mridul Gupta published on blog pleader website. The link for the same is herein. https://blog.ipleaders.in/debentures-and-debenture-trustees-under-companies-act-2013/
• This article was written by anonyms published on law lawtimesjournal website. The link for the same is herein. https://lawtimesjournal.in/debentures-trustees-company-act-2013/#_ftn1
• This article was written by editorial team published on lawyersgyan website. The link for the same is herein. https://lawyersgyan.com/blog/debenture-trustee-its-position-rights-and-duties/
• This article was originally written by Kunal Basu published on slideshare website. The link for the same is herein. https://www.slideshare.net/shantanu_leo/debenture-trustees
• This article was originally written by Pragati published on indianlawportal website. The link for the same is herein. https://indianlawportal.co.in/debenture-trustee/
• This article has taken some ideas from the source https://blog.ipleaders.in/debentures-and-debenture-trustees-under-companies-act-2013/