Friday, November 25, 2011

A Brief Understanding of Debentures

Sub-section (12) of Section 2 of the Companies Act, 1956 defines “debenture” as follows:

“Debenture includes debenture stock, bonds and any other securities of a company, whether constituting a charge on the assets of the company or not.”

Sub-clause (i) of Clause (h) of Section 2 of the Securities Contracts (Regulation) Act, 1956 defines the term “Securities” as follows:

“Securities” include – (i) shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate;”

Etymologically, the word ‘debenture’ is derived, in 15th Century, from the Latin “debentur” meaning, “there are owed”.  In Thomas Froude & Eric V.E. White, The Practice Relating to Debentures (1935) a passage about debentures reads as follows:  “The word, ‘debenture’ in its archaic sense was applied to a form given under seal as an acknowledgment for goods supplied to the Royal Household, and as such probably meant a charge on Public Funds. The term was further applied to drawback certificates issued for repayment, on the exportation of goods, of duty which had already been paid upon them, and this term is still so used by H.M. Customs…. The word is now, however, generally used to indicate an acknowledgment of indebtedness given under seal by an incorporated company, containing a charge on assets of the company, and carrying an agreed rate of interest until payment, but the variety of the forms which a debenture may take makes it difficult to find a good general definition in any reported case.” See: Black’s Law Dictionary, Ninth Edition at 460.

‘The term itself [debenture] imports a debt – an acknowledgment of a debt – and speaking of the numerous and various forms of instruments which have been called debentures without anyone being able to say the term is incorrectly used, I find that generally, if not always, the instrument imports an obligation or covenant to pay.  This obligation or covenant is in most cases at the present day accompanied by some charge or security.  So that there are debentures which are secured, and debentures which are not secured … I am not bound to hold that an instrument is a debenture because it is called a debenture by the company issuing it, nor to hold it is not a debenture because it is not so called by the company.  I must look at the substance of the instrument itself … I have seen debentures of various kinds and classes, and it is a mistake to say that to be debentures the instruments must be issued and numbered seriatim.  I have seen even a single debenture issued to one man.’  Edmonds v. Blaina Furnaces Co, Beesley v. Blaina Furnaces Co (1887) 36 Ch D 215 at 219-221, per Chitty J

The term ‘debenture’, “as used in modern commercial parlance is of extremely elastic character”.  Palmer’s Company Law, 24th Edn., at 673.

No precise definition of ‘debenture’ can be found, but various forms of instruments are called debentures.  A debenture is a document which either creates or acknowledges a debt.  The debt secured may be all moneys due from the company on any account whatsoever, and is then known as an ‘all moneys debenture’.  Even so, it does not cover moneys due on unsecured loan stock issued to a third party and subsequently acquired by the debenture holder.  A document may be a debenture even though, under its term, the debt is to be repaid out of only a part of the profits.  The term ‘debenture is usually associated with a company of some kind, and most debentures are securities given by companies.  Nevertheless debentures are often granted by clubs and occasionally by individuals. [Halsbury’s Laws of England (4th Edn) (2004 Reissue) Vol. 7(2) para 1553].

In Narendra Kumar Maheshwari v. Union of India, AIR 1989 SC 2138, the Supreme Court of India cited with approval the meaning of the term ‘debenture’ as stated in Palmer’s Company Law, 24th Edition at p. 672 as under:

“A debenture has been defined to mean essentially as an acknowledgement of debt, with a commitment to repay the principal with interest.”

In Sudhir Shantilal Mehta vs. Central Bureau of Investigation [2010]155CompCas339(SC), commenting on the scope of securities encompassed by the definition of the term in Section 2(h) of the Securities Contracts (Regulation) Act, 1956, the Hon’ble Supreme Court of India, at paragraphs 41 and 42, observed as follows:

"41. The definition of `securities' is an inclusive one. It is not exhaustive. It takes within its purview not only the matters specified therein but also all other types of securities as commonly understood. The term `securities', thus, should be given an expansive meaning.

42. In State of Bombay v. The Hospital Mazdoor Sabha AIR 1960 SC 610 this Court while interpreting the definition of "industry" as contained in Section 2(j) of the Industrial Disputes Act, 1947 held as under:

It is obvious that the words used in an inclusive definition denote extension and cannot be treated as restricted in any sense. (Vide: "Stroud's Judicial Dictionary", 5th Edition, Vol. 3 at 1263). Where we are dealing with an inclusive definition it would be inappropriate to put a restrictive interpretation upon terms of wider denotation.  (See also Regional Director, Employees' State Insurance Corporation v. High Land Coffee Works of P.F.X. Saldanha and Sons AIR 1992 SC 129."

Therefore, it follows from the above that ‘debentures’ are creditorship securities representing long-term indebtedness of a company. A debenture is an instrument executed by the company under its common seal acknowledging indebtedness to some person or persons to secure the sum advanced. It is, thus, a security issued by a company against the debt. A public limited company is allowed to raise debt or loan through debentures after getting certificate of commencement of business if permitted by its Memorandum of Association.

Debentures, like shares, are equal parts of loan raised by a company. Debentures are usually secured by the company by a fixed or floating debentures at periodical intervals, generally six months and the company agrees to pay the principal amount at the expiry of the stipulated period according to their terms of issue. Like shares, they are issued to the public at par, at a premium or at a discount. Debenture-holders are creditors of the company. They have no voting rights but their claims rank prior to preference shareholders and equity shareholders. Their exact rights depend upon the nature of debentures they hold.

The definition of debenture reads… “debenture includes debenture stock…”, it would be desirable to understand the difference between debenture and debenture stock.  Debenture stock is borrowed capital consolidated into one mass, which may be divided into and transferable in convenient units of fixed amount.  In other words, ‘debenture stock’ is of the same nature as debentures but instead of each lender having a separate debenture bond, the lender gets a certificate entitling him to a specified portion of one large loan.

Rule 2 (b)(x) of the Companies (Acceptance of Deposits) Rules, 1975 reads as follows:

“"deposit" means any deposit of money with and includes any amount borrowed by, a company, but does not include-

(x)  any amount raised by the issue of bonds or debentures secured by the mortgage of any immovable property of the company or with an option to convert them into shares in the company provided that in the case of such bonds or debentures secured by the mortgage of any immovable property the amount of such bonds or debentures shall not exceed the market value of such immovable property.”

It follows from the reading of the Rule 2(b)(x) above, while any amount raised by the issue of bonds or debentures secured by mortgage of any immovable property of the company or with an option to convert them into shares in the company does not include within the meaning of the term ‘deposit’, unsecured debentures or those debentures which are secured by movable property are deposits and accordingly attract the provisions of Section 58A of the Companies Act, 1956.   Further, it is also to be noted that the Rule 2(b)(x) speaks of issue of debentures with an option to convert them into shares.  Since the Rule does not specify the type of shares, there is an option to convert the debentures into preference shares or equity shares.

Sub-section (12) of Section 2 of the Companies Act, 1956 provides that ‘debenture’, inter alia, includes any other “securities” of a company.  As per the sub-clause (i) of Clause (h) of Section 2 of the Securities Contracts (Regulation) Act, 1956, “Securities” include – (i) shares, scrips, stocks, bonds, debentures, debenture stock or “other marketable securities of a like nature” in or of any incorporated company or other body corporate.  Since the definition is an ‘inclusive’ one, as such the use of the words “other marketable securities of a like nature” in the definition would mean that the preceding terms used the definition under sub-section (12) are in the nature of marketable securities.

The use of the expression ‘marketable securities’ in the definition would give rise to an argument that only listed instruments are marketable.  Hence the moot question arises whether the term securities and hence, the debentures under the scheme of the Companies Act, 1956 can only be listed instruments.  This argument has been set at rest by the Supreme Court of India in  Naresh K. Aggarwala and Co. vs. Canbank Financial Services Limited AIR 2010 SC 2722, while referring to the definition of the term “securities” defined under the SCR Act observed that “perusal of the above quoted definition shows that it does not make any distinction between listed securities and unlisted securities.”

Thus, debentures under the Companies Act, 1956 can be publicly listed or unlisted in stock exchange.

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