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 15^th 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, 24^th 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 (4^th 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.

Can a Company have more than one Managing Director

ABC Co. Ltd. has 3 businesses, namely, Textile, Sugar and Fertilizers.  Mr. X, Mr. Y and Mr. Z have been simultaneously appointed as Managing Director of each of the above businesses.  Are the appointments valid in law?

Sub-section (26) of Section 2 of the Companies Act, 1956 defines the expression “Managing Director” as follows:

“ “managing director” means a director who, by virtue of an agreement with the company or of a resolution passed by the company in general meeting or by its Board of directors or, by virtue of its memorandum or articles of association, is entrusted with substantial powers of management which would not otherwise be exercisable by him, and includes a director occupying the position of a managing director, by whatever name called :

   Provided that the power to do administrative acts of a routine nature when so authorized by the Board such as the power to affix the common seal of the company to any document or to draw and endorse any cheque on the account of the company in any bank or to draw and endorse any negotiable instrument or to sign any certificate of share or to direct registration of transfer of any share, shall not be deemed to be included within substantial powers of management :

            

  Provided further that a managing director of a company shall exercise his powers subject to the superintendence, control and direction of its Board of directors;”

A perusal of the definition of the expression ‘managing director’ will show that only a director who is entrusted with substantial powers of management which would not otherwise be exercisable by him will be deemed to be a managing director.  Further, it is apparent that a director occupying the position of a managing director, by whatever name called, will also be deemed to be a managing director.  Whether more than one managing director can be appointed in a company is better appreciated by examining the distinguishing features between the definitions of the terms ‘manager’ and ‘managing director’.

Sub-section (24) of the Section 2 of the Companies Act, 1956 reads as follows:

“ “manager” means an individual (not being the managing agent”) who, subject to the superintendence, control and direction of the Board of directors, has the management of the whole, or substantially the whole, of the affairs of a company, and includes a director or any other person occupying the position of a manager, by whatever name called, and whether under a contract of service or not;”

The distinguishing features in the two definitions are that while Clause (26) of Section 2 of the Companies Act, 1956 stipulates that the managing director should be entrusted with substantial powers of management, under Clause (24) of Section 2 of the Companies Act, 1956, it is provided that a manager has the management of “the whole, or substantially the whole, of the affairs of a company”.  It is pertinent to note that the words “the whole, or substantially the whole, of the affairs of a company” as contained in the definition of ‘manager’ when contradistinguished with the words “entrusted with substantial powers of management” in the definition of ‘managing director’ clearly indicates that while the essence of the powers of management of the ‘manager’ are defined in terms of the ‘quantum’, the connotation of the expression ‘substantial powers of management’ in the absence the words “of a company”, in the definition of ‘managing director’ relates to the ‘nature’ of powers entrusted.  This standpoint is only buttressed by a plain reading of the first proviso to the sub-section (26) of Section 2 of the Companies Act, 1956, which speaks of the nature of powers.

The upshot of the distinction is that while only one person can hold the position of manager with the power of management of the whole or substantially the whole of the affairs of a company, which power is derived by virtue of the very appointment to the office of manager, substantial powers of management can be entrusted to one or more than one director in a company.

The Department of Company Affairs has issued the following Clarification in this regard:

“Department’s Clarification.–  “Section 2(26) defines “Managing director” as a director who is entrusted with substantial powers of management which term refers to the nature of the powers and not the quantum thereof.  Section 2(24) of the Companies Act, 1956, on the other hand has defined the word “manager” as an individual who has the management of the whole or substantially the whole of the affairs of a company.  Thus the managing director of a company may be entrusted with substantial power of management but not necessarily of the whole or substantially the whole of the affairs of a company.  A company may, therefore, have more than one managing director. [Department’s Clarification F. No. 8/16(1)/61-PR].

In view of the above, in the instant case, the simultaneous appointments of Mr. X, Mr. Y and Mr. Z as Managing Director of each of the 3 business divisions of ABC Co. Ltd., viz., Textile, Sugar and Fertilizers, is valid in law as it involves entrustment of substantial powers of management to them, and does not involve the management of the whole or substantially the whole of the affairs of a company; and as such the same is in line with the definition of the term managing director in Clause (26) of Section 2 of the Companies Act, 1956.  

Principles of Interpretation of Commercial Contracts

Interpretation of contracts is a topic of vital importance in corporate law practice. Formation of contracts, mistake and misrepresentation, frustration are all interesting topics to study and grasp the concepts thereof.  However, it is interpretation and construction of contracts which is far more important in practice.  There appears to be a shortage of academic work on the subject, perhaps because it would be a great labour to assemble to the definitive work from a great mass of material. Some of the principles of interpretation of commercial contracts arising out of body of authorities are provided hereunder.

In Chitty On Contracts, Twenty-Eighth Edition, it is stated as follows:

“12-042   Object of construction.   The object of all construction of the terms of a written agreement is to discover therefrom the intention of the parties to the agreement. Marquis of Cholmondeley v. Clinton (1820) 2 Jac. & W. 1, 91.

12-044 Further it has long been accepted that the courts will not approach the task of construction with too nice a concentration upon individual words.

“The common and universal principle ought to be applied: namely, that [an agreement] ought to receive that construction which its language will admit, and which will best effectuate the intention of the parties, to be collected from the whole of the agreement, and that greater regard is to be had to the clear intention of the parties than to any particular words which they may have used in the expression of their intent.” Ford v. Beech (1848) 11 Q.B. 852, 866.  See also Smith v. Packhurst (1742) 3 Atk. 135, 136; Lloyd v. Lloyd (1837) 2 My. & Cr. 192, 202; SA Narutune et Commerciale of Geneva v. Anglo-Iranian Oil Co. Ltd. [1953] 1 W.L.R. 1379; affd. [1954] 1 W.L.R. 496.

12.055   Mercantile contracts.   Although it has been stated that there is not in law any difference of construction between mercantile contracts and other instruments [Southwell v. Bowditch (1876) 1 C.P.D. 374, 376], commercial documents “must be construed in a business fashion” [Southland Frozen Meat and Produce Export Co. Ltd. v. Nelson Brother Ltd. [(1898) A.C. 442, 444.  See also Menth & Co. v. Ropner & Co. (1913) 1 K.B. 27, 32 (“must be understood in a business and practical sense”)] and “there must be ascribed to the words a meaning that would make good commercial sense.” [Miramar Maritime Corpn. v. Holborn Oil Trading Ltd. [(1984) A.C. 676, 682; International Fina Services AG v. Katrina Shipping Ltd. (1995) 2 Lloyd’s Rep. 344, 350].  Indeed, In The Antaios Compania Naviera SA v. Salen Rederierna A.B. [1984]A.C. 191, 201, Lord Diplock said that “if detailed semantic and syntactical analysis of words in commercial contract is going to lead to a conclusion that flouts business commonsense, it must yield to business commonsense.” See also Shipping Corpn. of India Ltd. v. NBB Niederelke Schiffartsgesellschaft mbH & Co. [1991] 1 Llyod’s Rep. 77, 80; Bankers Trust Co. v. State Bank of India [1991] 2 Lloyd’s Rep. 443, 456; International Fina Services AG v. Katrina Shipping Ltd., supra, at 350; Charter Reinsurance Co. Ltd. v. Fagan [1997] A.C. 313, 355; but cf. ibid., at 387.

In Pollock & Mulla, Indian Contract And Specific Relief Acts, Twelfth Edition 2001, Vol. 1 at 264, it is stated as follows:

“The court should put itself in a frame of mind which would make itself possible to understand how commercial minds work [Navneet Lal & Co. v. Kishan Chand & Co. AIR 1956 Bom 151 at 153].  The House of Lords in Adamastos Shipping Co. Ltd. v. Anglo-Saxon Petroleum Co. Ltd., [1959] AC 133 at 158, [1958] 1 All ER 725 (HL); Dhanrajamal Gobindram v. Shamji Kalidas & Co. [1961] 3 SCR 1020 at 1035, AIR 1961 SC 1285, summarizing the rules applicable to construction of commercial documents laid down that effort should be made to construe commercial agreements broadly and one must not be astute to find defects in them or reject them as meaningless.  The dealings of men should, as far as possible, be treated as effective and the law may not incur the reproach of being the destroyer of bargains. Hillas & Co. v. Acros Ltd. (1932)147 LT 503 per Lord Tomlin at 512, [1932] All ER Rep 494 at 499; Coffee Board v. Janab Dada Haji Ibrahim Halari AIR 1966 Mys. 118; Dhanrajamal Gobindram v. Shamji Kalidas & Co. [1961] 3 SCR 1020, AIR 1961 SC 1285.

“Where the parties have used unambiguous language, the court must apply it. This can be seen from the decision of the Court of Appeal in Co-operative Wholesale Society Ltd v. National Westminster Bank plc [1995] 1 EGLR 97.  … The court held that ordinary principles of construction applied to rent review clauses and applied the principles in The Antaios (Antaios Compania Naviera SA v Salen Rederierna AB) [1985] AC 191. After quoting the passage from the speech of Lord Diplock cited above, Hoffmann LJ said, at p 98:

"This robust declaration does not, however, mean that one can rewrite the language which the parties have used in order to make the contract conform to business common sense. But language is a very flexible instrument and, if it is capable of more than one construction, one chooses that which seems most likely to give effect to the commercial purpose of the agreement."  See also International Fina Services AG v Katrina Shipping Ltd, The Fina Samco [1995] 2 Lloyd's Rep. 344, where Neill LJ said at page 350 it was necessary when construing a commercial document to strive to attribute to it a meaning which accords with business common sense.

In Society of Lloyd's v Robinson [1999] 1 All ER (Comm) 545, 551 it was held as follows:

"Loyalty to the text of a commercial contract, instrument, or document read in its contextual setting is the paramount principle of interpretation. But in the process of interpreting the meaning of the language of a commercial document the court ought generally to favour a commercially sensible construction. The reason for this approach is that a commercial construction is likely to give effect to the intention of the parties. Words ought therefore to be interpreted in the way in which a reasonable commercial person would construe them. And the reasonable commercial person can safely be assumed to be unimpressed with technical interpretations and undue emphasis on niceties of language".

In Gan Insurance Co Ltd v Tai Ping Insurance Co Ltd [2001] CLC 1103, 1118-1119; [2011] EWCA Civ 1047; [2001] 2 All ER (Comm) 299, Mance LJ observed:

"13. Construction, as Sir Thomas Bingham MR said in Arbuthnott v Fagan [1995] CLC 1396 at p 1400 is thus 'a composite exercise, neither uncompromisingly literal nor unswervingly purposive'. To para (5), one may add as a coda words of Lord Bridge in Mitsui Construction Co Ltd v A-G of Hong Kong (1986) 33 BLR 14, cited in my judgment in Sinochem International Oil (London) Ltd v Mobil Sales and Supply Corp [2000] CLC 878 at p 885. Speaking of a poorly drafted and ambiguous contract, Lord Bridge said that poor drafting itself provides:

'no reason to depart from the fundamental rule of construction of contractual documents that the intention of the parties must be ascertained from the language that they have used interpreted in the light of the relevant factual situation in which the contract was made. But the poorer the quality of the drafting, the less willing the court should be to be driven by semantic niceties to attribute to the parties an improbable and unbusinesslike intention, if the language used, whatever it may lack in precision, is reasonably capable of an interpretation which attributes to the parties an intention to make provision for contingencies inherent in the work contracted for on a sensible and businesslike basis.'

…

16 ... in my judgment the sub-clause has no very natural meaning and is, at the least, open to two possible meanings or interpretations - one the judge's, the other that it addresses two separate subject-matters. In these circumstances, it is especially important to undertake the exercise on which the judge declined to embark, that is to consider the implications of each interpretation. In my opinion, a court when construing any document should always have an eye to the consequences of a particular construction, even if they often only serve as a check on an obvious meaning or a restraint upon adoption of a conceivable but unbusinesslike meaning. In intermediate situations, as Professor Guest wisely observes in Chitty on Contracts (28th edn) vol 1, para. 12-049, a 'balance has to be struck' through the exercise of sound judicial discretion."

In Homburg Houtimport BV v Agrosin Private Ltd: The Starsin [2004] 1 AC 715, para 10 Lord Bingham referred to "the rule to which Lord Halsbury LC alluded in Glynn v Margetson & Co [1893] AC 351, 359, 'that a business sense will be given to business documents. The business sense is that which businessmen, in the course of their ordinary dealings, would give the document."

Three other cases merit brief reference. The same approach was adopted by Arden LJ in In the Matter of Golden Key Ltd (In Receivership) [2009] EWCA Civ 636, paras 29 and 42 as also in In Re Sigma Finance Corporation (in administrative receivership) [2009] UKSC 2; [2010] 1 All ER 571, where Lord Mance observed at para 12 that the resolution of an issue of interpretation in a case like the present was an iterative process, involving checking each of the rival meanings against other provisions of the document and investigating its commercial consequences.

In Barclays Bank plc v HHY Luxembourg SARL [2011] 1 BCLC 336, paragraphs 25 and 26:

"25. The matter does not of course rest there because when alternative constructions are available one has to consider which is the more commercially sensible. On this aspect of the matter Mr Zacaroli has all the cards. ...

26. The judge said that it did not flout common sense to say that the clause provided for a very limited level of release, but that, with respect, is not quite the way to look at the matter. If a clause is capable of two meanings, as on any view this clause is, it is quite possible that neither meaning will flout common sense. In such circumstances, it is much more appropriate to adopt the more, rather than the less, commercial construction."

The House of Lords of the UK in Sirius International Insurance Company (Publ) v. FAI General Insurance Limited [2004] UKHL 54, at paragraph 18, has held as follows:

"The aim of the inquiry is not to probe the real intentions of the parties but to ascertain the contextual meaning of the relevant contractual language.  The inquiry is objective: the question is what a reasonable person, circumstanced as the actual parties were, would have understood the parties to have meant by the use of specific language.  The answer to that question is to be gathered from the text under consideration and its relevant contextual scene."

In Rainy Sky SA v Kookmin Bank [2011] UKSC 50, the UK Supreme Court citing various authorities as above concluded and held as follows:

“30.   In my opinion Longmore LJ has there neatly summarised the correct approach to the problem. That approach is now supported by a significant body of authority. As stated in a little more detail in para 21 above, it is in essence that, where a term of a contract is open to more than one interpretation, it is generally appropriate to adopt the interpretation which is most consistent with business common sense.”  See also [1997]89 Comp Cases 849 (SC) : (1995) 1 SCC 478 and (2007) 3 GLR 899  

Further, in Chitty On Contracts, Twenty-Eighth Edition, it is stated as follows:

“12-052   Established judicial construction.   Where the same words or contractual provisions have for many years received a judicial construction, the court will suppose that the parties have contracted upon the belief that their words will be understood in the accepted legal sense. Thames and Mersey Marine Insurance Co. v. Hamilton, Fraser & Co. (1887) 12 App. Cas. 484, 490; Skips A/S Nordheim v. Syrian Petroleum Co. Ltd. [1983] 2 Lloyd’s Rep. 592, 597; Navrom v. Callitsis Ship Management SA [1987] 2 Lloyd’s Rep. 276, 278 (affd. [1988] 2 Lloyd’s Rep. 416); Marc Rich & Co. Ltd. v. Tourloti Compania Naviera SA [1988] 2 Lloyd’s Rep. 101, 105; Chiswell Shipping Ltd. v. National Iranian Tanker Co. [1991] 2 Lloyd’s Rep. 251, 257.  But contrast Wickman Machine Tool Sales Ltd. v. L.G. Schuler A.G. [1974] A.C. 235; Macedonia Maritime Co. v. Austin & Pickersgill Ltd. [1989] 1 Lloyd’s Rep. 73.”.

The Supreme Court of India in The Union of India v. D.N. Revri & Co., AIR 1976 SC 2257 at 2262 held as follows:

"It must be remembered that a contract is a commercial document between the parties and it must be interpreted in such a manner as to give efficacy to the contract rather than to invalidate it.  It would not be right while interpreting a contract, entered into between two lay parties, to apply strict rules of construction which are ordinarily applicable to a conveyance and other formal documents.  The meaning of such a contract must be gathered by adopting a commonsense approach and it must not be allowed to be thwarted by a narrow pedantic and legalistic interpretation."

The Supreme Court of India, in Citibank N.A. v. TLC Marketing PLC, (2008) 1 SCC 481 : 2007 AIR SCW 6263, has held as follows:

 "Commercial contract must be broadly construed with a view to give efficacy to such contract rather than to invalidate it.  Clauses of the contract must be liberally interpreted.  Narrow and technical approach should be avoided. [see also Russel on Arbitration (1997); p.60]"