Compliances

Issuance of Non-convertible Debentures: Procedure and Various Laws applicable

Investors prefer investment options that can manage liquidity and risks while giving substantial returns. Debentures are considered as long-term financial instruments that are issued by a company for a particular tenure with an assurance to pay fixed interests to the investors. There are two types of debentures: a) convertible debentures, b) no- convertible debentures.

 In this article, we shall closely look at the issuance of non-convertible debentures (NCD) and the applicability of various laws.

What are Non-Convertible Debentures?

After a period of time, some debentures can be converted into shares at the discretion of its owner. The debentures that cannot be converted into shares are known as Non-Convertible Debentures. They are regarded as fixed income instruments and are issued by high rated companies to accumulate long term capital appreciation.

NCD’s are used as tools to facilitate long term funds by companies through public issue therefore lenders are generally given a higher rate of return in comparison to convertible debentures.

Who can issue Non-convertible Debentures?

NCD’s can be issued by a corporate. It can be eligible to issue NCD only if it fulfils the following conditions:-

• If the corporate, as per the latest audited balance sheet, has a net worth of not less than 4 crore rupees;
• If the corporate has been approved of working capital limit or a term loan by banks or all India financial institutions;
• If the borrower account of the corporate is categorised as a standard asset by the financing banks.

Maturity

NCD’s would not be issued for maturities of less than 90 days or beyond the validity period of the credit rating of the instrument from the date of issue. The exercise date of option (put/call) attached to the NCD’s will not fall within the prescribed period of 90 days from the date of issue

The Amount and limits of Issue of NCD’s

The total amount of NCD’s issued by a corporate shall be within the limits approved by the Board of Directors of the corporate or the quantum indicated by the CRA (Credit Rating Agency) for the rating granted, whichever is lower.

The aggregate amount of NCD’s proposed to be issued shall be completed within the time period of two weeks from the date which the corporate opens the issue for the subscription.

What are the features of Non-Convertible Debentures?

The main features of NCD’s are as follows:

Returns–

One of the attractive things that stand out in favour of NCD’s is the interest rate that it offers. Unsecured NCD’s give higher returns than compared to secured NCD’s. This is because unsecured NCD’s have no underlying asset to give value to the debentures. This makes it risky and therefore higher returns are promised. Interest is paid through Direct Credit / NEFT/ECS / RTGS mode.

Maturity–

There are different kinds of debentures with different maturities. RBI has stipulated that the maturity must not be less than 90 days. Maturities range from 90 days to as long as 10 or even 30 years.

Risk–

High rated Non-convertible debentures generally exhibit lower credit risk. NCDs lose value when the interest rate in the system goes up and gain when the interest rate declines. However, when the NCD is held till maturity one is likely to realize the promised return and the risk due to movement in interest rates will not be there.

Liquidity-

One can sell debentures in the secondary market before maturity if it is listed.

Tax-

Returns on non-convertible debentures are taxed as income. There is no tax deduction at source (TDS) if you invest through the DEMAT mode. Income tax on the interest income will have to be paid at the time of declaring one’s income.

Procedure for issuance of Non-Convertible Debentures

• The corporate shall reveal to the prospective investors, its financial position in accordance with the standard market practice.
• The auditors of the corporate must certify to the investors that all the eligibility conditions prescribed by the RBI are complied with.
• The conditions of all the provisions of the Companies Act, 1956 and the Securities and Exchange Board of India (SEBI) (Issue and Listing of Debt Securities) Regulations, 2008, or any other law, that may be applicable, shall be followed by the corporate.
• The Debenture Certificate shall be issued within the time period mentioned in the Companies Act, 1956 or any other law in force at the time of issuance.
• NCD’s may be issued at face value carrying a coupon rate or at a discount to face value as zero-coupon instruments as determined by the corporate.

Roles and Responsibilities of Corporate and Debenture Trustees

Following are the roles and responsibilities of Corporate and Debenture Trustees:

• The corporate must ensure that the procedures and guidelines laid down for the issuance for NCD are followed strictly.
• The debenture trustees shall function by the regulations of SEBI (Debenture Trustee) Regulations, 1993 and the trust deed and offer document.
• The debenture trustee must report to the chief general manager RBI, within three days from the date of completion of the issue.
• A report on the outstanding amount of NCD’s of maturity up to a year must be submitted to the RBI on a quarterly basis by the debenture trustee.
• To monitor defaults in the repayment of the NCD’s, the debenture trustees are required to report full details of defaults in repayments of NCD’s to the financial markets department of the RBI immediately.

Other General Procedures:

Issuance of Debentures under the Companies Act, 2013

Applicable Provisions include Section 71 of the Companies Act, 2013 with Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014. The procedure is as follows-

• Board meetings are held and then it is decided as to which types of the debentures will be issued by the concerned company.
• If the Company decides to issue secured debenture, the company has to comply with the condition mentioned in Rule 18 of the Companies (Share Capital & Debentures) Rules, 2014.
• In case of an appointment of Debenture Trustee, consent has to be obtained from a SEBI registered Debenture Trustee, who is intended to be appointed. If debentures to be issued are Secured Debentures, a Debenture Trust Deed in Form No. SH – 12 or as near thereto as possible shall be executed by the Company in favour of Debenture Trustees within sixty days of allotment of Debentures.
• In the Board meeting, resolutions are passed for (a) Approval of Offer letter for private placement in Form No. PAS – 4 and Application Forms (In case of the private placement of debentures); (b) Approval of Form No. PAS – 5 (In case of a private placement of debentures); (c) Approval of Debenture Trustee Agreement and appointment of a Debenture Trustee (In case of Secured Debentures only); (d) Appointment of an expert for valuation (In case of a private placement of debentures); (e) Approval of increase of borrowing powers, if required; (f) To authorize for creation of charge on the assets of the company; (g) Approval of the Debenture Subscription Agreement; (h) To fix day, date and time for the extraordinary general meeting of shareholders.
• A draft is prepared of i) Debenture Subscription Agreement; ii) Offer Letter for private placement in Form No. PAS – 4 and Application Forms; iii) Records of a private placement offer in Form No. PAS – 5; iv) Debenture Trustee Agreement; v) Mortgage Agreement for the creation of charge on assets of the company.
• Notices are issued for extraordinary general meeting along with the explanatory statement.
• Extraordinary general meetings are held and special resolutions are passed to issue convertible secured debentures and to increase borrowing powers of the company and to authorize the Board to create a charge on the assets of the company.
• Form No. PAS 4 and PAS 5 in Form No. GNL – 2 with the Registrar of Companies is filed and also offer Letter in Form No. MGT 14.
• A copy of Board resolutions, Special Resolution, Debenture Subscription Agreement, Debenture Trustee Agreement, etc. in Form No. MGT – 14 is filed with the Registrar of Companies.
• Form No. PAS – 3 (Return of allotment) is filed with the Registrar of Companies after making allotment of debentures.
• Form No CHG – 9 is also filed for creation of charge on assets of the Company

Conclusion

If a person is looking for an investment that produces fixed income, then non-convertible debentures can be an ideal investment. It offers higher rates of interests as compared to FD’s (Fixed Deposits), postal savings etc. There are many other benefits of investing in NCD’s. It is the most common method of raising loan capital at lower rates than banks.

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