Change in Business Compliances

Procedure of Issue of Convertible Debentures by public company within borrowing limits and Exceeding borrowing limit

Issue of Convertible Debentures

Meaning Of Debenture

Section 2(30) of the Companies Act, 2013 defines “debenture” to include 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.

Provided that the instruments referred to in Chapter III-D of the Reserve Bank of India Act, 1934 shall not be included in the ambit of the term.

Debenture can be construed as a loan owed by the company to the subscribers of the instrument, bearing a fixed rate of interest and not carrying any voting right in the company.

Issue Of Debenture By Public Company

A Public Company may issue Debentures to raise funds by either Private Placement or a public issue by inviting the general public to subscribe to its debentures.

A debenture may be preferred over other sources of raising funds as:

  • It does not lead to dilution of the owner’s stake in the company as debentures do not carry voting right.
  • The interest paid is tax-deductible, i.e., interest paid is treated as expenditure and deducted from profit before tax, unlike equity shares.

Debentures may be classified into various categories. For example, Debentures may be classified on the Basis of Convertibility as follows:

Issue Of Debenture By Public Company

A company oversee issue of Convertible debentures or securities by following the provisions of the Companies Act, 2013, and the rules made thereunder, namely the Companies (Share Capital and Debentures) Rules, 2014.

Limits Specified Under The Companies Act, 2013

  • The authority of the Board of Directors is constrained under Section 180 of the 2013 Companies Act.
  • Section 180(1)(c) states that in order to borrow money, the amount must surpass the sum of the company’s paid-up share capital, free reserves, securities premium, and any money already borrowed.
  • Shareholders must approve a special resolution at a general meeting before the firm can proceed.
  • Temporary loans taken from the company’s bankers in the normal course of business are not included for the purposes of the aforementioned limit.

The ambit of the term ‘Temporary loans’ is restricted to loans repayable:

  • on-demand ‘or.’
  • Within six months from the date of the loan; Example:
    • Short-term, cash credit arrangements
    •  The discounting of bills
    • other short-term loans of a seasonal character
    • But does not include loans raised for the purpose of financial expenditures of a capital nature.

Procedure to Be Followed for Issue Of Convertible Debentures

The Board of Directors may borrow money under Section 179(3) (d) of the Companies Act following the adoption of a resolution at the board meeting (in the case of Section 8 companies, such resolution shall be adopted by circulation and not at the meeting of the directors); in other words, if the company decides to borrow money up to the amount allowed under Section 180(1)(c), it may do so without calling a general meeting of the shareholders. A Board Resolution adopted at a Board of Directors meeting is sufficient in this case.

However, in accordance with Section 71(1) of the Companies Act, 20131, shareholder approval by special resolution is required if a business wishes to issue debentures that are convertible into equity shares of the company, either fully or partially, at the time of the debentures’ redemption. Therefore, shareholder approval is required for the issuing of convertible debentures.

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If the company plans to borrow money over the amount allowed under Section 180(1)(c), a special resolution in the shareholders’ meeting must be obtained to allow the Board of directors of the company to borrow money up to a given amount. This is often referred to as a blanket resolution since it establishes the maximum amount that the Board may borrow from the company without calling a general meeting the next time they want to do so.

The procedure to be followed for the issue of convertible debentures is as follows:

  • Invite the Board of Directors to a meeting to discuss the issues.
  • Kind of the upcoming debentures.
  • Set the date, time, and location of the shareholders’ general meeting.
  • Approving and giving someone (or something) the go-ahead to call the general meeting.
  • In the event of a Private Placement
  • Approval of the offer letter in form PAS 4, approval of the private placement record in form PAS 5, and approval of the subscription agreement for debt securities.

The following additional approvals are also necessary in the event of secured debentures:

  • Permission from the debenture trustee to carry out their duties.
  • Acceptance of the terms and circumstances for the appointment of the debt trustee.
  • Create a fee to protect debentures with your permission.
  • Send a notice of the general meeting to the company’s shareholders. In accordance with Secretarial Standard -2 and Section 101(1) of the Companies Act, the Notice period must be at least 21 clear days long.
  • Call a shareholder general meeting to vote on the issuance of convertible debt.
  • If the amount to be borrowed combined with the amount already borrowed exceeds the thresholds outlined in section 180(1)(c), approval to raise the threshold must also be obtained.
  • Sending out a letter of offer and opening a bank account to receive contributions from debenture issuance investors.

Forms to be submitted to the Registrar of Companies

  • PAS 4 and PAS 5 must be provided as an attachment to GNL 2 CHG 9 in order to create a charge in the event that secured debentures are issued.
  • The allocation of funds will be supplied to the company along with the application in the format specified in the offer letter.
  • Call a Board meeting to discuss and pass the following motions:
  • Debenture allocation based on applications received.

The following additional points for secured debentures must be approved:

  • Before the Letter of Offer is issued, the Board must name the debenture trustee and sign a debenture trust deed no later than sixty days after the debentures are allotted.
  • Approval of the proposed agreement for the development of charges and giving the director the go-ahead to sign it.
  • Acceptance of the draught Debenture Trust Deed in SH-12 that will be drafted in the Debenture Trustee’s favour.
  • The Board is responsible for allocating the debentures granted to applicants and filing a return of allocation in PAS-3 with the Registrar of Companies.
  • Debenture certificates are given to the holders of the debentures within a maximum of six months of the date of the debentures’ allocation.

Conditions That Should Be Considered When Issuing Debentures

  • The issuance of voting debentures by an entity is not permitted.
  • A corporation may not publish an offer letter for the subscription of more than 500 of its debentures unless a debenture trustee has been named.
  • Debentures may be issued by a firm for a time frame of up to 10 years from the date of issuance.
  • The maximum duration for which the debentures may be issued in the case of infrastructure businesses is 30 years from the date of issuance.
  • In the event of secured debentures, the charge to be made in favour of the debenture trustee must be made on the company’s assets.
  • Out of the profits available for dividend distribution, the corporation shall establish a debenture redemption reserve account in the event of debenture redemption.
  • Suppose the debentures are fully convertible into business equity shares. However, no such reserve is required.
  • If the debentures are partially convertible, only the non-convertible portion of the debentures must be created in the reserve.
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Penalties and Punishments

  • When a firm fails to pay interest on debentures when it is due, redeems or converts the debentures before they mature, or both.
  • The Tribunal may order the firm to redeem the debentures immediately upon payment of the principal and interest payable thereon upon request from any or all debenture holders or the debenture trustee.
  • Every officer of the corporation who is in default shall be punished with imprisonment for a time which may extend to three years “or” if any default is made in complying with the order of the Tribunal.
  • With a fine that must be at least two lakh rupees but might be as much as five lakh rupees, “or.” with both.

Applicability of Chapter V of the Companies Act and Companies (Acceptance of Deposits) Rules, 2014 

If a debenture satisfies the requirements outlined in The Act and the Rules established thereunder, it may occasionally be categorized as a deposit. It fits into the category of:

Applicability Of Chapter V

As we see above, in case the company issues unsecured debentures, which are not convertible within 10 years of the date of issue, it has to comply with additional compliances pertaining to deposits.

Conclusion

The process of issuing a convertible debenture by a public company within its borrowing limits involves obtaining board approval, seeking shareholder authorization, preparing a prospectus, securing regulatory approval, and then conducting a public offering.

With such a wide range of requirements for this kind of security and a municipality with so many laws governing corporations, choosing the right procedures and adhering to these laws becomes a crucial task, not only for the company’s reputation but also for protecting the company and the officers in default from severe fines and penalties.

Frequently Asked Questions (FAQs)

  1. What is a convertible debenture?

    A convertible debenture is a kind of long-term debt that business issues and that, after a set time period, may be converted into shares of equity capital. Unsecured bonds or loans with no underlying collateral typically constitute convertible debentures.

  2. Why do companies issue convertible debentures?

    Corporate bonds that are convertible into the issuing company's common stock are known as convertible bonds. Convertible bonds are issued by businesses to reduce their debt coupon rate and postpone dilution. The number of shares an investor will receive in exchange for a bond depends on its conversion ratio.

  3. What is convertible vs non-convertible debenture?

    Debentures can be classified as either convertible or non-convertible based on their ability to be converted. Debentures that can be changed into business shares are known as convertible debt. Non-convertible debentures cannot be converted into the company's equity shares.

  4. What are the two types of convertible debentures?

    Fully Convertible Debenture: These are debentures with the option to convert the entire principal amount into stock in the company. Debentures that are only partially convertible into equity shares are known as partially convertible debentures.

  5. What are the different types of debentures?

    This allows for the further division of such bonds into completely and partially convertible bonds. Debentures that are fully convertible: Fully convertible debentures (FCDs) are a type of security debt in which the issuer permits the conversion of the entire principal amount into equity shares.

  6. What is the difference between fully and partially convertible debentures?

    With partially convertible debentures (PCDs), a portion of the security's value can be redeemed for cash while the remaining portion is transformed into equity. When an issuer issues a fully convertible debenture (FCD), the debt security is completely converted into equity.

  7. What is the main reason for issuing convertible bonds?

    Convertible bonds are issued by businesses to reduce their debt coupon rate and postpone dilution. The number of shares an investor will receive in exchange for a bond depends on its conversion ratio. If the stock price is higher than if the bond were to be redeemed, companies can force the conversion of the bonds.

  8. What are the benefits of issuing convertible debentures?

    The ability to convert convertible debentures into shares at predetermined intervals makes them special. By providing the bondholder with this functionality, some of the dangers associated with investing in unsecured debt may be mitigated.

  9. What do you mean by NCD?

    Non-Convertible Debentures are financial instruments that corporations issue for a set period of time in order to generate capital through a public offering or a private placement. It is not possible to convert this debt instrument into equity. Similar to bank fixed deposits, it is a fixed-income vehicle that may be exchanged on stock exchanges.

  10. What is the difference between NCD and bond?

    Bonds vs NCDs: One key distinction between the two is that an investment in NCDs does not require a mortgage or other form of collateral, whereas an investment in bonds necessitates the deposit of an investor's asset.

  11. What is the disadvantage of NCD?

    Investing in NCDs has drawbacks. NCDs are also issued by companies with mediocre or subpar credit ratings. These have a higher default risk and may not repay the principal and accumulated interest at maturity. NCD investors cannot become shareholders since NCDs are debentures that cannot be converted into stock.

  12. Is NCD tax-free?

    First off, interest earned on NCDs is taxed in the same manner as other interest, such as interest earned on FDs. In other words, by including interest income from NCDs under “Income from other sources,” it will be subject to tax at regular rates.

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References

  1. https://www.mca.gov.in/content/mca/global/en/acts-rules/ebooks.html

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