What are Debentures?

Debentures are one of the most important instruments through which companies raise borrowed capital. In company law, they represent a method by which a company can obtain funds without immediately diluting its ownership. Unlike shares, which reflect ownership in a company, debentures reflect a debt owed by the company to the debenture-holders. For this reason, debentures occupy a special place in corporate finance as well as in legal regulation.

In simple terms, a debenture is a written acknowledgement of debt. A company issues it to raise money, and in return it promises to repay the principal amount along with interest according to agreed terms. Debentures are usually medium-term or long-term borrowing instruments. They may be secured against the assets of the company or may be unsecured, depending on the nature of the issue.

The concept of debentures is important not only from the perspective of companies seeking capital, but also from the point of view of investors who prefer fixed returns with comparatively greater security than equity investment. Their legal treatment under company law also makes them distinct from other securities.

Meaning of Debentures

A debenture is a debt instrument issued by a company as evidence of money borrowed by it. The person who purchases a debenture becomes a creditor of the company and not an owner. The company remains under an obligation to pay interest on the debenture at a fixed rate and to repay the principal amount on maturity or according to the terms of redemption.

Under Section 2(30) of the Companies Act, 2013, the term “debenture” includes 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. This definition is important because it makes two things clear. First, the term is broad enough to include different forms of debt instruments. Second, a debenture need not always be secured by a charge on the company’s assets. Therefore, both secured and unsecured debentures fall within the legal meaning of debentures.

Debentures are issued when a company wants to borrow from the public or from selected persons at a predetermined rate of interest. In commercial terms, they serve as a source of debt capital. In legal terms, they create a creditor-debtor relationship between the debenture-holder and the company.

Essential Features of Debentures

Debentures have certain features that distinguish them from shares and other securities.

• First, they create a debt. The company borrows money and becomes liable to repay it. The debenture-holder does not become a member merely by holding debentures.
• Second, debentures usually carry a fixed rate of interest. This makes them attractive to persons seeking stable and predictable returns. The interest is payable irrespective of whether the company earns profit or suffers loss.
• Third, debentures may be secured or unsecured. Where they are secured, the debenture-holder gets the benefit of a charge over specific or general assets of the company.
• Fourth, debenture-holders generally do not have voting rights. Section 71(2) of the Companies Act, 2013 makes it clear that a company cannot issue debentures carrying voting rights.
• Fifth, debentures are ordinarily redeemable. This means the company is expected to repay the borrowed amount after a specified period. Some debentures may also carry a conversion feature, permitting conversion into equity shares under prescribed terms.

These features show that debentures combine legal certainty with financial utility. They help companies raise capital while giving investors a relatively structured form of return.

Why Companies Issue Debentures

A company may raise capital through retained earnings, equity capital, or debt capital. Debentures fall under debt capital. Many companies prefer debentures because they allow borrowing without immediate dilution of control.

One major reason for issuing debentures is that debenture-holders are creditors and not owners. This means the company can raise substantial funds without conferring voting rights or management participation. It helps promoters and existing shareholders retain control over the company’s affairs.

Another reason is certainty of cost. Debentures carry a fixed interest obligation. This allows the company to estimate its repayment burden in advance. Compared to equity, where dividends may fluctuate and ownership gets diluted, debentures may be commercially convenient.

Debentures are also useful where a company requires medium-term or long-term funds for expansion, acquisition of assets, construction, infrastructure, or general business purposes. They are therefore a common tool in organised corporate borrowing.

Types of Debentures

Debentures can be classified on different bases.

Debentures Based on Security

Secured Debentures

Secured debentures are those which are backed by a charge on the assets of the company. These are also referred to as mortgage debentures. If the company defaults in repayment, the debenture-holders or trustee may enforce the charge against the secured assets.

Secured debentures may involve a fixed charge or a floating charge. A fixed charge is created on specific assets such as land, building, machinery, or factory premises. The company cannot freely deal with those assets without the consent of the charge-holder. A floating charge, on the other hand, is created over a class of assets, present and future, which keeps changing in the ordinary course of business.

Unsecured Debentures

Unsecured debentures are not backed by any specific charge on the assets of the company. They are issued on the basis of the company’s reputation and creditworthiness. Since no security is provided, the risk is higher, and such debentures often carry a relatively higher rate of interest.

Debentures Based on Tenure

Redeemable Debentures

Redeemable debentures are those which the company is bound to repay after a specified period or on a specified date. Most debentures issued in practice are redeemable. On redemption, the company repays the principal amount and discharges its debt.

Irredeemable or Perpetual Debentures

Irredeemable debentures do not carry a fixed date of redemption. They continue until the company is wound up or until the terms of issue otherwise provide. In the Indian market, perpetual debentures are generally not favoured as a regular form of issue.

Debentures Based on Conversion

Convertible Debentures

Convertible debentures can be converted into equity shares after a specified period and at a predetermined ratio. These may be fully convertible or partly convertible. In the case of partly convertible debentures, only a portion is converted into equity, while the remaining part continues as debt.

Non-Convertible Debentures

Non-convertible debentures remain pure debt instruments throughout their life. They cannot be converted into equity shares and are redeemed according to the terms of issue.

Debentures Based on Registration

Registered Debentures

Registered debentures are those in respect of which the company records the name and details of the debenture-holder in its register. Section 88 of the Companies Act, 2013 requires every company to maintain a register of debenture-holders.

Bearer or Unregistered Debentures

Bearer debentures are transferable by mere delivery. The company does not maintain the name of the holder in a register in the same way as registered debentures. Interest is generally payable to the bearer on presentation of coupon or certificate.

Charge in Relation to Debentures

Charge is central to the law relating to secured debentures. Under Section 2(16) of the Companies Act, 2013, a charge means an interest or lien created on the property or assets of a company as security for a debt or obligation.

Fixed Charge

A fixed charge is created on definite and identifiable assets. The company cannot freely sell or dispose of those assets without the consent of the charge-holder. Fixed charge offers stronger protection to debenture-holders because the security is specific and identifiable.

Floating Charge

A floating charge covers a class of assets which change in the ordinary course of business. It remains floating until an event occurs that causes it to crystallise. Once crystallised, it becomes a fixed charge on the assets then existing.

In Government Stock and Other Securities Investment Co Ltd v. Manila Railway Co Ltd (1897), it was observed that a floating charge remains dormant until the undertaking ceases to be a going concern or until the charge-holder intervenes. This principle explains the nature of floating charge and its crystallisation.

Issue of Debentures Under Company Law

The issue of debentures is governed mainly by Section 71 of the Companies Act, 2013 and the Companies (Share Capital and Debentures) Rules, 2014.

A company may issue debentures with an option to convert them into shares, wholly or partly, but such issue requires a special resolution passed at a general meeting. Debentures cannot be issued with voting rights. Secured debentures may be issued subject to prescribed terms and conditions.

Where an offer or invitation is made to more than 500 persons for subscription of debentures, the company is required to appoint one or more debenture trustees. The trustee protects the interests of debenture-holders, monitors compliance, and may take action in case of default.

A debenture trust deed is also important in practice. It sets out the terms of the issue, security, rights of debenture-holders, duties of the trustee, and remedies in case of breach.

Debenture Redemption Reserve and Redemption

Debentures are ordinarily redeemed on maturity. Redemption may be at par, at premium, or, depending on terms, at discount. For protecting debenture-holders, the law has historically recognised the concept of the Debenture Redemption Reserve (DRR). The reserve is created out of profits available for dividend and is meant to be used only for redemption of debentures.

The company must ensure that the redemption process is carried out in accordance with the terms of issue and applicable rules. If the company fails to redeem debentures or pay interest, the debenture-holders or the debenture trustee may approach the Tribunal for appropriate orders.

Rights and Remedies of Debenture-Holders

Debenture-holders have the right to receive interest and principal in accordance with the contract. Where debentures are secured, they also have the benefit of the charge created on the company’s assets. In case of default, legal remedies may include enforcement of security, action through the debenture trustee, and recourse before the National Company Law Tribunal.

The importance of registration and priority was discussed in K. Roy & Bros v. Ramanath Das and Ors. (1943). In that case, the issue concerned the effect of registration of debentures and priority over company assets. The Calcutta High Court held that registration under company law determines the position of debenture-holders among themselves, whereas registration under the Registration Act, 1908 has significance in relation to claims over immovable property. The case highlights that legal formalities connected with security can directly affect priority and enforcement.

Difference Between Debentures and Shares

Debentures and shares are both instruments used by companies to raise funds, but they are fundamentally different. A shareholder is an owner to the extent of shareholding, whereas a debenture-holder is only a creditor. Shareholders may receive dividends depending on profits; debenture-holders receive fixed interest. 

Shareholders generally have voting rights, while debenture-holders do not. Shares involve ownership risk and possible appreciation, whereas debentures involve debt repayment and comparatively greater security, especially where a charge exists.

Conclusion

Debentures are an essential component of company finance and company law. They represent borrowed capital raised by a company through instruments acknowledging debt. The law recognises different forms of debentures, including secured, unsecured, redeemable, convertible, non-convertible, registered, and bearer debentures. 

Their legal framework under the Companies Act, 2013 ensures that while companies have flexibility in raising funds, debenture-holders receive a measure of protection through statutory safeguards, charge, trusteeship, and redemption rules.