Debentures | Company Law - CLAT PG PDF Download

Borrowing

• To run a business effectively, a sufficient amount of capital is essential.
• When capital from internal sources, such as issuing equity share capital or using accumulated profits, is inadequate, organizations turn to external resources for capital.
• External resources include External Commercial Borrowing (ECB), debentures, bank loans, public fixed deposits, etc.
• Borrowing is a method of arranging money through external resources with the intention of returning it, either implicitly or explicitly.

Power of Company to Borrow

• The power to borrow is exercised by the directors of the company, who cannot borrow more than the authorized amount.
• Directors must pass a resolution at a duly convened Board Meeting to borrow money or issue debentures.
• The power to issue debentures cannot be delegated, but the power to borrow can be delegated to a committee of directors or other principal officers.
• The resolution must specify the total amount up to which money may be borrowed by the delegates.
• Section 180(1)(c) of the Act limits the Board's borrowing capacity to the aggregate of paid-up share capital and free reserves, excluding temporary loans from bankers.
• Temporary loans include short-term loans like cash credit arrangements and bill discounting, but not loans for capital expenditure.
• Debts incurred beyond the limit set by Section 180(1) are not valid unless the lender proves good faith and lack of knowledge about the limit being exceeded.
• Private companies are exempt from the entire provisions of Section 180, as per recent notifications.
• If borrowing is ultra vires the company, the lender has no rights, and any security created is void.

Types of Borrowings

A company utilizes various types of borrowing to finance its operations. These borrowings can generally be categorized into:

1. Long Term Borrowings

• Funds borrowed for a period of five years or more are classified as long-term borrowings.
• Long-term borrowings are typically used to finance new projects or make significant capital investments.
• These borrowings are usually secured against a charge on the company's fixed assets.

2. Short Term Borrowings

• Funds borrowed for a short period, usually up to one year, are considered short-term borrowings.
• Short-term borrowings are primarily used to meet the company's working capital needs.
• These borrowings are often secured by hypothecation of stock and debtors.

IC. Medium Term Borrowings

In the context of borrowing funds for a period ranging from two to five years, these borrowings are classified as medium-term borrowings. Commercial banks typically finance the purchase of assets such as land, machinery, vehicles, and similar items within this timeframe.

2A. Secured/Unsecured Borrowing

• Secured Borrowing: A debt obligation is deemed secured when creditors have the right to claim the company’s assets on a proprietary basis or have priority over general claims against the company.
• Unsecured Debts: These are financial obligations where creditors do not have the right to claim the company’s assets to fulfill their claims.

3A. Syndicated Borrowing

• When a borrower requires a substantial or complex borrowing facility, it is often provided by a group of lenders known as a syndicate through a syndicated loan agreement. This allows the borrower to use a single agreement covering the entire group of banks and various types of facilities, rather than entering into multiple separate loans with different terms.

3B. Bilateral Borrowing

• Bilateral borrowing involves a company borrowing from a specific bank or financial institution. In this arrangement, there is a single contract between the company and the lender.

4A. Private Borrowing

• Private borrowing includes bank-loan type obligations where the company secures a loan from a bank or financial institution.

4B. Public Borrowing

• Public borrowing refers to financial instruments that are freely tradable on a public exchange or over the counter, with minimal restrictions. This includes instruments like debentures and bonds.

Debentures

A debenture, as defined in Section 2(30) of the Companies Act, 2013, encompasses various financial instruments such as debenture stock, bonds, or any other company-issued instrument evidencing a debt. These instruments may or may not constitute a charge on the company's assets. Additionally, certain instruments specified in Chapter III-D of the Reserve Bank of India Act, 1934, and those prescribed by the Central Government in consultation with the Reserve Bank of India, are excluded from being classified as debentures.

Nature of Debentures and Transferability

• According to Section 44 of the Companies Act, debentures issued by a company are considered movable property and are transferable in accordance with the provisions outlined in the company's Articles of Association.
• Transferability of debentures is governed by the Articles of Association, and the process is facilitated through Form SH-4 as per Section 56 of the Act.

Pari Passu Clause in case of Debentures

• Debentures are typically issued in series with a paripassu clause, ensuring equal treatment in terms of security.
• In the event of security enforcement, the proceeds are distributed prorata among debenture holders.
• In cases of asset deficiency, debenture holders will abate proportionately.
• The term paripassu means equal treatment, implying no distinction between old and new debentures.
• If paripassu is not specified, debentures are payable based on the date of issue or numerical order if issued on the same day.
• A company cannot issue a new series of debentures to rank paripassu with a prior series unless explicitly reserved in the previous debentures.

Debenture Trust Deed

A Debenture Trust Deed is a legal document that outlines the terms of a trust, typically established to secure a loan or mortgage through the conveyance of property to a trustee. It details the responsibilities of the trustee in protecting the rights of debenture holders.

Key Features of a Debenture Trust Deed

• Legally conveys property to a trustee to secure a loan or mortgage.
• Sets out the terms of the trust, including the names of trustees, beneficiaries, and trust property.
• Outlines the powers and duties of the trustees in safeguarding the interests of debenture holders.

Section 71(7) Provisions

• Any provision in a trust deed or contract with debenture-holders that exempts a trustee from liability for breach of trust is void.
• Trustees must demonstrate the required degree of care and due diligence as per the trust deed.
• Debenture trustee liability can be exempted by agreement among a majority of debenture-holders.

Inspection and Copies of Trust Deed

• A trust deed for securing debentures is open for inspection by any member or debenture holder of the company.
• Inspection is conducted similarly to the register of members, with applicable fees.
• A copy of the trust deed must be provided to any member or debenture holder upon request within seven days, subject to a fee.

Execution of Trust Deed

• As per Section 71 and Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014, a trust deed in Form No. SH. 12 or a similar format must be executed by the company issuing debentures in favor of debenture trustees.
• This execution should occur within three months of the closure of the debenture issue or offer.

Rule 18(8)

• A trust deed for debenture issuance must be accessible for inspection by any member or debenture holder of the company, similar to the register of members.
• A copy of the trust deed should be sent to any member or debenture holder upon request within seven days of its creation, subject to a fee.

Acceptance of Deposit by Companies

Companies often seek finance through various cost-effective methods to meet their financial needs. One such method is financing through deposits. To regulate this practice and prevent malpractices, the Companies Act, 2013 has introduced strict provisions governing the acceptance of deposits. Sections 73 to 76 of the Companies Act, along with the Companies (Acceptance of Deposits) Rules, 2014, outline the rules for inviting, accepting, and repaying deposits by companies.

Applicability

The provisions under Sections 73 to 76 of the Companies Act 2013 and the Companies (Acceptance of Deposits) Rules, 2014 are applicable to all companies, with the following exceptions:

• Banking Companies: Companies that are classified as banking companies are exempt from these provisions.
• Non-Banking Financial Companies (NBFCs): Companies defined as non-banking financial companies under the Reserve Bank of India Act, 1934 are also excluded.
• Housing Finance Companies: Companies registered as housing finance companies with the National Housing Bank, established under the National Housing Bank Act, 2013, are not subject to these regulations.
• Other Exemptions: The Central Government may specify other companies, in consultation with the Reserve Bank of India, that are exempt from these provisions.

Deposits are defined under the Companies Act, 2013 as any receipt of money by a company by way of deposit or loan or in any other form. However, certain categories of amounts may be excluded from this definition in consultation with the Reserve Bank of India.

Chapter V of the Companies Act, 2013, along with the Companies (Acceptance of Deposits) Rules, 2014, primarily governs regulations related to deposits. The Deposits Rules provide a comprehensive definition of deposits, which is exclusionary in nature, specifying certain amounts that are not considered deposits.

It is important to note that the definitions of deposits under the Companies Act, 1956 and the Companies (Acceptance of Deposits) Rules, 1975 were similar, with exclusions for certain amounts. However, some of the exclusions introduced in the Deposits Rules lack clarity and may contradict related provisions.

This article aims to analyze these contradictions and examine the practical challenges associated with the definition of deposits and their repayment framework under the Companies Act, 2013.

Exclusions under the 2013 Act and Deposits Rules

The amounts that do not fall within the definition of deposits under the Companies Act, 2013 and the Deposits Rules include:

• Loans taken by a company from another company.
• Loans from directors or relatives of directors, provided they declare that these amounts are not funded by borrowing or accepting loans or deposits from others, and the company discloses this in its Board's report.
• Non-interest bearing amounts received and held in trust.
• Amounts received from an employee of the company, not exceeding his annual salary, as a non-interest bearing security deposit.
• Other items mentioned in Rule 2(c) of the Deposits Rules.

One notable exclusion is outlined in Rule 2(c)(ii) of the Deposits Rules, which excludes amounts received from foreign institutions, foreign governments, foreign banks, foreign corporate bodies, and foreign citizens (collectively referred to as "Foreign Bodies"). This exclusion is subject to the provisions of the Foreign Exchange Management Act, 1999 (FEMA) and the rules and regulations made thereunder.
FEMA stipulates that capital instruments should be issued by the company within 180 days from the receipt of inward remittance. If this timeline is not adhered to, the inward remittance should be refunded immediately. Failure to comply with these timelines may result in penalties. In exceptional cases, the Reserve Bank of India (RBI) may consider the refund of the amount of consideration outstanding beyond 180 days from the date of receipt, based on the merits of the case.
This creates a dichotomy within the Deposits Rules. According to the rules, an amount received as share application money will not be considered a deposit as long as the allotment against the amount is made within 60 days of receipt or the money is refunded within 15 days after the completion of 60 days.
The question arises regarding whether the allotment should be made within the 60-day period specified in the Deposits Rules or the 180-day period mandated by FEMA.

This discrepancy has led to two interpretations:

1. 2013 Act as Specific Legislation: It can be argued that the 2013 Act governs companies incorporated in India and all related matters, making it a specific legislation. In contrast, FEMA provides general guidelines for foreign investment. Thus, the provisions of the 2013 Act should take precedence over the general provisions of FEMA. According to this interpretation, share application money would not be treated as a deposit for 60 days, and securities should be issued within 60 days of receiving the application money.

2. FEMA as Governing Framework: Alternatively, one could argue that FEMA governs foreign investment and should apply to foreign investors. This interpretation would grant foreign investors more leniency compared to domestic investors. However, this approach may create an imbalance between domestic and foreign investors.

Share Allotment Timeline and Exclusions from Deposits Rules

Share Allotment Timeline

• To prevent issues related to the Deposits Rules and external commercial borrowing regulations, it's advisable to allot shares within 60 days of receiving the application money.

Exclusion in Rule 2(c)(ix)

• Rule 2(c)(ix) provides an exclusion for amounts raised through the issuance of bonds or debentures secured by a first charge or a charge ranking pari passu with the first charge on assets listed in Schedule III of the 2013 Act, excluding intangible assets.
• This exclusion also applies to bonds or debentures that are compulsorily convertible into shares within 10 years.

Secured vs. Unsecured Debentures

• Secured debentures, regardless of their tenure or convertibility, are exempt from being classified as deposits.
• Non-convertible unsecured debentures are considered deposits unless they are compulsorily convertible within 10 years.
• Non-convertible and unsecured debentures listed on a stock exchange as per Securities and Exchange Board of India (SEBI) regulations are not considered deposits.

Analysis of Rule 2(c)(ii) and Rule 2(c)(ix)

• When analyzing the exclusions in Rule 2(c)(ii) and Rule 2(c)(ix), it is crucial to determine whether an unsecured debenture issued to a Foreign Body, convertible in more than 10 years and compliant with FEMA, will be classified as a deposit.

Exemption for Inter-Company Amounts

• Rule 2(c)(vi) exempts any amount received by a company from another company from being considered a deposit.

Debentures Issued to Foreign Bodies

• A straightforward interpretation of these provisions suggests that debentures issued to a Foreign Body are exempt from deposit regulations, regardless of whether they are secured, unsecured, convertible, or unconvertible, and irrespective of the tenure.

Exclusions under the 1956 Act

• The term 'deposits' in the 2013 Act and the Deposits Rules raised questions about its alignment with the definition under the 1956 Act.
• On March 30, 2015, the Ministry of Corporate Affairs issued a Circular to clarify this issue.
• The Circular stated that amounts not considered deposits under the 1956 Act, such as those received by private companies from their members, directors, or relatives before April 01, 2014, would not be treated as deposits under the 2013 Act and Rules.
• This was contingent upon proper disclosures in the company's financial statements.
• The Circular also emphasized that any renewal or acceptance of new deposits from April 01, 2014, onward must comply with the 2013 Act and the Rules.

Repayment of Deposits

• Section 74 of the 2013 Act mandates that deposits accepted by a company before the Act's commencement must be repaid within one year from the Act's start or the due date of the deposit, whichever is earlier.
• The term 'repay' in Section 74 has not been extensively discussed, but it remains relevant because companies can seek tribunal permission for extended repayment periods.
• The Companies Amendment Bill, 2016, seeks to revise Section 74, extending the repayment period to three years from the Act's commencement or the deposit's original expiry date, whichever is earlier.
• The interpretation of 'repay' in Section 74(1)(b) is debated. Traditional views suggest actual repayment in cash or cash equivalents, while others argue for broader interpretations, including repayment through securities issuance.
• One perspective is that 'repay' signifies extinguishing liability rather than actual payment. If a company repays deposits as per lender instructions, it meets Section 74(1)(b) requirements.
• Conversely, some argue that Section 74 requires actual payment of deposit amounts, not merely liability extinguishment, as indicated by the use of 'amount of deposits' in other subsections.