A debenture is a certificate issued under the common seal of the company. It is an instrument that acknowledges the debt of the company in writing.
It specifies the value of debenture, the rate of interest to be paid, periodicity of payment, and terms of redemption.
Section 2(30) of the Companies Act, 2013 defines debentures as Debenture includes debenture, stock, bonds, and any other securities of a company, whether constituting a charge on the assets of the company or not.
Features of a Debenture
- A debenture is a document or certificate which acknowledges the debt of a company.
- Mode and period of payment of principal as well as interest is fixed.
- Rate of interest on the debenture is fixed. It is usual to prefix debentures with the rate of interest. Thus, if the rate of interest is 9% the name given will be 9% debentures. Debenture interest is generally paid on half yearly basis.
- It is considered as external equity or long-term borrowing of the company.
- Debentures are issued under the common seal of a company.
- Debentures generally carry a charge on the assets of the company. In case the company fails to redeem the debentures, as per the terms of issue of debentures, the debentureholders have option to move to the court. They can get their money back through relisation of assets.
Types of Debentures
Debentures can be classified from the following standpoints :
1. From a Security point of View
(a)Secured Debentures or Mortgage Debentures: When debentures are secured by a mortgage or charge on the property of the company then such debentures are called a mortgage or secured debentures. The debentures may be secured through a fixed charge or a floating charge.
A fixed charge is created generally on immovable assets such as land, building, plant and machinery, long-term investments, etc. It may be considered a mortgage. A floating charge is generally in respect of movable properties, for example:- stock in trade.
(b)Unsecured Debentures: Unsecured debentures are those that have no security attached to them. Such debentures are not very common these days, so much so that, unless otherwise stated, a debenture is presumed to be secured. However, a floating charge may be created on these debentures by default.
2. From Redemption Point of View
(a)Redeemable Debentures: Redeemable debentures are those that will be repaid by the company at the end of a specified period during the existence of the company either in a lump sum or in installments.
(b)Irredeemable Debentures: Irredeemable debentures are those that are not repayable during the lifetime of the company. These are repayable only at the time of liquidation of the company.
3. From Convertibility Point of View
(a)Convertible Debenture: Convertible Debenture is convertible into equity shares or other securities at the option of the company or at the option of the debenture holders as the case may be. They are of two types i. Partly Convertible
A debenture is a debenture where only a portion of the amount of debenture is convertible into shares or other securities at a specified time and the remaining portions of debenture are redeemable on agreed terms. ii. Fully Convertible
A debenture is a debenture where the full amount can be converted into equity shares of the company at agreed terms and conditions.
(b)Non-Convertible Debenture: Non-Convertible debentures are those debentures where the holders have no right to convert them into equity shares or any other securities. Most debentures issued by companies fall in this category.
4. From Records Point of View
(a)Registered Debentures: Registered debentures are those in respect of which the names, addresses, and particulars of holdings of the debenture holders are entered in a register kept by the company. Such debentures can be transferred only by executing a regular transfer deed.
(b)Bearer Debenture: Bearer debentures are Transferable by mere delivery. The company keeps no record of such debenture holders. Interest on debentures is paid to the person who produces the interest coupon attached to such debentures.
5. From Priority Point of View
(a)First Debentures: The debentures which have to be repaid on a priority basis before the other debentures are known as first debentures.
(b)Second Debentures: The debentures which will be repaid after the first debentures have been redeemed are known as second debentures.
6. From Coupon Rate Point of View
(a) Specific Coupon Rate Debentures: These debentures are issued with a specified rate of interest which is called the coupon rate. The specified rate may either be fixed or floating. The floating interest rate is usually tagged with the bank rate.
(b) Zero Coupon Rate Debentures: These debentures do not carry a specific rate of interest. In order to compensate the investors, such debentures are issued at a substantial discount and the difference between the nominal value and the issue price is treated as the amount of interest related to the duration of the debentures.
Issue of Debentures as Collateral security
Collateral security may be defined as secondary security besides primary security when a company obtains a loan for an overdraft from a bank or any other financial institution.
When a company obtains a loan from a bank or any other financial institution it may mortgage some assets as security against the loan.
But the lending institution may insist on some more assets as collateral security. In such a situation the company may issue debentures to the lenders as secondary security. Such an issue of debenture is known as debentures issued as Collateral security.
If the company fails to repay the loan along with interest the lender is free to receive his money from the sale of primary security and if the realizable value of the primary security falls short to cover the entire amount the lender has the right to get the benefit of collateral security whereby debentures may either be presented for redemption or sold in the open market.
The debentures issued as Collateral security do not carry any right as long as the terms of the contract are not breached. Interest is paid on the loan amount and no interest is payable on such debentures. After the loan amount has been paid back by the company these debentures are returned back.