Debentures and Debenture Holders

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PROJECT

ON

DEBENTURES AND DEBENTURE HOLDERS

SUBMITTED BY

RAWISEN GURIA

I.D. 207062

FOR

CORPORATE LAW I

OFFERED BY DR. SREENIVSASULU NS.


Submitted by Rawisen Guria (ID – 207062) Topic: Debentures and Debenture Holders
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INTRODUCTION
The word ‘debenture’ means to borrow or that which is due and has been derived from a
Latin word ‘debere’.1 Though there is no precise definition of debenture nevertheless Section
2 (12) of the Companies Act 1956 reads: “debenture” includes debenture stock bonds and
any other securities of a company, whether constituting a charge on the assets of the
company or not”.
This is an inclusive definition and amounts to borrowing of monies from the holders of
debentures on such terms and conditions subject to which the debentures have been issued.
It’s not a technical term and the definition provided does not describe the nature of debenture.
It could be applied to any mechanism showing that the party making it owes money and is
obliged to pay it and is one of the means to raise the capital of the company. Any document
which either creates a debt or acknowledges it is a debenture.2
Section 117 to Sections 123 of the Companies Act, 1956 regulate the provisions relating to
debentures, appointment of debenture trustees, their duties, creation of Debenture
Redemption Reserve Account, liability of trustees etc.

Requirements regulating issue of Debentures


While the articles of a company should contain an enabling provision for issue of debentures
and creation of security therefore by the Board, the quantum of such issue should be
adequately covered by a borrowing resolution of its shareholders under section 293(l)(d) of
the Companies Act,1956 (the Act).3
Consent of the shareholders would also be required for selling, leasing or disposing of the
whole or substantially the whole of the undertaking of the company under section 293 (1) (a).

The attributes of Debentures

Ø A movable property
Ø Issued in the form of a certificate of indebtedness by the company.

1
Victor E. Cappa, The Corporate Debenture System of South American Countries, The Yale Law Journal, Vol.
43, No. 4 (Feb., 1934), pp. 571-598
2
See Chitty J. in Levy v. Abercorris Slate Co. (1888), 37 Ch. D. 260 at 264
3
This article says: 293. Restrictions on powers of Board - (1) The Board of directors of a public company, or of
a private company which is a subsidiary of a public company, shall not, except with the consent of such public
company or subsidiary in general meeting,- (d) borrow moneys after the commencement of this Act, where the
moneys to be borrowed, together with the moneys already borrowed by the company (apart from temporary
loans obtained from the company's bankers in the ordinary course of business), will exceed the aggregate of the
paid-up capital of the company and its free reserves, that is to say, reserves not set apart for any specific
purpose;

Submitted by Rawisen Guria (ID – 207062) Topic: Debentures and Debenture Holders
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Ø Generally it specifies the date of redemption, repayment of principal and interest


Ø A charge on the assets of the company may or may not be created.

Kinds of debentures

Debenture can be classified as under: Secured debentures refer to those debentures where
1. From security point of view
Secured debentures: These are the debentures that are secured by a charge on the assets of
the company and are also called mortgage debentures. The holders of have the right to
recover their principal amount with the unpaid amount of interest on such debentures out of
the assets mortgaged by the company. A charge is produced on the assets of the company for
the use of disbursement in case of defaulting which may be fixed or floating. A fixed charge
is produced on a specific asset while a floating charge is on the general assets of the
company.4
In India, debentures must be secured which can be of two types:
a. 1st mortgage debentures: The holders have a 1st claim on the assets charged.
b. 2nd mortgage debentures: The holders have a 2nd claim on the assets charged.
Naked/Unsecured debentures: Debentures which do not carry any security with regard to
the principal sum or due interest are called unsecured debentures or simple debentures. They
do not have a specific a charge on the assets of the company though a floating charge can be
formed on the debenture by default.
2. On the basis of redemption
Redeemable debentures: These are issued for a fixed period and the principal amount is
paid off on the expiry of such period in lump sum or in instalments during the life time of the
company. These can be redeemed by annual drawings or by purchasing from the open
market.
Non-redeemable or irredeemable debentures: These are the debentures which are not
redeemed in the life time of the company but are repayable on the on winding-up of a
company or on the expiry of a long period. Such debentures are paid back only when the
company goes into liquidation. It is also known as Perpetual Debentures because no
undertaking is given for the repayment of money borrowed by issuing such debentures.

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The fixed charge is created against those assets which are held by a company for use in operations not meant
for sale whereas floating charge involves all assets excluding those assigned to the secured creditors.

Submitted by Rawisen Guria (ID – 207062) Topic: Debentures and Debenture Holders
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3. On the basis of Records


Registered debentures: These are the debentures that are registered with the company and
the amount of such debentures is payable only to those debenture holders whose name
appears in the register of the company like all details including names, addresses and
particulars of holding of the debenture holders are entered in a register kept by the company.
These debentures are transferred only by executing a regular transfer deed.
Bearer debentures: These are the debentures which are not recorded in a register of the
company. These are transferrable merely by delivery. Interest is paid to person who produces
the interest coupon attached to such debentures.
4. On the basis of convertibility
Convertible debentures: The debentures that can be converted into shares of the company
or in any other security on the expiry of pre-decided period at the option of the company or
the debenture holders are called convertible debentures. The term and conditions of
conversion are generally announced at the time of issue of debentures and are either fully
convertible or partly convertible.
Non-convertible debentures: The debenture holders of such debentures cannot convert their
debentures into shares or in any other securities of the company. Most debentures issued by
companies fall in this category.

Issue of Debentures and creation of security


Section 117A of the Act puts a company which issues debentures under an obligation to
create security pursuant to by executing trust deed.5 The need for executing a trust deed arise
when a company wants to issue a prospectus or letter of offer to the public for securing
subscription to its debentures and for this purpose appoints one or more debenture trustees.
The documents states that the debenture trustees have consented to be appointed as such as
required by section 117B of the Act. A debenture trustee hence enjoys an exclusive place of
an independent entity unconnected with the issuer of security but appointed to guard the
interest of holders of debentures.

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117A. Debenture trust deed: (1) A trust deed for securing any issue of debentures shall be in such form and
shall be executed within such period as may be prescribed.
(2) A copy of the trust deed shall be open to inspection to any member. or debenture holder of the company and
he shall also be entitled to obtain copies of such trust deed on payment of such sum as may be prescribed.
(3) If a copy of the trust deed is not made available for inspection or is not given to any member or debenture
holder, the company and every officer of the company who is in a default, shall be punishable, for each offence,
with fine which may extend to five hundred rupees for every day during which the offence continues.

Submitted by Rawisen Guria (ID – 207062) Topic: Debentures and Debenture Holders
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I. DEBENTURE HOLDERS

Debenture holders are not the members but the creditors of the company. The legal
relationship between the company and the debenture holder is simply that of a contractual
relationship of debtor and creditor. If the debt is secured on some or all of the company’s
assets then the relationship is that of mortgager and mortgagee. Registration of a charge for
issue of debentures is obligatory as per Section 125 (4) of the Companies Act. If a company
issues debentures which are secured by charge then as per the provisions of Section 128
benefit is available to all debenture holders.

Rights of the debenture holders

Following rights are available to the Debenture Holders:


1. Rights to obtain copies and inspect trust deed
Under s 118(1) of the Companies Act each debenture holder of a company has the right to
ask for the copy of the trust deed. Within seven days of the making of the payment a copy of
any trust deed shall be forwarded to the holder of any such debenture for securing any issue
of debentures. To get the copy of trust deed prescribed fee is needed to be submitted. If the
copy is not forwarded within the time specified the company shall be punishable for the
offence with a fine of up to Rs.500 and then with a further fine up to Rs.200 for every day
default is levied.
Debenture holders have a right to inspect the trust deed under clause (4) of s.118. This right
was available only to the debenture holders under the previous Act but the present Act
permits any member of the company to inspect the trust deed.
In Narotamdas T. Toprani v. Dyeing & Mfg Co. Ltd 6 this right is examined by Justice Sujata
Manohar of the Bombay High Court. In this case a company proposed to issue a new series of
debentures. The validity of the proposal was questioned and a stay order on the proposal was
sought in the court. The Court agreed with the company and held that the individuals who
had 4 % of the debentures had no rights to go beyond the declared accounts. It allowed the
company to go ahead with its debenture issue subject to the condition that if the aggrieved
shareholder wanted payment he should be paid out in cash. The Court held that it can inspect
the purpose of petitioner so as to see whether the issue is of the interest of the debenture

6
(1986) 3 Company Law Journal 179 Bombay

Submitted by Rawisen Guria (ID – 207062) Topic: Debentures and Debenture Holders
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holders or otherwise. The right of a debenture holder of inspecting the company’s record is
extremely limited and under section 118 he can only inspect the debenture trust deed and
obtain a copy of it. The annual reports, copies of certificates, other documents the register of
members and of the debenture holders can be inspected and copies obtained by the provisions
of section 163. The right of detailed inspection of the record and registers and books of
account is not allowed and no bad conclusion can be drawn if the company does not permit it.
2. Authority to modify the rights of debenture holders with the consent of majority
The trust deed sometimes contains a clause that the rights of the debenture holders may be
modified with the consent of a majority of (three fourth, for instance) of them, and that this
consent shall bind all the debenture holders.7
There is general principal applicable to all authorities conferred on majorities of classes
enabling them to bind minorities that the power must be exercised for the purpose of
benefiting the class as whole and not merely individual members only.
The majority of the debenture holders in the exercise of this power cannot authorize the
company to sell the assets charged and to divide the proceeds among all the debenture
holders, but among only those willing to accept the lowest price for their debenture.8
3. Right to get notice before confirming the alteration of Memorandum of Association
[sec.17 (3) (a)]: As mentioned under sec 17(3) (a) of the Act, before confirming the
alteration, the central government must be satisfied that sufficient notice has been given to
every holder of the debenture of the company, and to every other person or class of persons
whose interests will be affected by the alteration of the memorandum.9
4. Right to take possession of charged property: A legal chargee gets the legal title to the
charged property and therefore has an immediate right to possession of the property. Justice
Harman in the case of Four-Maids Ltd v. Dudley Marshall(properties) Ltd.,10 gave a proper
insight in this matter. The mortgagee may go into possession as soon as possible unless there
is something in the contract expressly or impliedly whereby the mortgagee has contracted out
of those rights.
The execution of a decree is only complete after attachment and sale. Until then the property
remains that of the execution debtor and the title does not pass to execution creditor. Thus
although in the case the goods were, at the time of appointment of the receivers, under the

7
Sneath v. Valley Gold Co. Ltd.,(1893) 1 Ch 477
8
New York Taxi Cab Co., Re, (1913) 1 Ch 1
9
Orient paper mills Ltd., Re, (1958) 28 Com Cases 523,529
10
(1957) Ch 317 at 320

Submitted by Rawisen Guria (ID – 207062) Topic: Debentures and Debenture Holders
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control of the court broker, the goods remained subject to the floating charges created by the
debentures.11
5. Right to demand for the appointment of the receiver: Debenture holders may appoint a
receiver to take charge of the assets subjected to the charge. The circumstances under which
the debenture holders can apply for the appointment of a receiver are:
i. where there is a danger of property being lost or diminished in the
value
ii. where principal or interest is in arrear or even where there is no such
arrear the assets are in danger.
iii. Where the company is in liquidation or is on the point of being wound
up.
iv. When there are decrees and the judgments against the company.12
v. Where the company is in a state of suspended animation.
In Bank of Credits & Commerce International SA v. BRS Kumar Bros.Ltd.13
Administrative receivers were appointed by the court over the assets of a company. The
company had transferred its assets to an associated company. The exact arrangement under
which the transfer of assets had taken place and what was the financial and commercial
relationship between the two companies was very difficult for the court to reconstruct, though
there was some evidence that the associated company had acquired its own assets in the
course of trading. The debenture holder sought appointment of a receiver and manager for the
associated company also. The court granted the order. It was arguable that the associated
company was nothing more than the transferor company itself in a new guise.
The charge crystallized because of the transfer and the assets transferred remained subject to
the charge. The mixed individual assets of the associated company could be ascertained when
an account was taken.
An appointment of a receiver by a debenture holder takes effect when the document of
appointment is handed to him by the person having the necessary authority in the
circumstances from which it is fairy to be said that he was appointing a receiver, and the
receiver accepts the proffered appointment, although the acceptance may be tacit.14
6. Right to apply for winding up of the company if the company fails to pay its debt

11
Lochab Brothers v. Kenya Furfural, (1985) LRC (Comm) 737 (Kenya CA). The court of
Appeal followed Mackerzie (Kenya) Ltd v. Pharamico, (1976) KLR 270 (kenya)
12
Lawrence v. West Somerset Rly., (1918)
13
(1994) 1 BCLC 211 (Ch D)
14
Cripps (pharmaceuticals) Ltd v. Wickenden( 1973) 2 All ER 606.

Submitted by Rawisen Guria (ID – 207062) Topic: Debentures and Debenture Holders
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Debenture holder has a right to apply for the winding up of the company if he can prove that
he claims an undisputed debt and that the company has failed to discharge it. A contingent or
the prospective creditor (such as the holder of a bill of exchange yet to mature or of
debentures not yet payable or a guarantor of company’s debts) is also entitled to petition for
winding up of the company. But he must give a reasonable security for costs and establish a
prima facie case for winding up [section 439(8)].
Debenture holder can present a petition for winding up as he is creditor for the amount of his
principal and interest, but not for any premium payable on redemption, unless the debenture
expressly so provides.15
A debenture holder’s petition is generally based on the ground that the company is unable to
pay its debts. He will not ordinarily be heard to urge that a winding up order should be made
because the substratum of the company is gone which is usually the proper concern of the
company’s shareholders.16
The mere fact that the debenture holder files a suit for the realization of the debt, when his
petition for winding up the company is already pending does not debar him from proceeding
with his petition for winding up of the company.17 A winding up proceeding is not merely for
the benefit of the petitioner, but for that of all contributories and all creditors.
Where there is a trustee who is given all the rights of ownership, a debenture holder as such
will not be deemed to be a creditor. But in the case of any debenture where the holder of the
debenture is given the right to receive or collect the interest amounts directly from the
company or the debenture is a bearer bond, the holder of the debenture will be entitled to a
winding up petition as a creditor. In all the cases the question will be “Is the holder of the
debenture is entitled to collect the amounts or the principal sum without reference to the
trustee”? If he is so entitled, he will be deemed to be a creditor.18

Remedies for debenture holders

A debenture holder who wishes to realize his security and get his money back, may either
exercise remedies given by the debenture trust deed without recourse to the court or take

15
Consolidated Goldfields of South Africa v. Simmer and jack East ltd., (1913) 82 LJ Ch
214
16
Bukhtiarpur Bihar Light Rly. Co. v. U.O.I, AIR 1954 Cal. 499
17
Central Bank of India v. Sakhani Minning and Engineering Industries Pvt. Ltd.[1977]
ASIL XIII 427
18
See Narotamdas T. Toprani v. Bombay dyeing and Mfg.Co. Ltd. (1990) 68 Com
Cases 300 (Bom)

Submitted by Rawisen Guria (ID – 207062) Topic: Debentures and Debenture Holders
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proceedings to enforce his rights. Where the debenture is repayable on demand, it is required
of the lender that he should give the borrower a reasonable opportunity to collect the money
owned. It is not necessary to allow time to permit the borrowing company to engage in
commercial transactions for the purpose of raising the money.19
The remedies which may be available to the debenture holders are as follows:
1. Sale of charged property
If the debenture holder is the holder of a single debenture giving a charge on assets of the
company, he will usually have an express power of sale or the implied power of sale given to
mortgagees by the Transfer of Property Act, 1882, sec.67.
A holder of one of a series of debentures cannot sell the property charged, unless the
debenture contains an express power of sale.20
2. Duty to realise true market value
Exercising a power of sale over charged property a chargee cannot sell to himself, either as a
sole purchaser or jointly with others; though he can sell to a company in which he is
interested.21
3. Foreclosure
The trustees may make an application to the court for an order of foreclosure, the effect of
which is that the borrowers’ interest in the assets charged is completely extinguished and the
lenders become the owner of them. For the action of the foreclosure it is necessary that all
debenture holders of the class concerned join hands.22
Where no trust deed has been executed in favor of debenture holders a debenture holder
may, on default in payment of principal or interest, bring an action (called a debenture
holders’ action) on behalf of him and other debenture holders of the same class asking for:
i. a declaration that the debenture have a charge on the assets;
ii. an account of what is owned to the debenture holders: the amount of
assets; prior claims, etc.;
iii. an order of foreclosure or sale;
iv. the appointment of a receiver.

19
Lloyds Bank Plc. V. Lampert(1999) BCC 507.
20
Blaker v. Herts and Essex Waterwork co. (1889) 41 Ch D 399
21
Tse Kwong Lam v. Wong Chit Sen, (1983) 1 WLR 1349 (PC)
22
Wallace v. Evershed(1899) 1 Ch 891

Submitted by Rawisen Guria (ID – 207062) Topic: Debentures and Debenture Holders
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If a debenture holder owes a debt to the company which is insolvent, the holder cannot set off
his debt against the liability he owes to the company. The rule is that a person who claims a
share in a fund must first pay up everything he owes to the fund before he can claim a share.23

II. CONCLUSION

Companies frequently need to borrow large sums of money. The loan requirement of a
company may not be met by a single lender or it may have to be divided into numerous units.
For borrowing money one very handy means is through debentures.
Debenture holders play a vital role by providing money to the company by means of
debentures. In comparison with the role of debenture holders with the rights available to them
we can observe that their rights are not compatible with their role. Debenture holders should
be given some more rights so as to protect their interest in the company.
There is a need to focus more on the protection of the interest of the debenture holders in a
company. Effective measures must be initiated for protecting the interest of the debenture
holders through legal basis for a sound corporate governance practices particularly in a
country like India the literacy rate is very low and a large number of literate population is
also not aware of the law and procedure applicable in Company.
The government has recognized that an investor culture and a protection fund for the benefit
of the investors is necessary. There is a need to revamp the structure and administration of the
fund and schemes should be made more comprehensive and their scope expanded to enable
flow of correct information to the investors as well as their education in respect of their
rights.

23
Re Brown and Gregory Ltd. [1904] Ch. 627

Submitted by Rawisen Guria (ID – 207062) Topic: Debentures and Debenture Holders
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BIBLIOGRAPHY

A Ramaiya, Guide to the Companies Act Part I, 16th Edition, reprint 2006, Wadhwa Nagpur
A.K. Majumdar & Dr. G.K. Kapoor, Taxman’s Student Guide to Company Law, 9th Edition,
University Edition.
Avtar Singh, Company Law, 14th Edition, 2005, Eastern Book Company
Gower & Davies, Principle of Modern Company Law, 7th Edition, Paul L Davies, Sweet &
Maxwell, 2003
Pennington’s Company Law, Contract tort and Crime, 8th Edition, Oxford University Press
Victor E. Cappa, The Corporate Debenture System of South American Countries, The Yale
Law Journal, Vol. 43, No. 4 (Feb., 1934), pp. 571-598

Submitted by Rawisen Guria (ID – 207062) Topic: Debentures and Debenture Holders

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