Debentures in company law are a common way for companies to raise funds through debt instruments. Under Section 2(30) of the Companies Act, 2013, a debenture includes debenture stock, bonds, or any instrument that acknowledges a company’s debt, whether secured or unsecured.
Companies issue debentures to raise long-term capital while offering investors a fixed rate of interest. Unlike shares, debenture holders do not get ownership in the company but receive regular interest payments.
Key features of debentures include:
- Debt Instrument: Represents money borrowed by the company
- Secured or Unsecured: May or may not be backed by company assets
- Fixed Interest: Investors receive a fixed return over a period
- Convertible or Non-Convertible: Some debentures can be converted into equity shares
- No Ownership Rights: Debenture holders are creditors, not owners
The issue and regulation of debentures are governed by Section 71 of the Companies Act, 2013, which lays down rules for issuance, security, and investor protection.
This guide explains debentures in company law, including their meaning, features, types, and provisions under Section 71 of the Companies Act, 2013.
What is a Debenture? Features in Company Law
According to Section 71 of the Companies Act 2013:
- Debentures are usually the unsecured form of bonds, which are not backed by any asset or collateral. Instead, the investors consider the issuer’s creditworthiness as a primary parameter for the purchase. Also, being a long-term instrument, their tenure usually lasts for 10 years or more.
- They have a fixed coupon rate, at which the investors receive interest at specific intervals, i.e., monthly, quarterly, half-yearly, or yearly. Some investors also get accumulated interest on redemption.
- The issuing company pays off the interest as an expense before paying the dividends. The interest is thus tax-deductible, bringing down the taxable income.
- Some companies issue debentures, as after a specified period, they can be changed into equity stocks. This facilitates the investors to procure ownership in the organization and benefit from its earnings when its income is enhanced. In addition, the issuer enjoys low-cost borrowing since they offer a lower interest rate than non-covertibles.
- Repayments can be attained either in installments payable yearly or all at once. Thus, if the issuer pays off annual installments to the holders, it may do so by making a redemption reserve.
- They can be easily exchanged in the stock market, just like other securities. Thus, they are a flexible debt instrument.
A real-world example is L&T Finance Ltd planning to issue secured, redeemable non-convertible debentures in 2012. The debenture issued by a company is an acknowledgment that the company has borrowed an amount of money from the public, which it promises to repay at a future date. Debenture holders are, therefore, creditors of the company.
Types of Debenture in Company Law
Under the Companies Act 2013, companies can issue different types of debentures based on security, registration, conversion, and tenure.
1. Debenture Based on Security: Secured and Unsecured
Secured Debentures: These debentures are backed by a charge on the company’s assets (fixed or floating). In case of default, debenture holders have a legal right to recover their dues from the secured assets.
Unsecured Debentures (Naked Debentures): These are not backed by any security or charge on assets. Investors rely solely on the creditworthiness and reputation of the company, making them riskier than secured debentures.
2. Debenture Based on Registration: Registered and Bearer
Registered Debentures: The names and details of debenture holders are recorded in the company’s register. Transfer of these debentures requires execution of a proper transfer deed and approval by the company.
Bearer Debentures: These debentures are transferable by mere delivery, and the holder (bearer) is entitled to interest and repayment. However, bearer debentures are rare in India due to regulatory restrictions and transparency requirements.
3. Debenture Based on Conversion: Convertible and Non-Convertible
Convertible Debentures: These can be converted into equity shares (fully or partially) after a specified period, as per the terms of issue. They may be:
- Fully Convertible Debentures (FCDs)
- Partly Convertible Debentures (PCDs)
Non-Convertible Debentures (NCDs): These cannot be converted into equity shares and remain purely debt instruments, offering fixed interest returns.
4. Debenture Based on Tenure: Redeemable and Perpetual
Redeemable Debentures: These debentures are repayable after a specified period or in installments during the company’s lifetime. Most debentures issued in India fall under this category.
Irredeemable (Perpetual) Debentures: These are not repayable during the lifetime of the company and are repaid only on winding up. However, such debentures are generally not permitted under the Companies Act, 2013, making them practically obsolete in India.
Companies (Share Capital and Debentures) Rules, 2014
The Companies (Share Capital and Debentures) Rules, 2014, were notified under the Companies Act, 2013, to regulate the issue, management, and transfer of share capital and debentures by companies in India. These rules ensure transparency, investor protection, and proper corporate governance.
Key Areas Covered Under the Rules
1. Share Capital
The rules regulate various aspects of share capital, including:
- Issue of shares
- Voting rights
- Sweat equity shares
- Employee stock options (ESOPs)
- Bonus shares
- Rights issue
- Private placement
2. Types of Share Capital
Under the Act, share capital is classified as:
- Authorized Share Capital – Maximum capital a company can issue
- Issued Share Capital – Portion offered to investors
- Subscribed Capital – Portion accepted by investors
- Paid-up Capital – Amount actually paid
3. Issue of Shares at Discount (Section 53)
Companies cannot issue shares at a discount, except for sweat equity shares issued to employees or directors.
Any issue at discount (other than permitted cases) is void.
4. Sweat Equity Shares (Rule 8)
Companies can issue sweat equity shares subject to:
- Approval by special resolution
- Minimum 1 year of business commencement
- Limit:
- Not exceeding 15% of paid-up equity capital in a year or ₹5 crore (whichever is higher)
- Overall cap: 25% of paid-up equity capital
5. Employee Stock Option Scheme (ESOP) – Rule 12
- Requires special resolution
- Applicable to employees and directors (excluding independent directors)
- Includes:
- Vesting period (minimum 1 year)
- Disclosure requirements in the Board’s report
6. Issue of Bonus Shares (Section 63)
Issue of Bonus shares under Section 63:
- Out of free reserves, securities premium, or capital redemption reserve
- Subject to:
- Authorization in Articles
- No default in statutory dues
- Fully paid-up shares
7. Rights Issue (Section 62)
- Existing shareholders get the first right to subscribe
- Offer must remain open for 15–30 days
- Can be renounced unless restricted
8. Private Placement (Section 42)
- Shares or debentures offered to identified persons (max 200 in a year)
- Requires:
- Special resolution
- Filing of offer letter (PAS-4)
- Allotment within 60 days
Debentures Under the Rules
1. Issue of Debentures
Companies may issue:
- Secured debentures
- Unsecured debentures
2. Debenture Redemption Reserve (DRR)
- Created out of profits for redemption
- Requirement relaxed for:
- Listed companies
- NBFCs and housing finance companies (as per amendments)
3. Debenture Trustee
Mandatory when:
- Public issue of debentures
Trustee ensures: - Protection of debenture holders’ interests
- Monitoring of asset security
4. Debenture Redemption
- Companies must redeem debentures as per the terms
- Can use:
- Profits
- DRR
- Fresh issue
The Companies (Share Capital and Debentures) Rules, 2014, form the backbone of corporate financing in India.
Advantages of Debentures in Company Law
The following are the key benefits of debentures for companies under the Company Law:
- Debentures ensure a higher position in the ‘pecking order’ for repayment as a creditor. Otherwise, the loan is unsecured – the position of unsecured creditors near the bottom of the payment hierarchy means a significantly lower chance of recovering any money.
- Valuable financial protection and reassurance are provided for directors as regards their personal funds.
- The use of debentures can encourage long-term funding to grow a business. It is also cost-effective when compared with other forms of lending.
- Debentures usually provide lenders with a fixed rate of interest, and the company must pay this interest before issuing any dividends to shareholders.
- Existing shareholders retain control of the company, and profit-sharing remains in the same proportion.
Disadvantages of Debentures in Company Law
The following are the top disadvantages of debentures for Indian companies:
- As far as the company is concerned, there is no flexibility in their obligation to make interest payments on the debenture. In times of financial difficulty, this can compromise business growth and even force insolvency in some cases.
- Restrictions imposed by securing the debenture with an asset or asset class take away the management’s freedom to control or use the assets at will.
- By holding a debenture, the lender loses their right to vote and take a share of the company’s profits.
Difference Between Shares and Debentures in Company Law
Many confuse the usage of debentures and shares. The following table differentiates shares and debentures in Company Law for easier understanding:
| Basis | Shares | Debentures |
|---|---|---|
| Meaning | Shares represent ownership in a company and make the holder a shareholder. | Debentures represent a loan taken by the company, making the holder a creditor. |
| Nature | Ownership instrument | Debt instrument |
| Status of Holder | Shareholder (owner) | Debenture holder (creditor) |
| Return | Dividend (not fixed; depends on profits) | Interest (fixed and payable regardless of profits) |
| Voting Rights | Shareholders usually have voting rights | Debenture holders generally do not have voting rights |
| Risk Level | Higher risk (returns not guaranteed) | Lower risk (fixed interest obligation) |
| Security | Usually unsecured (except preference shares with certain rights) | Can be secured or unsecured |
| Repayment | No repayment during lifetime (except buyback or liquidation) | Repayable after a fixed period or on maturity |
| Priority in Liquidation | Paid after creditors | Paid before shareholders |
| Convertibility | Shares are not convertible into debt | Debentures may be convertible into shares |
| Control | Shareholders have ownership and control | Debenture holders have no control over management |
| Issue Purpose | To raise ownership capital | To raise borrowed funds |
| Tax Treatment | Dividend is not a deductible expense for the company | Interest is a tax-deductible expense |
| Legal Provision | Governed by Companies Act, 2013 (e.g., Sections 43, 44) | Governed by Companies Act, 2013 (e.g., Section 71) |
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