LAW RELATED TO INVESTMENT, SECURITIES,
CORPORATE FINANCE AND COMPETITION-
PROJECT
A STUDY OF SECURED AND UNSECURED
DEBENTURE WITH EXAMPLES
CHANAKYA NATIONAL LAW UNIVERSITY, PATNA
under the guidance of:
MR. ASHOK KUMAR SHARMA
project submitted by:
ANKIT PANDEY
ROLL NO.- 1309
TH
SEMESTER- 9
SESSION- 2015-2020
COURSE- B.A. LL.B (HONS.)
ACKNOWLEDGEMENT
I feel highly elated to work on the topic “A study of secured and unsecured debenture with
examples”.
The practical realization of this project has obligated the assistance of many persons. I express
my deepest regard and gratitude for Mr. Ashok Kumar Sharma, faculty of Law Related To
Investment, Securities, Corporate Finance And Competition. His consistent supervision, constant
inspiration and invaluable guidance have been of immense help in understanding and carrying
out the nuances of the project report.
I would like to thank my family and friends without whose support and encouragement, this
project would not have been a reality.
I take this opportunity to also thank the University and the Vice Chancellor for providing
extensive database resources in the Library and through Internet.
Some printing errors might have crept in, which are deeply regretted. I would be grateful to
receive comments and suggestions to further improve this project report
- Ankit Pandey
Roll No. 1309
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TABLE OF CONTENTS
TABLE OF CONTENTS...................................................................................................................................3
INTRODUCTION...........................................................................................................................................4
HYPOTHESIS........................................................................................................................................................................... 5
RESEARCH QUESTIONS........................................................................................................................................................ 5
RESEARCH METHODOLOGY...............................................................................................................................................5
TYPES OF DEBENTURE ON THE BASIS OF SECURITY.....................................................................................7
HOW SAFE ARE DEBENTURES....................................................................................................................10
CONCLUSIONS...........................................................................................................................................13
BIBLIOGRAPHY...........................................................................................................................................15
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CHAPTER 1
INTRODUCTION
In every corporate organization, enormous or not, engaged in doing business or involved in
manufacturing activity or industry providing services, there is always requirement of finances
and funds. In order to run a business effectively and successfully, adequate amount of capital is
necessary. In some cases it is capital is arranged through internal resources i.e. by way of issuing
equity share capital or using accumulated profit . Equity funds are raised by taking money from
the shareholders by way of their initial contribution in fixed income securities such as treasury
bills and bonds. The share holders are the owners of the company. Equity funds most of the
times is not adequate and the organization is resorted to external resources for arranging capital
i.e. External Commercial Borrowing(ECB), Debentures, Bank Loan, Public Fixed Deposits etc.
There is a provision of powers to borrow for the company in the memorandum of association of
a company. The loans are raised by the corporate sector by the way of issuance of debentures. As
the funds raised by the issue of shares are are not adequate to meet the financial demand of the
company for long run. Hence, the companies choose to raise long- term funds through
debentures. A Debenture is basically some of the loan amount the company was interested to
raise from the public , that is why it issues debentures. A person who has bought a debenture and
holding it is called a debenture holder. A debenture holder is the creditor of the company. Under
the seal of the company . Debenture is document issued under the seal of the company.
Debenture is an acknowledgment of the funds received by the company equal to the nominal
value of the debenture. It includes the payment of interest at a fixed rate till the times the
principal sum becomes repayable. There may or may not be a charge put on the sets of the
company as security. The date of redemption along with the rate and mode of payment of interest
are mentioned in it. The last few years has seen the capital market of India to evolve at a much
faster rate, the reasons are launch of new instruments and the modifications in the old
technology. In the present situation debentures prove to be a great contributor to support the
financial needs of the corporate sector. The issue of debentures is a means significant for raising
capital from the market as contrasted with the other modes like , preference shares, bonus as
shares, equity shares, rights issues. The provisions of the Companies Act identifying with plan
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additionally apply to debentures where they are issued to the general population. The Companies
act does not provide for a exhaustive definition of debentures but an inclusive definition. As per
the definition of debenture[1]given in Section 2(30) of the Companies Act 2013 "Debenture
includes debenture stocks, bonds or any other instruments of a Company evidencing a debt,
whether constituting a charge on the assets of the Company or not". This sections proves that the
company has right to issue bonds or debenture which are instruments as an debt, which can be
both secured or unsecured by the way of creating charge on the way of creating charge on the
assets of the company. A company may issue debentures as a type of long-term unsecured bond
on agreeing to repay it at a predetermined future date. The company usually pays interest to the
debenture holders at the end of every year till the time of maturity , but if it is not able to pay
either the interest or the principal amount of the loan the creditors of the company has right to
ask company into liquidation to recover their money by the way of selling the assets of the
company.
HYPOTHESIS
The hypothesis is that,
An investor should not be misled by the fact that when a debenture is secured against
the assets of the company means it is a safe and secure investment.
RESEARCH QUESTIONS
1. What is debenture?
2. What are different types of debenture on the basis of security ?
3. How far investment in debenture is safe ?
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RESEARCH METHODOLOGY
AIMS & OBJECTIVES
1. To understand the concept of debenture.
2. To understand what are the risk to the investors if investing in debentures.
\
METHOD OF RESEARCH:
The researcher has adopted a doctrinal method of research. The researcher has made extensive
use of the library at the Chanakya National Law University and also the internet sources
available.
SOURCES OF DATA
The sources of data for this project are secondary in nature, including books, articles and online
resources.
LIMITATION OF STUDY
In spite of best of efforts to minimize all limitations that might creep in course of the research,
there were certain constraints within which the research was completed. The project offers a
comprehensive study. However due to paucity of time and pages the research paper does not
provide a complete understanding of the all the provisions related to it.
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CHAPTER 2
TYPES OF DEBENTURE ON THE BASIS OF SECURITY
On the basis of security, Debentures are classified into following categories:
(A) Secured Debentures –The instruments which are secured as there is a charge on the fixed
assets of the company. This is to secure the debenture holder as and when the issuer makes a
defaults in the payment of either the principal or interest amount, the assets of the issuer can be
sold of in order to do away with the liability to the debenture holders by repayment. In
Companies Act, 2013 there is a provision in Section 71(3) which says that a company has right
to issue secured debenture subjected to the conditions of the government of India.
(B) Unsecured Debentures– These type of debentures are unsecured in the way that if there is a
default in payment of the principal amount or interest amount the debenture holder will have be
along with other unsecured lenders and hence could not sell any property or anything for
repayment hence they are also called naked debentures.
Security Interest :
A security interest is a legal right granted by a debtor to a creditor over the
debtor's property (usually referred to as the collateral1) which enables the creditor to have
recourse to the property if the debtor defaults in making payment or otherwise performing the
secured obligations.2 One of the most common examples of a security interest is a mortgage:
When person, by the action of an expressed conveyance, pledges by a promise to pay a certain
sum of money, with certain conditions, on a said date or dates for a said period, that action on the
page with wet ink applied on the part of the one wishing the exchange creates the original funds
and negotiable Instrument. That action of pledging conveys a promise binding upon the
1
"Collateral". Investopedia. 2003-11-18. Retrieved 1st August 2019.
2
"Security Interest". Investopedia. 2009-12-03. Retrieved 1st August 2019.
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mortgagee which creates a face value upon the Instrument of the amount of currency being asked
for in exchange. It is therein in good faith offered to the Bank in exchange for local currency
from the Bank to buy a house. The particular country's Bank Acts usually requires the Banks to
deliver such fund bearing negotiable instruments to the Countries Main Bank such as is the case
in Canada. This creates a security interest in the land the house sits on for the Bank and they file
a caveat at land titles on the house as evidence of that security interest. If the mortgagee [clarification
needed]
fails to pay defaulting in his promise to repay the exchange, the bank then applies to the
court to for-close on your property to eventually sell the house for profit.3
Although most security interests are created by agreement between the parties, it is also possible
for a security interest to arise by operation of law.[4] For example, in many jurisdictions a
mechanic who repairs a car benefits from a lien over the car for the cost of repairs. This lien
arises by operation of law in the absence of any agreement between the parties.
Most security interests are granted by the person who owns the property to secure their own
indebtedness. But it is also possible for a person to grant security over their property as collateral
for the debts of another person (often called third party security). So a parent might grant a
security interest over their home to support a business loan being made to their child. Similarly,
most security interests operate to secure debts or other direct financial obligations. But
sometimes a security is granted to secure a non-financial obligation. For example in construction
a performance bond may secure the satisfactory performance of non-financial obligations.
The different types of security interest which can arise and the rights which they confer will vary
from country to country.4
Security in Different Jurisdictions :
In the United States, debenture refers specifically to an unsecured corporate bond5, i.e. a bond
that does not have a certain line of income or piece of property or equipment to guarantee
repayment of principal upon the bond's maturity. Where security is provided for loan stocks or
bonds in the US, they are termed 'mortgage bonds'.
3
"What is a 'security interest'?". CFPB. Retrieved 2nd August 2019.
4
"Cross-Border, Asset-Based Loans". ABF Journal. Retrieved 2nd August 2019.
5
Glossary: D on the [Financial Industry Regulatory Authority] (FINRA) website, United States.
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However, in the United Kingdom a debenture is usually secured.6
In Canada, a debenture refers to a secured loan instrument where security is generally over the
debtor's credit, but security is not pledged to specific assets. Like other secured debts, the
debenture gives the debtor priority status over unsecured creditors in a bankruptcy; 7 however
debt instruments where security is pledged to specific assets (such as a bond) receive a higher
priority status in a bankruptcy than do debentures
In Asia, if repayment is secured by a charge over land, the loan document is called a mortgage;
where repayment is secured by a charge against other assets of the company, the document is
called a debenture; and where no security is involved, the document is called a note or 'unsecured
deposit note'.[6]
6
Chandra Gopalan (2007); Company Law in Singapore 3rd Edition; McGraw-Hill Education (Asia)
7
Restructuring and insolvency in Canada: overview, Thomson Reuters Practical Law. Retrieved 03 August 2019.
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CHAPTER 3
HOW SAFE ARE DEBENTURES
Presently, the capital market is experiencing a boom and all the investors seem gung ho.
However, most of the small investors having burnt their fingers in earlier scams would like to
keep a safe distance from investing in equity shares. In recent years, there has been an increase in
the debt instruments being issued by companies for raising resources. This trend gathered
momentum, particularly after the Ketan Parikh scam. There is a general belief that debt
instruments are safer than investment in equity and there are assured and regular returns.8
In theory, there cannot be any argument with the fact that an investment in a debt instrument
would be safer as compared to investment in equity. Besides, the investor can also look forward
to regular receipt of interest on the said investment. Moreover, amongst the various debt
instruments, debentures are one of the most widely used instruments by various companies. Of
course, there several types of debentures, but basically there are two kinds of debentures viz.
Secured and Un-secured debentures.
A company is permitted to issue secured debentures in accordance with the provisions of the
Companies Act, 1956 (the Act). A listed company also has to follow SEBI regulations. The very
term secured debenture tends to raise visions of an instrument in which the amount invested
would not be lost as the same is secured. In other words, investors tend to believe that investment
in secured debentures is safe as the company creates a charge on its assets, thereby assuring the
investors that their moneys are safe.. Is that the reality Are secured debentures really secure
First of all, every investor needs to realise that there is nothing like safe investment. Every
investment entails a degree of risk, which would vary, depending upon the nature, terms and
conditions of the instrument, background of the promoters, etc. Even assuming that secured
debentures are issued by one of the best companies in the country, still there is no guarantee that
the debentures would be redeemed on the due date.
8
https://www.financialexpress.com/archive/how-safe-are-secured-debentures/47841/ Retrieved 03 August 2019.
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While the regulators are aware of the pitfalls of the so-called secured debentures and have been
taking steps to strengthen the law. The Act was amended in 2000 and more stringent provisions
have been made for companies intending to issue debentures. Even the trustees are sought to be
made more accountable so as to ensure that they protect the interests of investors.
So far as listed companies are concerned, they have to adhere to SEBI guidelines as well. A
listed company cannot make a public or rights issue of debt instruments unless credit rating from
a credit rating agency has been obtained and is disclosed in the offer document. A trust deed has
to be executed by the issuer company in favour of the debenture trustees within six months of the
closure of the issue.
Similarly, the merchant banker is required to file with SEBI, along with the draft offer document,
a certificate from the companys banker that the assets on which security is to be created are free
from any encumbrances. Alternatively, a No-objection Certificate has to be obtained from the
financial institutions or banks for a second or pari passu charge in cases where assets are
encumbered.
Even trustees have been given certain duties under the Act. A debenture trustee has to ensure
compliance with the following, that:
(a) The lead financial institution monitors the correct utilisation of funds raised through
debentures.
(b) The lead bank for the company has to monitor the debentures raised for working capital
funds.
In addition, the trustee is required to obtain a certificate from the companys auditors:
(i) In respect of utilisation of funds during the implementation period of projects.
(ii) In the case of debentures for working capital, certificate has to be obtained at the end of each
accounting year.
In fact, the law also requires the debenture trustees to supervise the implementation of the
conditions regarding creation of security for the debentures and the debenture redemption
reserve.
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However, in spite of the various measures provided by the Department of Company Affairs
(DCA) and SEBI, the interests of investors in secured debentures is hardly protected. The case in
point is the debenture issue made by Essar Oil (the company) in 1995. The company issued
debentures with a coupon rate of 14.5% ; a very attractive rate and as a result nearly three lakh
investors put their hard-earned money into these debentures. The scheme looked very good as,
apart from offering good return on investment, the debentures were secured and were being
issued by a reputed company. Moreover, they were to be redeemed in April 2003.
Unfortunately for the three lakh investors in Essar Oil, reality turned out to be grim as the
subsequent events have proved. After paying interest for some years, the company regularly
defaulted in meeting its obligation towards the debenture-holders. In fact, since 1999, the
company virtually stopped paying interest on the secured debentures issued by it. But more
trouble was in store for the hapless investors. Recently, in April 2003, when the debentures were
due for redemption, instead of repaying the debenture amount, the company came up with a
scheme of arrangement. The substance of the scheme being that the debenture holders would
have to take a severe hit. This has happened notwithstanding all the laws and regulations
available to protect the interests of investors in debentures.
The investors, particularly small investors, should note that the case of Essar Oil is neither the
first nor a unique case. During the last five decades, there have been several companies who have
failed to honour their commitment towards debenture holders. Many have defaulted in
redeeming the debentures, while several others were unable to pay even the periodic interest
payable on the debentures.
Hence, the moral of the story is that, an investor should not be misled by the fact that when a
debenture is secured against the assets of the company means it is a safe and secure investment.
Even the so called reputed managements can badly let down the investors, as has happened in
several cases. Remember, with the markets booming, many companies are planning to once
again tap the market. Whether it is equity shares or secured debt instruments, unless you are
extremely cautious, once again you will be running the risk of loosing your hard earned money.
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CHAPTER 4
CONCLUSIONS
A debenture is one of the capital market instruments which is utilized to raise medium or long
haul stores from open. A debenture is basically an obligation instrument that recognizes a credit
to the organization and is executed under the normal seal of the organization. The debenture
record, called Debenture deed contains arrangements as to installment, of intrigue and the
reimbursement of important sum and giving a charge on the advantages of a such an
organization, which may give security for the installment over the a few or every one of the
benefits of the organization. Issue of Debentures is a standout amongst the most widely
recognized techniques for raising the assets accessible to the organization. It is an imperative
wellspring of back.All organizations are offered energy to obtain by their articles which settle the
greatest furthest reaches of borrowings. The ability to obtain monies and to issue debentures
(regardless of whether in or outside India) must be practiced by the Chiefs at an appropriately
gathered meeting. Where the organization obtains without the expert presented on it by the
Articles or past the sum set out in the Articles, it is a ultra vires acquiring and henceforth void.
Ultra vires borrowings can't be sanctioned by a determination gone by the organization as a rule
meeting. If there should arise an occurrence of ultra vires borrowings the moneylender has the
accompanying cures: (an) Injunction and Recovery, (b) Subrogation, (c) Suit against Directors.
A debenture is a record given by an organization under its seal as a confirmation of an obligation
to the holder generally emerging out of a credit and most generally secured by a charge.
Debentures might be of various types, viz. redeemable debentures, enlisted and conveyor
debentures, secured and unsecured or stripped debentures, convertible debentures. A debenture
stock is an obtained capital combined into one mass for comfort. An advance makes a privilege
in the loan boss to request reimbursement, and the substance of an obligation is a risk upon the
indebted person to reimburse the cash. A debenture trust deed is one of the few instruments
required to be executed to secure recovery of debentures what's more, installment of enthusiasm
on due dates. Section 71(4) of the Act required each organization to make a debenture
reclamation save record to which sufficient sum should be credited out of its benefits accessible
for installment of profit until the point that such debentures are recovered and might use the same
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only for recovery of a specific set or arrangement of debentures as it were. Certificate of store is
an archive of title to a period store. Commercial paper alludes to unsecured promissory notes
issued by credit commendable organizations to get supports on a here and now premise.
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BIBLIOGRAPHY
Websites-
1. http://www.legalserviceindia.com/legal/article-262-concept-of-debentures-
in-india.html
2. https://www.investopedia.com/terms/d/debenture.asp
3. https://en.wikipedia.org/wiki/Security_interest
4. http://www.mondaq.com/india/x/326478/Securities/Secured+NCDs+Under+
Companies+Act+2013
5. https://www.oxfordreference.com/view/10.1093/oi/authority.201108031004
51609
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