[The following is a guest post from Vinod Kothari and Nidhi Ladha of Vinod Kothari & Company. The authors can be contacted at firstname.lastname@example.org and email@example.com respectively.
Other laws affecting debentures
Following are the other guidelines, rules or directions attracting issue debentures:
Issue of debentures by listed companies:
Issue of convertible debentures by listed companies attracts provisions of SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 along with provisions of Companies Act. Issue of short term non-convertible debentures (having an initial maturity up to 12 months) will require compliance of Issuance of Non-Convertible Debentures (Reserve Bank) Directions, 2010. If the issue of NCDs is to be listed (whether public or privately placed issue) or is a public issue, SEBI (Issue and Listing of Debt Securities) Regulations, 2008 is required to be complied with.
Issue by unlisted public companies:
The issue of convertible debentures by unlisted public companies on preferential basis is governed by Unlisted Public Companies (Preferential Allotment) Rules, 2003, amended from time to time. Issue of short term non-convertible debentures (having an initial maturity up to 12 months) will require compliance of Issuance of Non-Convertible Debentures (Reserve Bank) Directions, 2010. If the issue of NCDs is to be listed (whether public or privately placed issue) or is a public issue, SEBI (Issue and Listing of Debt Securities) Regulations, 2008 is required to be complied with.
Issue of debentures by private companies:
Private companies are prohibited from accepting deposits, hence, such companies can issue only either convertible debentures or non convertible secured debentures as per the Notification.
As such, no regulations have been provided for issue of debentures, whether convertible or non convertible, by private companies. However, private companies can issue to a maximum of 49 people as beyond which the issue will be deemed public issue and SEBI (Issue and Listing of Debt Securities) Regulations, 2008 will be required to be complied with. If private companies are to get its issue of NCDs listed, then also, it needs to abide by the SEBI (Issue and Listing of Debt Securities) Regulations, 2008.
Implications of stamp laws in case of mortgage debentures
The mortgage debentures may attract duty as payable on: (a) creation of the mortgage; and (b) the issuance of debenture certificate.
As the debentures certificate is a debt certificate and hence, is liable to stamp duty as applicable in the state where the registered office of the issuing company is situated. In addition, in case of debentures secured by mortgage of specific property, applicable stamp duty on mortgage deed shall also be required to be paid.
Generally, mortgage is created on immovable property, however, the definition of ‘mortgage deed’ as defined in Indian Stamp Act, 1899 reads as:
“Mortgage-deed includes every instrument whereby, for the purpose of securing money advanced, or to be advanced, by way of loan, or an existing or future debt, or the performance of an engagement, one person transfers, or creates, to, or in favour of, another, a right over or in respect of specified property”.
The definition, as is evident, is not limited to immovable property – hence, even a mortgage of movable property, if done by way of a mortgage deed, may be liable to stamp duty. It is a different, and contentious, issue, whether a mortgage of movable property requires a deed at all, since there are no mandatory provisions requiring a written instrument in case of a mortgage of movable property, unlike section 59 of the Transfer of Property Act.
The definition is quite clear that the mortgage debentures shall be chargeable, however, subject to applicable stamp acts in different states. In terms of Article 23A of the said Act, instruments of mortgages of marketable securities are to be charged with such stamp duty as applicable on normal agreements.
However, different states have different stamp duties and different charging rule, so issuer has to carefully see the stamp duty implications before considering mortgage debentures. For example, Article 27 of Schedule IA of the West Bengal Stamp Act includes mortgage debentures also within the article specified for the marketable debentures and also provides duty for mortgage deeds. Delhi Stamp Act also has the same provision as there in West Bengal Stamp Act. Schedule I of Bombay Stamp Act provides Article 54 under which security bonds or mortgage deeds are stamp able as per the specified rates.
While the intent of the MCA in extending the benefit of issuing secured debentures to all fixed assets of the company is laudable, the unwarranted use of the word mortgage may greatly curtail the extension of the benefit, particularly due to the stamp duty unclarity highlighted above.
Practical implications of the Notification
The Notification has provided that the issue of bonds or debentures secured by fixed assets having same or more value as of the issue shall be exempted from the Deposit Rules. Below we discuss the applicability of the exemption in some practical situations:
- A company is issuing NCDs for Rs 100, secured by fixed assets of Rs 100, this will be exempted from Deposit Rules.
- An issuer is issuing NCDs of Rs 100, secured by fixed assets having book value of Rs 80 but market value of Rs 100. This will be exempted as the Notification exempts the issues secured by fixed assets having same or more market value.
- Issuer is issuing NCDs of Rs 100, secured by fixed assets having book value of Rs 100 but the market value of such assets is Rs 80. This will not be exempted as Notification speaks about market value of secured assets.
- Issuer is issuing NCDs of Rs 100, secured by fixed assets having market value of Rs 100, however, there are other charge holders holding floating charge over the same fixed assets – in our view, the creation of a floating charge (such as “all present and future assets of the company” ) does not prevent the company from creating a fixed charge. If the debentures in question are secured by fixed charge, the fixed charge takes priority over the floating charge, and the conditions of the Notification stand satisfied, hence, exempted.
- Issuer is issuing NCDs of Rs 100, secured by fixed assets having market value of Rs 100, however, there are other charge holders holding fixed charge over the same fixed assets. First of all, charge cannot be created in favour of debenture holders, unless existing creditors cede a charge. Even if charge is ceded, the amount of claims exceeds the market value of the assets – hence, such issue will not be exempted.
- Company is issuing NCDs of Rs 100, secured by fixed assets having market value of Rs 500, however, there are other charge holders holding fixed charge over the same fixed assets, with claims amounting to Rs 300. Assuming charge is ceded by the existing charge holders, the amount of claims is within the market value of the assets – hence, exempted. We advise that a secured debenture issuance should typically have an “asset cover” clause whereby the trustees will monitor the adherence of the asset cover condition by the issuer.
- NCDs of Rs 10, secured by fixed assets having market value of Rs 100. However, after issue, the market value declines to Rs 80- exempt. As the Notification requires equal or more market value at the time of issue of debentures. Hence, debentures exempted at the time of issue will not be again treated as deposits if market value of security falls.
The Notification is to come into effect from the date of its publication in Official Gazette and as such the Notification has only been placed on MCA Portal, publication in Official Gazette is awaited. There is no doubt that the Notification will widen the scope of corporate bonds by exempting debentures secured by mortgage of ‘fixed assets’ instead of mortgage of ‘immovable property’. Though the government is making continued efforts to improve the bond market of India and the issue of this Notification is yet another example of such efforts, however, such flawed language of the Notification will create confusion and uncertainty only until proper clarifications are issued in this regard.
- Vinod Kothari & Nidhi Ladha
[This series is concluded]