[The following post is contributed by Nidhi Bothra of Vinod Kothari & Co. She can be contacted at firstname.lastname@example.org]
The new Companies Act, 2013 has changed the regulatory face of the corporate India; “raising the bar on Corporate Governance.” The new regulatory changes including need for CSR activities, increased investor protection, greater transparency in business and have been the larger issues of discussion with the elite section of the corporate sector. However smaller refinements in the new Act against the old one have also created quite a buzz.
Recently an issue was raised by some members of the legal fraternity on an age old settled issue of the difference between negotiable instruments and transferable/ marketable instruments and whether the new definition of “debentures” u/s 2 (30) of the Companies Act, 2013 now includes instruments such as commercial paper as well. Some of the counsels are holding the view that commercial paper will now be included within the ambit of the definition of debentures forcing people to re-think on a question that must have been concluded some hundreds of years ago. This post aims to discuss the merit in the thought.
What is the change?
To be able to see the genesis of the discussion one needs to see the change that has been introduced vis-à-vis the Act, 1956. Textually the changes are small but none the less it is extremely crucial to address their interpretation so as not to start on the wrong foot from the very beginning.
Section 2 (12) of the Companies Act, 1956 debentures were defined 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”
Under the Act, 2013 the definition of debentures u/s 2 (30) has been changed to:
‘debenture’ includes debenture stock, bonds and any other instrument evidencing a debt, whether constituting a charge on the assets of the company or not”.
Syntactically the new definition replaces “any other securities” with “any other instrument evidencing a debt”. Debenture is creation or acknowledgment of debt instrument whether or not it constitutes charge over the assets of the company. The intent of the law makers with the change seemingly is to include any such instrument which is in garb is nothing but an instrument evidencing debt, i.e. debentures even if by nomenclature it may be any different. Commercial paper on the other hand is in the form of usance, a promissory note negotiable by endorsement and delivery. It is a short-term unsecured promissory note sold by large business firms to raise funds.
At the first blush, if commercial paper being a promissory note can be included in the definition of debentures then any negotiable instrument could be included in the definition of debentures as well. The intent of the lawmakers could not have been to include negotiable instruments within its periphery at all.
In the case of Essar Steel Ltd. vs. Gramercy Emerging Market Fund, judgment dated 17 October, 2002, the company had issued floating rate notes (FRNs) and the issuer company defaulted in paying the dues in connection with the notes and hence the note holders took the company for winding up. The defence by the issuer company among other things also included that the FRN holders were not debenture holders or holders of any security as contemplated by the Companies Act read with the Securities Contracts (Regulation) Act, 1956. The relevant extracts of the ruling are reproduced below –
The fundamental purpose underlying Securities Acts is to eliminate serious abuses in a largely unregulated securities market. There is virtually limitless scope of human ingenuity especially in the creation of the numerous schemes devised by those who seek the use of money of others on promise of profits. The inclusive definition of the term 'security' is wide enough to include within that definition many types of instruments that might be sold as an investment.
The term 'Note' is relatively broad to encompass instruments having different characteristics depending on whether issued in a consumer context as a commercial paper or in some other investment context. If the notes are issued in a commercial or consumer context, they will not be treated as securities while those issued in investment context would be securities.
Whether the Note is issued in investment context can be ascertained on the basis of the circumstances surrounding the transactions. In order to determine whether a transaction involves a 'security', the transaction has to be examined to assess the motivations that would prompt a reasonable seller and buyer to enter into it. If the seller's purpose is to raise money for the general use of a business enterprise or to finance substantial investments and the buyer is interested primarily in the profit the note is expected to generate, the instrument is likely to be a 'security'. On the other hand, if the note is exchanged to facilitate the purchase and sale of a minor asset or consumer goods, or to advance some other commercial or consumer purpose, such note cannot be classified as 'security'. One other factor to be examined would be whether the Note in question is an instrument in which there is common trading for speculation or investment and how is it views by the investing public [See Reves v. Ernst & Young 494 US 56 (1990)].
The ruling clearly explains that any instrument cannot be considered to be a security, one has to look at the intent whether the instrument was representing commercial loan or was it issued for investment and trading. In several Indian and U.S. rulings the question has been considered but in the context of U.S. law the purpose of debentures being defined in the Indian law is completely different. The intent in India it is to regulate issue of debentures by companies and provide for debenture redemption reserve, debenture trustees etc to ensure that the investors interest is protected at all times. Commercial paper on the other hand is a money market instrument, largely issued for working capital needs of the business houses.
If for the sake of argument one had to include commercial paper within the periphery of debentures, any issuance of commercial paper would also require maintenance of DRR, liquid funds for yearly redemption (not to forget these are less than a year instrument), trustee and so on, apart from the RBI guidelines existing on the instrument already. Money market instruments are regulated by RBI as per the powers vested in RBI by virtue of Section 45W of the RBI Act and there are already elaborate guidelines laid down with regard to issuance of commercial paper already. Such onerous compliance requirements surely would neither have been envisaged by the lawmakers nor could have been required considering the short-term nature of the instrument.
Further, Section 1 (4) (e) of the Companies Act, 2013 states that the provisions of the Special Act shall prevail over the provisions of the Companies Act, 2013. Considering the fact that commercial paper issuance is regulated by RBI under the powers derived from the RBI Act which is a special Act, commercial paper shall continue to be regulated by RBI and cannot be considered under the so called inclusive and expansive definition of debentures under the Companies Act, 2013.
Commercial paper has existed for almost 500 years and nay, debentures have also existed for 500 years. There is nothing new in the definition of debentures in the Act, 2013 and the definition was substantively the same earlier as well. One cannot interpret the law so as to disturb age old notions which are established by custom. So by merely trying to twist the language of the definition of debentures to try and include any sort of instrument is trying to reinvent the wheel which is an age old invention anyway.
- Nidhi Bothra
 In its judgment in Narendra Kumar Maheshwari vs Union of India, 1990 case, Supreme Court has defined debentures to mean essentially as an acknowledgement of debt, with a commitment to repay the principal with interest.
 Section 4 of the Negotiable Instruments Act, 1881 defines a promissory note as - an instrument in writing (not being a bank-note or a currency note) containing an unconditional undertaking signed by the maker, to pay a certain sum of money only to, or to the order of, a certain person, or to the bearer of the instrument.
 In case of Reves v. Ernst & Young, Fletcher International Ltd vs. ION Geophysical Corp., Pollack v. Laidlaw Holdings, Inc., 27 F.3d 808, 813 (2d Cir. 1994), the Courts held that all notes are presumptively securities, unless presumption is rebutted. The Courts used the ‘family resemblance test’ to examine the question whether a note in question is an investment or whether the note represents a commercial or consumer loan transaction. The Court held that short-term notes that are situational to the particular lender and borrower, and not the types of instruments that are easily traded. if the note in question looks more like a corporate bond, debenture, or other instrument the value of which rises and falls with the success of the issuer’s business, has a term of several years, and is easily traded, then that presumption will not be rebutted, because the note will not bear a strong resemblance to any of the notes listed in Reves for the basic reason that such a note is easily characterized as an investment, and thus a security.