Unsecured Debentures in India: Legal Regulations & Lacunae

By: Sahithi Shyam, National University Of Juridical Sciences

The Companies Act, 1956 defines debentures under Section 2(12) as including debenture stock bonds and any other securities of a company, whether constituting a charge on the assets of the company or not. Over the years, many companies have raised corporate finances through the issue of unsecured debentures. While the issue of unsecured debentures translates into reduced liabilities for a company, this article seeks to provide observations on how the Indian legal system perceives such instruments.

On a plain reading of the definition of debentures provided, one would gather that debentures/bonds may be secured or unsecured. However, we find divergent views regarding this subject.

Debentures if secured are subject to the provisions of Section 125 of the Act requiring registration of charge with the ROC. On the other hand, the Companies Act does not define or address the issue of unsecured debt instruments throughout its text. The relevant rules/guidelines which do address this issue are the SEBI (Disclosure & Investor Protection) Guidelines, 2000, the Companies (Acceptance of Deposits) Rules, 1975 and the NBFC Acceptance of Public Deposits (Reserve Bank) Directions, 1998.

Unsecured debentures do not get the benefit as an exempt deposit under Rule 2(b) (x) of the Companies (Acceptance of Deposits) Rules, 1975 and are treated as "deposits" under the same. Under the SEBI (Disclosure & Investor Protection) Guidelines, 2000, clause 10.6.5 mandates that where no charge is created on debentures, the issuer company shall ensure compliance with the provisions of the Companies (Acceptance of Deposits) Rules, 1975. However, the NBFC Acceptance of Public Deposits (Reserve Bank) Directions, 1998 make an exception in case of such issue by treating any amount received as hybrid debt or subordinated debt the minimum maturity period of at least sixty months as an exempt deposit.

SEBI (Disclosure & Investor Protection) Guidelines, 2000 in Clause 10.7.2 further provide that companies may issue unsecured/subordinated debt instrument/obligations (which are not public deposits as per section 58A of the Companies Act, 1956) but only Qualified Institutional Buyers or investors who have given consent for subscribing to such unsecured/subordinated debt instruments/obligations may subscribe to such issue.

In light of these provisions, we are faced with a patent legal lacuna- as SEBI Guidelines primarily apply only to listed companies; there is need for clarity on the subject with relation to unlisted/private companies.

The Companies (Amendment) Act, 2000 which became effective from 13-12-2000 introduced some special provisions exclusively applicable to debentures in Sections 117 to 123 to the Companies Act. On careful consideration of these provisions with regard to issue of debentures, we see that the amended section 117C requires that any Indian company that issues debentures must create a Debenture Redemption Reserve (DRR) to protect investors against the possibility of default by the company. The company is required to credit adequate amounts to DRR from its profits every year until such debentures are redeemed.

The overall tenor of the Companies Act suggests that the any debt instrument must be secured. The Act mandatorily requires the creation of a DRR. In absence of a definition of unsecured debentures in the Companies Act, there is an urgent need to address the question of whether DRRs are to be treated as security/charge. Under the present legal framework, it cannot be argued successfully that a DRR is distinct from a security as perceived by Act.

There could thus be two possibilities- if DRRs are to be treated/understood to be the same as security/charge as understood under the Companies Act, then it effectively implies that the Companies Act does not recognize unsecured debt instruments/debentures in its implementation. Conversely, if DRRs are not to be treated as security per se, then this needs to be explicitly stated in the Act to validate the existence of unsecured debt instruments/debentures to clear the air on this subject.

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