DEBENTURES

Meaning: Repayment of the amount borrowed by a company is called redemption of

debentures. The amount required for the redemption can come from the following ways: - Out of the profits. - Through a sinking fund set up for the purpose of such redemption. - Out of the proceeds of new shares/debentures issue.

A debenture is a document which either creates a debt or acknowledges it. Debenture issued by a company is in the form of a certificate acknowledging indebtedness. The debentures are issued under the Company's Common Seal. Debentures are one of a series issued to a number of lenders. The date of repayment is specified in the debentures. Debentures are issued against a charge on the assets of the Company. Debentures holders have no right to vote at the meetings of the companies

Its obligation to repay the sum at a specified rate and also carrying an interest. It is only one of the methods of raising the loan capital of the company. A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the company's capital structure, it does not become share capital.

Redemption may be at par, at a discount, or at a premium.

For example: (1) A denture loan of $250,000 is redeemed at par. The double entries are: Dr Debenture Loan Account $250,000 Cr Bank Account $250,000 (2) A debenture loan of $200,000 is redeemed at 98 (ie, $98 out of $100). The double entries are: Dr Debenture Loan Account $200,000 Cr Discount on Redemption of Debentures $4,000 Cr Bank Account $196,000 (3) A debenture loan of $100,000 is redeemed at 103 (ie, $103 out of $100). The double entries are: Dr Debenture Loan Account $100,000 Dr Premium on Redemption of Debentures $3,000

Cr Bank Account $103,000 (The Premium on Redemption of Debentures is written off to the profit and loss account or to the share premium account)

Debentures may be irredeemable; but this unusual, except in companies formed under special act of parliament. Debentures may be redeemed either at the end of a given period or by annual drawings. The trust deed, or if there is no trust deed, then the debentures themselves, will contain provision for redemption and will unusually stipulate the establishment of a sinking fund for repayment out of profits.

Alternatively a company may take out of a sinking fund policy with an insurance company for the amount of debentures.

A company which has redeemed debentures to reissue them, either by reissuing the same debentures, or by issuing other debentures in lieu; unless provision, express or implied, is contained in the articles or the conditions of issue, or unless the company has, by passing a resolution, or by some other act, shown its intention that the debentures shall be cancelled. Where a company has redeemed debentures, every balance sheet must show particulars of debentures that may be reissued. On reissue the debentures must be stamped as an original issue; they retain, however, the same priorities as the original debentures. The company can purchase its own debentures; when debentures are purchased at below the issued price a capital profit will result from the purchase. Strict accounting demands appropriate adjustments for accurate interest included the purchase price. In practice this would frequently be ignored.

When a company gets loan, company issues debentures. Company gets this loan through debentures for a fixed time. After that fixed time, company will return the money of debentures to debenture holders. The refund of money to debenture holders is called redemption of debentures. Following are the various methods of redemption of debentures giving accounting treatment.

1st Method of Redemption of Debentures - Redemption Out of Profit In this method, we repay the money of debentures out of profit. Now, understand, how is it possible? Suppose, you have estimated that you will get $ 1,00,0000 profit in march 2011 and in same month, you have to redeem $ 10,000 debentures. Now, one side, you will pay $ 10000 through your cash or bank account and other side, you will deduct same $ 10000 from your profit and loss account by making redemption reserve account. Following entry will be passed : A) Transfer of Profit to debenture redemption reserve account Profit and loss appropriation account Dr. 10000 Debentures Redemption account Cr. 10000 B) Redemption of Debentures Debentures account Dr. 10000 Bank account Cr. 10000 2nd Method of Redemption of Debentures - Redemption Out of Capital It means we directly repay the debentures out of capital. We just pass following entry after repay of debentures by cheque. Debentures account Dr. Bank account Cr. This entry's effect on our capital and it will reduce by same amount. There is no need to transfer of profit to redemption reserves in this method. 3rd Method of Redemption of Debentures - Redemption by Conversion Company can also redeem the old debentures by conversion these into new debentures or equity or pref. shares. At that time, we will pass following entry Old Debentures account Dr.

New Debentures account Cr or Equity Share capital account Cr. or Pref. Share capital account Cr. 4th Method of Redemption of Debentures - Redemption by Buying Own Debentures In this method, directors go to debenture market and for redemption of debentures, they have bought own debentures. For this, following entry will be passed. Own Debenture or investment in own debentures account Dr. Bank account Cr. Investment in own debentures account or simply own debentures account will be shown on the assets side of the balance sheet. Debentures will continue to be shown on the liabilities side of the balance sheet. Here, it is assumed that the debentures are purchased immediately after the payment of interest. As and when the company wants to cancel investment in own debentures, the following entry is done. Debentures account Dr. Loss on redemption of debentures account Dr. Own debentures account Cr. Profit on redemption of debentures account Cr.

5th Method of Redemption of Debentures - Redemption by Making Provision In this method, we create provision for redemption of debentures when we issue debentures. To making provision for redemption is good method to repay the amount of

debenture on the time. We keep a small amount of provision and invest in good scheme. At the time of redemption, we liquidate our provision and repay the amount of debentures, it has two sub-methods.

(A) Sinking Fund for Redemption Method (B) Insurance Policy Method
In this method, we invest provision for redemption of debentures in insurance company, we pay premium of insurance annual. When we have to redeem the debentures, we collect all the money of insurance policy. After this, we repay the debenture amount. Following entry will be passed in this method First year

a) For amount of premium appropriated from profit and loss account

profit and loss account appropriated account Dr. debenture redemption fund account Cr.

b) For amount of premium paid to insurance company

Debenture redemption fund policy account Dr. bank account Cr. ( Note : these entries will be passed every year including the last year also ) The following entries will also be passed at the end of the specific period on realization of the policy:

a) For the amount received from insurance company

bank account Dr. debenture redemption fund policy account Cr.

b) For the balance of debenture redemption fund policy account, excess amount received is transferred to debenture redemption fund account.
Debenture redemption fund policy account Dr. debenture redemption fund account Cr.

c) For amount paid to debentures

debentures account Dr. bank Cr.

d) For balance of debenture redemption fund account transferred to general reserve

debentures redemption fund account Dr general reserve account Cr.

Provisions regulating issue of Debentures

The power to issue debentures can be exercised on behalf of the company at a meeting of the Board of Directors {Section 292(1)(b) of the Companies Act}. A public company may, however, require the approval of shareholders to borrow money in excess of the aggregate of its paid up capital and free reserves.{Section 293 (1) (d)}. Consent of the shareholders would also be required for selling, leasing or disposing of the whole or substantially the whole of the undertaking of the company under section 293 (1) (a). Debentures have been defined under Section 2 (12) of the Act to include debenture stocks, bonds and any other securities of the company whether constituting a charge on the company's assets or not. The attributes of a debenture are: a. A movable property. b. Issued by the company in the form of a certificate of indebtedness.

c. It generally specifies the date of redemption, repayment of principal and interest on specified dates. d. May or may not create a charge on the assets of the company. Section 372 A of the Companies Act also regulates inter-corporate loan and investments and stipulates the ceiling limits on investments and the amount of loan that can be borrowed by a company. The explanation clause of this section states that the loan shall include debentures. Section 117 to Sections 123 of the Companies Act, 1956 regulate the provisions relating to debentures, appointment of debenture trustees, their duties, creation of Debenture Redemption Reserve Account, liability of trustees etc. The debentures issued under the Act shall not carry any voting rights. In the case of public issue of debentures, there would be a large number of debenture holders on the register of the company. As such it shall not be feasible to create charge in favour of each of the debenture holder. A common methodology generally adopted is to create Trust Deed conveying the property of the company. A Trust deed is an arrangement enabling the property to be held by a person or persons for the benefit of some other person known as beneficiary. The Trustees declare the Trust in favour of the debenture holders. The Trust Deed may grant the Trustees fixed charge over the freehold and leasehold property while a floating charge may be created over other assets. The Company shall allow inspection of the Trust Deed and also provide copy of the same to any member or debenture holder of the company on payment of such sum as may be prescribed. Failure to provide the same would invite penalties by way of fine under the Act. Any provision contained in the Trust Deed, which exempts a Trustee from liability for breach of Trust, is void. As per Section 125 (4) of the Companies Act, registration of a charge for purpose of issue of debentures is mandatory. Section 128 stipulates that where a company issues series of debentures which is secured by charge, benefit of which will be available to all debenture holders pari passu, the company shall file the prescribed particulars in Form 10 and 13 with the Registrar of Companies for registration of charge. These forms shall be filed within 30 days after the execution of the deed.

Appointment and Duties of Debenture Trustees

In terms of Section 117 B, it has been made mandatory for any company making a public/rights issue of debentures to appoint one or more debenture trustees before issuing the prospectus or letter of offer and to obtain their consent which shall be mentioned in the offer document. The Debenture Trustees shall not: a. beneficially hold shares in a company. b. be beneficially entitled to monies which are to be paid by the company to the debenture trustees. c. enter into any guarantee in respect of principal debt secured by the debentures or interest thereon. This section also lists the functions that shall be performed by the Trustees. These include:

i. Protecting the interests of the debenture holders by addressing their grievances. ii. Ensuring that the assets of the company issuing debentures are sufficient to discharge the principal amount. iii. To ensure that the offer document does not contain any clause which is inconsistent with the terms of the debentures or the Trust Deed. iv. To ensure that the company does not commit any breach of the provisions of the Trust Deed. v. To take reasonable steps as may be necessary to undertake remedy in the event of breach of any covenant in the Trust Deed. vi. To convene a meeting of the debenture holders as and when required. If the debenture trustees are of the opinion that the assets of the company are insufficient to discharge the principal amount, they shall file a petition before the Central Government and the latter may after hearing the parties pass such orders as is necessary in the interests of the debenture holders. As per the SEBI (Debenture Trustees) Regulations, 1993, {hereinafter referred to as the 'Regulations'} a Debenture Trustee can be a scheduled bank, an insurance company, a body corporate or a public financial institution.

Debenture Trust Deed

A Debenture Trust Deed shall, interalia, include the following: a. An undertaking by the company to pay the Debenture holders, principal and interest. b. Clauses giving the Trustees the legal mortgages over the company's freehold and leasehold property. c. Clauses that may make the security enforceable in the event of default in payment of principal or interest i.e. appointment of receiver, foreclosure, sale of assets etc. d. A clause giving the Trustees the power to take possession of the property charged when security becomes enforceable. e. Register of Debenture holders, meeting of all debenture holders and other administrative matters may be included in the Deed. In addition thereto, the SEBI regulations have laid format of the Trust Deed in Schedule IV to the regulations. Some of the important provisions would include f. Time limit of creation of security for issue of debentures. g. Obligations of the body corporate towards the debenture holders. h. Obligations towards the debenture holders - equity ratio and debt service coverage ratio. i. Procedure for the inspection of charged assets by the Trustees.

Creation of debenture Redemption Reserve

Section 117 C of the Act casts an obligation on the company to create a Debenture Redemption Reserve. This account will be credited with proceeds from the profits of the company arrived at every year till redemption of the debentures. The Act, however, does not stipulate the time period for creation of security. SEBI regulations provides for creation of security within six months from the date of issue of debentures and if a company fails to create the security within 12 months, it shall be liable to pay 2% penal interest to the

debenture holders. If the security is not created even after 18 months, a meeting of the debenture holders will have to be called to explain the reasons thereof. Further, the issue proceeds will be kept in escrow account until the documents for creation of securities are executed between the Trustees and the company.

Compliances under Registration Act and Stamp Duty Act

In the case of English Mortgage, the trust deed will attract ad valorem stamp duty. After execution, such deed will be registered with the sub registrar of Assurances. Registration charges will have to be paid in addition to the stamp duty. While in case of an equitable mortgage, if no document, deed etc. is signed then nothing is required to be registered with the sub registrar of Assurances. If however, a note or letter is made then it will attract stamp duty. It is pertinent to mention that once a mortgage is created by registration then no further stamp duty is payable on registration.

Default
In the event of failure on the part of the company to redeem the debentures on the date of maturity, the Company Law Tribunal may, on the application of any debenture holder, direct redemption of debentures forthwith by payment of principal and interest due thereon. If a default is made in complying with the orders of the Tribunal, every officer of the company who is in default shall be punishable with imprisonment for a term which may extend to three years and shall also be liable to fine of not less than Rs.500/- for every day during which the default continues. (Section 117C) Further this offence is not compoundable under section 621A of the Act. There are contradictions between the Companies Act and the SEBI regulations on issues relating to: a. Utilisation of Debenture Redemption Reserves. The Act provides that the Debenture Redemption Reserve will be used towards redemption of debentures only whereas the SEBI regulation states that these will be a part of the General Reserves, which can be utilised for the purpose of bonus issues. . Any debentures issued with a maturity period of 18 months or less is exempted from the creation of Debenture Redemption Reserve Account, whereas no such exemption is provided under the Companies Act. c. No Public Issue/Rights Issue of Debentures shall be made by a company unless it has appointed one or more Debenture Trustees for such debentures whereas under SEBI guidelines, appointment of Debenture Trustees is compulsory only in case of debentures with maturity of 18 months or more. A listed company though subjected to SEBI regulations must comply with stringent norms between the two legislations / regulations made there under.

KINDS OF DEBENTURES
(a)Bearer Debentures:
They are registered and are payable to the bearer. They are negotiable instruments and are transferable by delivery.

(b) Registered Debentures:

They are payable to the registered holder whose name appears both on the debentures and in the Register of Debenture Holders maintained by the company. Registered Debentures can be transferred but have to be registered again. Registered Debentures are not negotiable instruments. A registered debenture contains a commitment to pay the principal sum and interest. It also has a description of the charge and a statement that it is Issued subject to the conditions endorsed therein.

(c) Secured Debentures:

Debentures which create a change on the assets of the company which may be fixed or floating are known as secured Debentures. The term "bonds" and "debentures"(secured) are used interchangeably in common parlance. In USA, BOND is a long term contract which is secured, whereas a debentures is an unsecured one.

(d) Unsecured or Naked Debentures:

Debentures which are issued without any charge on assets are insecured or naked debentures. The holders are like unsecured creditors and may see the company for the recovery of debt.

(e) Redeemable Debentures:

Normally debentures are issued on the condition that they shall be redeemed after a certain period. They can however, be reissued after redemption.

(f) Perpetual Debentures:

When debentures are irredeemable they are called perpetual. Perpetual Debentures cannot be issued in India at present.

(g) Convertible Debentures:

If an option is given to convert debentures into equity shares at the stated rate of exchange after a specified period, they are called convertible debentures. Convertible Debentures have become very popular in India. On conversion the holders cease to be lenders and become owners. Debentures are usually issued in a series with a pari passu (at the same rate) clause which

entitles them to be discharged rateably though issued at different times. New series of debentures cannot rank pari passu with the old series unless the old series provides so. New debt instruments issued by public limited companies are participating debentures, convertible debentures with options, third party convertible debentures convertible debentures redeemable at premiums, debt equity swaps and zero coupon convertible notes. These are discussed below:

(h) Participating Debentures:

They are unsecured corporate debt securities which participate in the profits of the company. They might find investors if issued by existing dividend paying companies.

(i) Convertible Debentures with options:

They are a derivative of convertible debentures with an embedded option, providing flexibility to the issuer as well as the investor to exit from the terms of the issue. The coupon rate is specified at the time of issue.

(j) Third Party Convertible Debentures:

They are debt with a warrant allowing the investor to subscribe to the equity of third firm at a preferential price visa vis the market price. Interest rate on third party convertible debentures is lower than pure debt on account of the conversion option.

(k) Convertible-Debentures Redeemable at a Premium:

Convertible Debentures are issued at face value with 'a put option entitling investors to sell the bond to the issuer at a premium. They are basically similar to convertible debentures but embody less risk.

(I) Debt-Equity Swaps:

Debt-Equity Swaps are an offer from an issuer of debt to swap it for equity. The instrument is quite risky for the investor because the anticipated capital appreciation may not materialise.

(m) Deep discount Bonds:

They are designed to meet the long term funds requirements of the issuer and investors who are not looking for immediate return and can be sold with a long maturity of 25-30 years at a deep discount on the face value of debentures. IDBI deep discount bonds for Rs 1 lakh repayable after 25 years were sold at a discount price of Rs. 2,700.

(n) Zero-Coupon Convertible Note:

A zero-coupon convertible note can be converted into shares. If choice is exercised investors forego all accured and unpaid interest. The zero-coupon convertible notes are quite sensitive to changes in interest rates.

(o) Secured Premium Notes (SPN) with Detachable Warrants:

SPN which is issued along with a detachable warrant, is redeemable after a notice period, say four to seven years. The warrants attached to it ensures the holder the right to apply and get

allotted equity shares; provided the SPN is fully paid. There is a lock-in period for SPN during which no interest will be paid for an invested amount. The SPN holder has an option to sell back the SPN to the company at par value after the lock in period. If the holder exercises this option, no interest/ premium will be paid on redemption. In case the SPN holder holds its further, the holder wili be repaid the principal amount along with the additional amount of interest/ premium on redemption in instalments as decided by the company. The conversion of detachable warrants into equity shares will have to be done within the time limit notified by the company.

(p) Floating Rate Bonds:

The rate on the floating Rate Bond is linked to a benchmark interest rate like the prime rate in USA or LIBOR in eurocurrency market. The State Bank of India's floating rate bond was linked to maximum interest on term deposits which was 10 percent. Floating rate is quoted in terms of a margin above or below the bench mark rate. The-floor rate in the State Bank of India case was 12 per cent. Interest rates linked to the bench mark ensure that neither the borrower nor the lender suffer from the changes in interest rates. When rates are fixed, they are likely to be inequitable to the borrower when interest rates fall subsequently, and the same bonds are likely to be inequitable to the lender when interest rates rise subsequently.

WARRANTS
A warrant is a security issued by a company granting the holder of the warrant the right to purchase a specified number of, shares at a specified price any time prior to an expirable date. Warrants may be issued with debentures or equity shares. The specific rights are set out in the warrant. The main features-of a warrant are number of shares entitled, expiry date and state price / exercise price. Expiry date of warrants, generally in USA, is 5 to 10 years from the original issue date. The exercise price is 10 to 30 percent above the prevailing market price. The Warrants have a secondary market. The minimum value of a warrant represents the exchange value between the current price of the share and the shares purchased at the exercise price. Warrants have no flotation costs and when they are exercised the firm receives additional funds at a price lower than the current market, yet about those prevailing at issue time. New or growing firms and venture capitalists issue warrants. They are also issued in mergers and acquisitions. Warrants are called sweeteners and have been issued in the recent past by several companies in India. Debentures issued with warrants, like convertible debentures, carry lower coupon rates.

NON-CONVERTIBLE DEBENTURES (NCDs) WITH DETACHABLE EQUITY WARRANTS

The holder of NCDs with detachable equity warrants is given an option to buy a specific number of shares from the company at a predetermined price within a definite time-frame.

The warrants attached to NCDs will be issued subject to full payment of NCD is a value. There is a specific lock-in period after which there detachable option to apply for equities. If the option to apply for equities is not exercised, the unapplied portion of shares would be disposed off by the company at its liberty.

ZERO-INTEREST FULLY CONVERTIBLE DEBENTURES (FCDs)

The investors in zero-interest fully convertible debentures will not be paid any interest. However, there is a notified period after which fully paid FCDs will be automatically and compulsorily converted into shares. There is a lock-in period upto which no interest will be paid. Conversion is allowed only for fully paid FCDs. In the event of the company going for rights issue prior to the allotment of equity resulting from the conversion of equity shares into FCDs, FCD holders shall be offered securities as may be determined by the company.

SECURED ZERO-INTEREST PARTLY CONVERTIBLE DEBENTURES (PCDs) WITH DETACHABLE AND SEPARATELY TRADEABLE WARRANTS:
This instrument has two parts; A and B. Part A is convertible into equity shares at a fixed amount on the date of allotment. Part B is non-convertible, to be redeemed at par at the end of a specific period from the date of allotment. Part B will carry a detachable and separately tradeable warrant which will provide an option to the warrant holder to receive equity shares for every warrant held at a price as worked out by the company.

FULLY CONVERTIBLE DEBENTURES (FCDs) WITH INTEREST (OPTIONAL)

This instrurnent does not yield interest in the initial period of say, 6 months. After this period option is given to the holder of FCDs to apply for equity at a "premium" for which no additional amourit needs to be paid. The option has to be indicated in the application form itself. However, interest on FCDs is payable at a determined rate from the date of first conversion to the second / final conversion and in lieu of it, equity shares are issued.

SEBI GUIDELINES FOR DEBENTURES

Fully Convertible Debentures (FCD):
SEBI restricts the conversion period to 36 months. Credit rating is required if the conversion is made after 18 months. Conversion beyond 36 months is permissible only if the conversion is made optional with "put" and "call" option. It may be noted that an option is merely an instrument that gives its owner the right to buy or sell shares of a company within a specified period of time. Options are a derivative instrument which have a beneficial impact all round. They stabilise share price by reducing its volatility and provide a hedge against risk for the

investor. They are likely to be popular in this country. Premium on Conversion of

Debentures:
Premium on conversion has to be predetermined and stated in the prospectus. The company is free to determine the rate of interest payable.

Redemption Reserve Debenture:

In the case of non-convertible debentures, a Debenture Redemption Reserve has to be created. A moratorium upto the date of commercial production is provided for the creation of the Debenture Redemption Reserve in respect of debenture raised for project finance. Debenture Redemption Reserve may be created either in equal instalments or with higher amounts in the remaining period, if profits permit. Companies are allowed to distribute dividends out of general reserves in certain years if the residual profits after transfer to the Debenture Redemption Reserve are inadequate to distribute reasonable dividend. The Debenture. Redemption Reserve will treated as part of general reserve for consideration of bonus issue proposals and for price fixation related to post-tax relurn. In the case of new companies, distribution of dividend requires the approval of the trustees to the issue and the lead institution. Debenture redemption can be taken up only after 50 per cent of the amount of the debenture issue is created. Drawal from the Debenture Redemption Reserve is permissible only after 10 per cent of the debenture liability has been actually redeemed by the company. Dividends exceeding 20 per cent cannot be declared by existing companies without the prior permission of the lead institution or as per loan convenants if the cornpany does notcomply with institutional condition regarding interest and debt service coverage ratio. The company is free to redeem debentures in greater number of instalments. The first instalment may start from the fifth instead of the seventh year.

Debenture Trustees:
The names of the debenture trustees must be stated in the prospectus. The trust deed should be executed within six months of the close of the issue.

Conversion Option:
Any conversion in part or whole of the debenture will be optional at the hands of the debenture holder, if the conversion takes place at or after 18 months from the date of allotment but before 36 months.

Nonconvertible Debentures (NCDs) and Partly Convertible Debentures (PCDs) Debentures of less than 18 months Duration:
If the maturity period of debentures is less than 18 months, it is hot necessary to create a charge or appoint a trustee or create a Debenture Redemption Reserve. If no charge is created on such debentures they are unsecured and are treated as "deposits". the issuer has to comply with the requirements of the Companies (Acceptance of Deposits) Rules, 1975. The otfer document should disclose this.

Prospectus and PCDs / NCDs:

In the case of PCDs, the premium amount at the time of conversion shall be predetermined

and stated in the prospectus. Redemption amount, period of maturity, yield on redemption of PCDs/NCDs shall be indicated in the prospectus. The prospectus should indicate the discount on the non-convertible portion of the PCD in case they are traded and the procedure for their purchase on spot trading basis must be stated in the prospectus.

Roll-over of Non-convertible Portion:

Roll-over of non-convertible portion of PCD/NCD with or without change in interest rate can be done only on positive consent and not on passive consent. It is compulsory for companies to give an option to those debentures holders who want to withdraw and encash their debentures. Before roll-over, execution of fresh trust deed for non convertible debenture or non convertible portion of PCD is required. A company has to obtain credit rating six months prior to the date of redemption and communicate it to the debenture holder. A company desirous of roll-over of its NCD or non convertible portion of PCDs has to submit the letter of information containing credit rating, debenture holders resolution, option for conversion and such other items SEBI may prescribe from time to time to SEBI for vetting.

Discloses for issue of Debentures:

The discloures relating to raising of debentures should include, among others, existing and future debt equity ratios, servicing behaviour on existing debentures, payment of due interest on due dates on term loans and debentures, certificates from a financial institution or banker about their no objection for a second or pari passu charge being created in favour of the trustees to the proposed debevnture issue.

Protection of Debenture Holders' Interest:

Trustees to the debenture issue should be vested with requisite powers to protect the interest of debenture holders including a right to appoint a nominee director on the board of the cornpany in consultation with the debenture holders. The progress in respect of debentures raised for project finance / modernisation / expansion / diversification / normal capital expenditure is to be monitored by the lead institution / investment institution. In regard to debentures issued for working capital, the lead bank for the company should do the monitoring. Institutional debenture holder and trustees should obtain a certificate from the company's auditors about the utilisation of funds during the period of implementation of the project. In the case of debentures for working capital, a certificate has to be obtained at the end of each accounting year. Issues by companies belonging to the groups for replemishing funds or to acquire share holding in other companies is not permitted. The company issuing debentures has to file with SEBI certificates from its bankers that the assets on which security is to be created are free from encumbrances and the necessary permission to mortgage the assets have been obtained or a no objection certificate from the financial institution or bank'for a second or pari passu charge in cases where assets are encumbered. The security should be created within six months from the date of issue of the debentures. If the company. for any reason, is not in a position to create a security within 12 months from the date of issue of the debentures, a penal interest of 2 per cent has to be paid to debenture holders. If the security is not created even after 18 months, a meeting of

debenture holders should be called within 21 days to explain the reason why, and.the date by which, the security would be created. The trustees to the Debenture Issue will superwise the implementation of the conditions regarding the creation of security for the debentures, and regarding the Debenture Redemption Reserve.

Past Issues of FCDs and PCDs:

In the case of FCDs and PCDs issued in the past where conversion was to be made at a price to be determined by the Controller of Capital Issues at a later date, SEBI has laid down the procedure :- The price of conversion and the time of conversion should be determined bythe company in a duly organised meeting of the debentureholders and shareholders. The decision in the meeting has to be certified by the shareholders Such conversion will be optional. The dissenting shareholders shall have the right to continue as debentureholders if the terms of conversion are not acceptable to them. The letter of option should be vetted by SEBI.

New types of Debentures

New types of Debentures mentioned by SEBI are deep discount bonds, debentures with warrants and secured premium notes. While making an issue of any new financial instrument, the issuer of capital shall make adequate disclosures regarding the terms and conditions, redemptions, security, conversion and any other relevant features of the instruments.

COMMERCIAL PAPER
Commercial Paper is one of the non-bank sources of working capital finance. It is a money market instrument, unlike debentures which are capital market instruments. Corporate Borrowers, especially the large and financially sound, can diversify their short term borrowing by the issue of Commercial Paper. Commercial Paper is especially attractive for companies with cyclical cash flows and for cash rich companies during periods of greater cash inflows than overdraft or cash credit since monitoring is more convenient. The raising of funds through Commercial Paper is regulated by the directions of the Reserve Bank of India. The issue of commercial paper is regulated by Non-banking Companies (Acceptance of Deposits through Commercial Paper) Directions, 1989 which came into force on January 1, 1990. Scheduled Banks have emerged as significant holders of Commercial paper. The secondary market is yet to develop. The commercial papers of a few companies are traded on the National Stock Exchange.

Issue of Commercial Paper

Commercial Paper can be issued by a company whose (i) tangible net worth (paid-up capital plus free reserves) is not less than Rs 4 crores (ii) fund based working capital limits are not less than Rs. 4 crores (iii) Specified Credit Rating of P2 is obtained from CRISIL, A2 from ICRA and PR2 from CARE (iv) Borrowal health is classified under health code No. 1 and

(v) Current ratio is 1.33: 1.

Usance
Commercial Paper should be issued for a minimum period of three months and maximum of one year (with effect from October 1993). No grace period is allowed for payment and if the maturity date falls on a holiday it should be paid on the previous working day. Every issue of commercial paper is treated as a fresh issue.

Denomination:
Commercial Paper is issued in denominations of Rs. 5 lakhs. But the minimum lot or investment is Rs 25 lakhs (face value) per investor. The secondary market transactions can be for Rs. 5 lakhs or multiples thereof. The total amount proposed to be issued should be raised within two weeks from the date on which the proposal is taken on record by the bank. The paper may be issued in a single day or in parts on different dates in which case each paper should have the same maturity date.

Ceiling
The aggregate amount that can be raised by commercial paper should not exceed 75 per cent of the company's fund based working capital.

Mode of Issue and Discount Rate

Commercial Paper should be in the form of usance promissory note negotiable by endorsement and delivery. It can be issued at such discount to face value as may be decided by the issuing company.

Issue Expenses
Issue expenses consisting of dealers fees, rating agency fees and other relevant expenses as well as the charges derived by tpe bank for providing stand-by facilities should be borne by the company.

Investors
Commercial Paper may be issued to any person, bank, company or other registered (in India) corporate body and incorporated body. Issue to NRI can only be on non-repatriable basis and is not transferable. The paper issued to NRI should state that it is non-repatriable and nonendorseable.

Procedure for Issue

Commercial Paper is issued only through the bankers who have sanctioned working capital limits to the company. It is counted as a part of working capital. Unlike public deposit, commercial paper really cannot augment working capital resources. There is no increase in the overall short term borrowing facilities. Every company proposing to issue commercial paper should submit the proposal in the form prescribed by the RBI to the bank which provides working capital along with the credit rating of the company. The bank Scrutinises the application and on being satisfied that eligibility

criteria are met and conditions stipulated are met will has to be privately place the issue within two weeks by the company or through the good offices of a merchant banker. The initial investor pays the discounted value of the paper to the account of the issuing company with the bank in writing. The working capital limit is correspondingly reduced by the bank. the company must advise RBI, through the bank, of the amount of commercial paper issued within three days.

What Does Debenture Redemption Reserve Mean?

A provision that was added to the Indian Companies Act of 1956 during an amendment in the year 2000. The provision states that any Indian company that issues debentures must create a debenture redemption service to protect investors against the possibility of default by the company.

Investopedia explains Debenture Redemption Reserve

Under the provision, debenture redemption reserves will be funded by company profits every year until debentures are to be redeemed. If a company does not create a reserve within 12 months of issuing the debentures, they will be required to pay 2% interest in penalty to the debenture holders. Only debentures that were issued after the amendment in 2000 are subject to the debenture redemption service.

GUIDELINES ON DEBENTURE REDEMPTION RESERVE

The object of Section 117C of the Companies Act, 1956 as inserted by the Companies (Amendment) Act, 2000 is to prevent default in redemption of debentures and to afford protection to the debenture holders thereby protecting the small debenture holders. The provision, which came into force with effect from December 3, 2000, mandates : "Where a company issues debentures after the commencement of this Act, it shall create a debenture redemption reserve for the redemption of such debentures, to which adequate amounts shall be credited, from out of its profits every year until such debentures are redeemed." Soon after the Section came into force, representations were received from Financial Institutions and others and the matter was deliberated by the Union Minister of Law, Justice and Company Affairs, Shri Arun Jaitley, followed by Secretary, DCA. Public Financial Institutions, NonBanking Financial Companies, Professionals, Chambers of Commerce and Industries sought for exemption from the provision. References were also received from the Reserve Bank of India (RBI) and Ministry of Finance giving their views in the matter. Elaborate discussions were held

with RBI and Securities and Exchange Board of India (SEBI) who have been in the field of regulating NBFCs PFIs and issues of debt instruments. Since banks, All India Financial Institutions and NBFCs are under the regulatory domain of RBI, they are subjected to healthy prudential norms. They have an understandable difficulty in complying with an over-rigorous definition of adequate DRR over and above the prudential norms applicable to them. Keeping in view of their genuine difficulties, the Government proposes to issue a Circular on adequate DRR as under: a. For NBFCs registered with the RBI under Section 45-1A of the RBI (Amendment) Act, 1997, 'the adequacy' of DRR will be 50 per cent of the value of debentures issued through public issue as per present SEBI (Disclosure and Investor Protection) Guidelines 2000 and no DRR is required in the case of privately placed debentures. b. For manufacturing and infrastructure companies, the adequacy of DRR will be 50 per cent of the value of debentures issued through public issue and 25 per cent for privately placed debentures. c. Section 117C will apply to debentures issued and pending to be redeemed and as such DRR is required to be created for debentures issue prior to 13.12.2000 and pending redemption subject to clarifications issued herein. d. No DRR is required for debentures issued by All India Financial Institutions and Banking Companies, regulated by RBI for both as well as privately placed debentures. e. Section 117C will apply to non-convertible portion of debentures issues whether they are fully or partly convertible. This clarification settles the definition on adequate DRR and corporate sector is likely to feel as sign of relief in the matter.

PUT AND CALL OPTION

These two terms are generally used in parlance to Shareholders Agreement in which the investor puts in his entire inestment either -intially into debt securities or into equity or partly in to debt and partly into equity. The wordings of the two terms can be like reproduced below in detail;

Put Option
In the event the Promoters / Company do not proceed with any event (a condition specified in the agreement), Investor shall have the option to issue a notice (Equity Put Notice) to the Promoters (which Equity Put Notice shall be irrevocable), requiring the Promoters or any Entity or Entities designated by them, to purchase within a period of thirty (30) days from the date of receipt of the Equity Put Notice all the Equity Shares held by any or all the Investor, and the Promoters shall in that event be under a mandatory obligation to purchase such Equity Shares or cause any Entity or Entities designated by them to purchase the same, free of any encumbrances, at the Equity Put Price.

The Equity Put Price shall be as under: (i)On the sale of the Equity Shares held by the Investorto an Entity resident outside India at a price which shall be the aggregate of (i) the Amounts Due in respect of the outstanding Convertible Debentures and other amounts payable by the Company in respect of the Equity Shares held by Investor and (ii) such further amount as ensures that Investor receives an IRR of 25% on the Investment Amounts from the date of disbursement of Phase- I Investment Amount as adjusted by payments already received by Investor towards interest, dividend or redemption, (hereinafter referred to as the Relevant Minimum Equity Price). (ii)On the sale of the Equity Shares to an Entity resident in India, at the price determined in accordance with applicable Law. Provided that if the price determined in accordance with applicable Law is not equal to or is less than the Relevant Minimum Equity Price, the Promoters agree that they shall ensure that the Entity designated by them is permitted to pay at least the Relevant Minimum Equity Price for the Equity Shares to Investor. If within a period of say six (6) months from the Date of Issue of Equity, the condition (prescribed in the agreement ) is not fulfilled, Investor shall have the option (Debenture Put Option) to issue a notice (Debenture Put Notice) to the Company and the Promoters (which Debenture Put Notice shall be irrevocable), requiring that within a period of thirty (30) days from the date of delivery of the Debenture Put Notice (i) the Company shall redeem or purchase all the outstanding Convertible Debentures held by Investor at the Debenture Put Price, or (ii) the Promoters or any Entity or Entities designated by them, shall purchase the Convertible Debentures held by any or all the Investor at the Debenture Put Price. For the purpose of the above, the Debenture Put Price shall be the aggregate of (i) the Amounts Due in respect of the outstanding Convertible Debentures and other amounts payable by the Company in respect of the Equity Shares held by Investor and (ii) such further amount as ensures that Investor receives an IRR of 25% on the Investment Amounts from the date of disbursement of Phase - I Investment Amount as adjusted by payments already received by Investor towards interest, dividend or redemption .

CALL OPTION:
Investor grants to the Promoters a call option to buy the Equity Shares held by Investor and all outstanding Convertible Debentures (Promoters Call Option) at a price which is the higher of (a) the average price determined under Clause Specified in the agreement(Promoters Call Exercise Price).

The Promoters shall be entitled to deliver to Investor written notice exercising the Promoters Call Option (a Promoters Call Exercise Notice) within fifteen (15) days of the valuer intimating the Promoters Call Exercise Price to the Promoters. In the event of the Promoters exercising the Promoters Call Option, the Promoters shall pay to Investor the Promoters Call Exercise Price and Investor shall transfer the Equity Shares held by Investor and all outstanding Convertible Debentures to the Promoters/their nominees including by redemption of the Convertible Debentures within seventy-five (75) days of the Promoters delivering the Promoters Call Exercise Notice to Investor. In the event (i) the Promoters do not exercise the Promoters Call Option as set out in Clause specified in the agreement, do not pay or cause to be paid the Promoters Call Exercise Price within the period stipulated in sub-clause (e), then within fifteen (15) days thereafter, Investor shall be entitled to buy itself and/or nominate its designee to buy all the Promoters Equity Shares at the value determined under clause specified in the agreement (Investor's Default Call Option).