Classification of Debentures | Differences

The terms debentures and bonds are interchangeable, and represent loan component in the capital structure of the company.

Providers of debenture capital are known as debenture holder. They are creditors of the company and have no right in the company except for payment of interest on their loans and repayment of the loans in accordance with the terms and conditions on which they are issued.

The company can raise money against issues of debentures as authorized under its Memorandum of Association and Articles of Association.

Debenture stock is the consolidated mass of debenture capital for the sake of convenience. Debenture stock differs from debentures in form rather than in substance.

Classification of debentures

Debentures are classified as follows:

1. Security

  • Uncensored / Naked Debentures
  • Secured Debentures.
  • Convertible Debentures.
  • Partially Convertible Debentures.

2. Repayment of Capital

  • Redeemable Debentures.
  • Irredeemably Debentures

3. Transfer

  • Bearer Debentures.
  • Registered Debentures.

Differences between Secured debenture and Unsecured debentures

Debentures may be secured or unsecured and companies frequently issue both kinds of debentures. Secured debentures bear charge on certain assets of the company viz., both existing and future, upon which the debenture holders may look in the event of default on interest payment/repayment of loan installment.

Unsecured debenture holders on the other hand, are entitled to repayment equally with ordinary secured creditors and rank in priority for their repayment vis-a-vis unsecured creditors. In the event of liquidation the unsecured debenture holders rank after secured debentures/loans equally with general creditors and before share capital.

Trustees are appointed for unsecured loan stock in the same way as for secured debenture stock but they hold to assets and simply watch the interests of stock holders particularly with regard to restrictions on borrowings which are included in the terms of issue of debentures.

Differences between Convertible and nonconvertible debentures

Both these types of debentures may be convertible or non-convertible. Convertible debentures are those which carry a right of being converted into equity capital of the company in a phased manner on fixed dates, whereas this privilege is not available to nonconvertible debentures.

The difference between the two, from the point of view of security, is that convertible debenture stock carries a lower coupon rate than the non-convertible loan stock because the former carries the right of conversion into equity shares at some future date. Debentures of some companies are quoted on Stock Exchange.

Redeemable debentures

Other classification of debentures include redeemable and irredeemable debentures or perpetual debentures. Debentures which are repayable on the expiry of the term of the loan are called redeemable debentures. These debentures can be reissued on redemption.

When a company re-issues the redeemed debentures it keeps the old debentures alive by transferring them to a nominee of the company who transfers them back and re-issue to the new holders. The perpetual debentures shall not be paid back and become redeemable only on winding up of a company or on appointment of recoverer as per the terms of agreement of the issue of debentures.

Differences between Bearer debentures and Registered debentures

Another way of classification is bearer debentures and registered debentures. Bearer debentures are negotiable instrument and are transferable by mere delivery like share warrants. The holders of such debentures is entitled to claim interest and recover the principal when due. He is a holder in due course unless contrary is proved. A person who acquires them in a due course gets a good title. No stamp duty is paid on transfer of such debentures as these are not required to be registered in the name of the holder.

On the other hand, registered debentures are required to be registered in the name of the holder in the register of the company. They are transferable in the same manner as the shares. The interest payment and the payment of installments of principal sum are made to the holders, whose names appear in the register of debenture holders.In the last few years, another instrument has gained immense popularity, i.e. partially convertible debentures.

Combining the features of both types of debentures and equity shares, the instrument provided an opportunity to the corporate sector to fix a lower premium on the issues of the company.