Debentures | Meaning, Issue, Features, Types, Advantages, Disadvantages

What is debenture?

Debentures – Meaning, Issue, Features, Types, Advantages, Disadvantages

The term debenture is derived from the Latin word “debere” which means “to owe a debt”. A debenture may, be defined as document issued by the company as an evidence of debt. It is the acknowledgement of the company’s indebtedness to its holders.

The debentures may be secured or unsecured. In the American terminology, only unsecured bonds are called as debentures. But we have borrowed our terminology from Britain where no such distinction is made between the two terms. Therefore, in our discussion, we will treat both the words as interchangeable.

The debentures provide for a fixed rate of interest to the debenture holders. A debenture holder cannot vote in the company meetings. Generally, debentures are secured. They may have a floating charge on the whole of the assets of the company.

Issue of Debentures

No company can solely depend on its ownership capital, though it is desirable. Some investors are more cautious and hesitate to invest their funds in the risk capital of the companies. To attract such type of investors to lend money as a loan, bonds and debentures are issued. These securities are also known as “Creditorship securities”. Just as uniform parts of capital are known as shares, uniform parts of loan raised by the companies are known as debentures or bonds. The issue of debentures is governed almost by the same consideration as shares.

Features of debentures

The following are the features of debentures.

1. Debenture-holders are entitled to periodical payment of interest at an agreed rate.

2. They are also entitled to redemption of their capital as per the agreed terms.

3. They have no voting rights.

4. Usually debentures are secured by charge on or mortgage of the assets of the company.

5. Debenture holders have the right to sue the company for any unpaid dues.

6. They can enforce the security by sale in case of default.

7. They can apply for winding up of the company to safeguard their interests.

Types of Debentures

Debentures on the basis of Registration

1. Registered Debentures

The debentures which are payable to the registered debenture holders are called registered debentures. These debentures are not transferable by mere delivery. The names of the holders of these debentures with details of the number, value and type of debenture held are recorded in the register of debenture holders. Registered debentures are not negotiable instruments. Transfer of such debentures requires registration.

2. Bearer Debentures

Bearer debentures are those which are payable to the bearer. These debentures are transferable by mere delivery. The register of debenture holders does not have the names of the debenture holder recorded. Hence they are transferable by mere delivery. Registration of transfer is not necessary. Bearer debentures are also called as Unregistered Debentures.

Debentures on the basis of Security

1. Secured Debentures

The debentures, which are secured fully or partly by a charge over the assets of the company are called secured debentures. The charge may be either a fixed charge or a floating charge. The charge, when created should be registered with the Registrar within 30 days of its creation.

2. Unsecured Debentures

The debentures, which are not secured fully or partly by a charge over the assets of the company are called unsecured debentures. They are also called Naked Debentures. They are not mortgaged. The general solvency of the company is the only security for the holders. The debenture holders are treated as only unsecured creditors. Issue of such debentures are not much popular.

Debentures on the basis of Redemption

1. Redeemable Debentures

The debentures, which are repayable after a certain period as per the terms of their issue, are called redeemable debentures. Sometimes, they can be redeemed by the company on demand by the holders or at the discretion of the company.

2. Irredeemable Debentures

They are perpetual debentures. The debentures, which are not repayable during the life time of the company, are called irredeemable debentures. The company has no obligation to make the payment of the principal of these debentures during its life time.

The company may repay the money at the time of liquidation or on the happening of a contingency or on the expiration of a longer period or when the company breaches the terms of issue of the debentures.

Debentures on the basis of Conversion

1. Convertible Debentures

The debentures, which are convertible into equity shares or preference shares at the option of the holders, after a certain period, are called convertible debentures.

2. Non-Convertible Debentures

The debentures, which are not convertible into equity shares, are called non-convertible debentures.

Debentures on the basis of Priority

1. Preferred Debentures

The debentures, which are paid first at the time of winding up, are called preferred debentures or first debentures. Thus they are just like preference shares.

2. Ordinary Debentures

Debentures, that are paid after the preferred debentures during the winding up of a company are called ordinary debentures.

Debentures on the basis of Status

1. Equitable Debentures

Debentures, that are secured by deposit of title deeds of the property with a Memorandum creating a charge, are called equitable debentures. In this case, the property is with the company.

2. Legal Debentures

The debentures, which are secured by actual transfer of the legal ownership of the property from the company to the holder, are called legal debentures.

Debentures with Pari Pasu Clause

The (secured) debentures, which are discharged ratably, though issued at different dates, are called debentures with pari pasu clause.

Advantages of debentures

The following are the advantages of debentures:

1. Secured investments

Debentures provide greatest security to the investors. They make a very good appeal to the conservative minds.

2. Fixed return

Debentures guarantee a fixed rate of interest.

3. Stable prices

Their prices are more stable as compared to shares because the changing monetary conditions affect the price movement of the debentures very little.

4. Non-interference in management

The debenture holders do not interfere in the management of the company.

5. Economical

It is a cheaper method of raising finance. Lower rate of interest further makes them more economical.

6. Availability of funds

The companies can raise money through debentures easily compared to equity and preference shares.

7. Regular source of income

The investors get fixed and regular interest, whether the company earns profit or not.

Disadvantages of debentures

The following are the limitations of Debentures.

1. Permanent burden of interest

Interest on debentures is always cumulative. It is to be paid irrespective of the profits or otherwise of the company. During the period of depression, it becomes a heavy burden.

2. Limits company’s credit

Since in most of the cases, the assets of the company are mortgaged with the debenture holders as a security against their advances, the credit worthiness of the company falls in the eyes of the public as well as the banks. Borrowings from other sources becomes difficult.

3. No right to participate in company management

Ordinarily debenture holder do not enjoy any voting rights in the companies. They have no interest in the election of directors. They do not have representation in the management of the affairs of the companies.

Debenture Trust Deed

When a company issues mortgage debentures, it is a common practice to secure them by means of a Trust Deed conveying the company’s property to the trustees to be held in trust for the benefit of the debenture holders.

The trust deed contains the conditions governing the rights of the debenture holders and the relationship between them and the company. The trustees hold the property in trust for the debenture holders and safeguard their interests. Besides, they are also vested with requisite powers to appoint а nominee director on the Board.

The trustees must act diligently and honestly in the discharge of their duties. Any clause in the trust deed, which, exempts them from liability for breach of their duty as trustees, is void.