Bonds and Debentures

Definition of Debentures

A company may not with to possess itself of the use of more share capital or ownership securities, and yet desire more available money. It may invite persons to kind their money as a loan, instead of contributing it as a part of the capital.

Money so lent must also be recorded and acknowledged. The document which the lender receives is called a debenture. The holder of this debenture is a creditor of the company, while the shareholder is one of the proprietors of the capital of the company and so responsible for its liabilities. The debenture holder is one of the liabilities for which the shareholder is responsible. Thus a company in order to secure long-term finance for initial needs and more often for extensions and developments to supplement its capital may issue debentures or “creditorship securities”. In fact in every country, debenture issue is one of the important methods of raising finance.

The Companies Act does not give a satisfactory definition of a debenture. Section 2 (12) only provides: “Debenture includes debenture stock, bonds and other securities of a company, whether constituting a charge on the assets of the company or not,” which tells us hardly anything about it. But it is usually (not always) issued under common seal, secured by a fixed or flowing charge on the assets of the company, and subject to payment of interest on specified dates, a debenture may be defined as an instrument executed by a company under its common seal acknowledging indebtedness to some person or persons to secure the sum advanced. Debentures are usually bonds issued by a company in a series of a fixed denomination, e.g., Rs. 100, Rs. 500, Rs. 1,000 face value and are offered to the public by means of prospectus. The term and conditions on which they are issued are endorsed on the back of the bond which gives different rights to the holders. One of the conditions usually is that the debenture is of a series of a certain number, and that all the debentures or series rank are passu, i.e., all the debentures of one series are to be paid so that, if there is not enough to go round, they shall all abate proportionally. If the words pair passu are not used, the debentures will be payable according to the date of issue, or if they are all issued on the same day, they will be payable according to their numerical order. The company cannot create new series to rank pari passu with the old series, unless the power to do so is expressly reserved or contained in the dentures of the prior series. A company may have a debenture stock, which is nothing but borrowed money consolidated into one mass for the sake of convenience. Instead of each lender having a separate mortgage, he has a certificate entitling him to a certain sum, being a portion of one large loan. Generally, debenture stock differs from a debenture in form rater than n substance. It is sometimes in the nature of a permanent loan, and is generally secured by a trust deed by which property is mortgaged to the trustee for the holder of debenture stock.

Types of Debentures

Debentures can be classified into different types on the basis of the terms and conditions of issue. Bearer debentures are payable to the bearer and are transferable by mere delivery.  They are negotiable instruments.  Interest coupons are payable to the bearer and are transferable by mere delivery.  They are negotiable instruments. Interest coupons are attached to them and interest is payable to the holder of the coupons. Registered debentures are payable to registered holders and their transfer is to be registered with company. Naked debentures are issued with merely a promise of payment, without any security for payment of interest or capital. Secured debentures are payable to the registered holder or to the registered holder or to the bearer but they are issued with a charge on the undertaking and assets of the company as security. They are sometimes called mortgaged debentures or bonds. The charge on debentures may be fixed or floating. Debentures secured by deposit of title deeds property with a memorandum in writing creating a charge on it are called equitable. Where the legal ownership of the property of the company is transferred by a deed to the debenture-holders a security for loan, the debentures are called legal debentures. Debentures, redeemable when payment of the principal is provided for on a specified date or on notice or on demand, or they are irredeemable or perpetual when no time is fixed within which the comp nay is bound to redeem them, and the debenture holders cannot demand payment as long as the company is a going concern. In India, mainly redeemable debentures are issued, as, contrary to the general belief that Indian investors go in for securities that appreciate in value, they look for security offered. In the case of irredeemable debentures the investor cannot be sure that the financial position of the concern is entirely above suspicion, while in the case of redeemable debentures interests are protected. Redeemable debentures are that subject to depreciation on account of depression or with the changes in the money market. In some cases they can be withdrawn before maturity and provision is generally made for that repayment of debenture loans out of a ‘sinking’ or ‘amortization’ fund, specially created for this purpose.

Merits of Debenture Issues

Debentures as the source of capital have many advantages. From the point of view of the investor, they offer greater security than preference shares and other securities. For example, a mortgage debenture-holder knows exactly what his security is, and generally, there are trustees to protect his interests. From the standpoint of the enterprise, debentures are particularly useful of the development of smaller organized industries. When the security offered is good, debentures are favored by the individual as well as the institutional investors. They are indeed meant for cautious investors, for there is generally a clause in the terms of a debenture issue which prevents the interest of the debenture-holder being jeopardized. But successful issue of debentures by a company depends on the nature of security offered by it. The better the security, the greater will be the chance of successful debenture issue.