Debentures and the Power to Nominate

No voting rights: section 71(2)

No company shall issue any debentures carrying any voting rights.

Absolute, with no proviso and no exception. It is the clearest statement in the Act of the difference between ownership and lending.

Secured debentures and the reserve: section 71(3) and (4)

Section 71(3). Secured debentures may be issued by a company subject to such terms and conditions as may be prescribed.

Where a debenture is secured on the company's assets it creates a charge, which must be registered under section 77. That is Module II territory.

Section 71(4): the debenture redemption reserve. Where debentures are issued under this section, the company shall create a debenture redemption reserve account out of the profits of the company available for payment of dividend, and the amount credited to that account shall not be utilised by the company except for the redemption of debentures.

Two features. The reserve comes out of distributable profits, so shareholders give up dividend to fund it. And it is ring-fenced: it may be used for nothing but redemption. Section 71(13) lets the Central Government prescribe the quantum of the reserve.

Debenture trustees: section 71(5), (6) and (7)

Section 71(5): when a trustee is compulsory. No company shall issue a prospectus or make an offer or invitation to the public or to its members exceeding five hundred for the subscription of its debentures, unless the company has, before such issue or offer, appointed one or more debenture trustees, on prescribed conditions.

The trigger is two-limbed: a prospectus or public offer, or an offer or invitation to more than five hundred members. Below that, no trustee is compelled.

Section 71(6): what the trustee does. A debenture trustee shall take steps to protect the interests of the debenture-holders and redress their grievances in accordance with the prescribed rules.

Section 71(7): the trustee cannot contract out of care. Any provision in a trust deed securing the issue of debentures, or in any contract with the debenture-holders secured by a trust deed, shall be void in so far as it would have the effect of exempting a trustee from, or indemnifying him against, any liability for breach of trust where he fails to show the degree of care and due diligence required of him as a trustee, having regard to the provisions of the trust deed conferring on him any power, authority or discretion.

The proviso allows a collective relaxation: the trustee's liability shall be subject to such exemptions as may be agreed upon by a majority of debenture-holders holding not less than three fourths in value of the total debentures at a meeting held for the purpose.

So the protection cannot be signed away by the company in the trust deed, but it can be relaxed by the holders themselves, by a three fourths value majority at a meeting.

Payment, and the Tribunal: section 71(8), (9) and (10)

Section 71(8). A company shall pay interest and redeem the debentures in accordance with the terms and conditions of their issue.

Section 71(9): the early warning power. Where at any time the debenture trustee comes to the conclusion that the assets of the company are insufficient, or are likely to become insufficient, to discharge the principal amount as and when it becomes due, the trustee may file a petition before the Tribunal, and the Tribunal may, after hearing the company and any other interested person, by order impose such restrictions on the incurring of any further liabilities by the company as it may consider necessary in the interests of the debenture-holders.

This is preventive, and it is unusual. The trustee does not have to wait for a default. He acts on the likelihood of one, and the Tribunal's remedy is to stop the company taking on more debt.

Section 71(10): the remedy after default. Where a company fails to redeem the debentures on the date of their maturity, or fails to pay interest when it is due, the Tribunal may, on the application of any or all of the debenture-holders, or of the debenture trustee, and after hearing the parties, direct by order that the company redeem the debentures forthwith on payment of principal and interest due.

Sub-section (11) was omitted by the Companies (Amendment) Act 2020 with effect from 21 December 2020, as part of the decriminalisation of the Act.

Specific performance, and rules: section 71(12) and (13)

Section 71(12). A contract with the company to take up and pay for any debentures of the company may be enforced by a decree for specific performance.

This is a real exception to the ordinary law. A contract to lend money is not usually specifically enforceable, because damages are an adequate remedy. Section 71(12) makes an agreement to subscribe for debentures enforceable in specie, which matters when a company is relying on a committed subscription.

Section 71(13). The Central Government may prescribe the procedure for securing the issue of debentures, the form of the debenture trust deed, the procedure for holders to inspect the trust deed and obtain copies, the quantum of the debenture redemption reserve required to be created, and such other matters.

The power to nominate: section 72

Section 72(1): the basic power. Every holder of securities of a company may, at any time, nominate, in the prescribed manner, any person to whom his securities shall vest in the event of his death.

Note "every holder of securities", so it covers shares and debentures alike, and "at any time".

Section 72(2): joint holders. Where securities are held by more than one person jointly, the joint holders may together nominate any person to whom all the rights shall vest in the event of death of all the joint holders.

So a nomination by joint holders operates only when all of them have died. While one survives, the ordinary rules of joint holding apply.

Section 72(3): the nomination overrides a will. Notwithstanding anything contained in any other law for the time being in force, or in any disposition, whether testamentary or otherwise, in respect of the securities, where a nomination made in the prescribed manner purports to confer on a person the right to vest the securities, the nominee shall, on the death of the holder or of all the joint holders, become entitled to all the rights in the securities to the exclusion of all other persons, unless the nomination is varied or cancelled in the prescribed manner.

This is the sub-section that is examined. A validly made nomination prevails over a will and over the general law, and the nominee takes to the exclusion of all other persons. The only escape is that the nomination is varied or cancelled in the prescribed manner.

Section 72(4): a minor nominee. Where the nominee is a minor, it is lawful for the holder making the nomination to appoint, in the prescribed manner, any person to become entitled to the securities in the event of the holder's death during the minority of the nominee.

A worked example

Bhandara Steel Limited raises forty crore rupees by issuing debentures to the public.

Convertibility. It wants the debentures convertible into equity at redemption. Under the proviso to section 71(1) that needs a special resolution at a general meeting. Having passed it before the issue, the later conversion is also outside the pre-emption rules by section 62(3).

Votes. A large subscriber asks for one vote per debenture. Section 71(2) forbids it absolutely. No resolution can grant it.

Security. The debentures are secured on the company's plant. They are secured debentures under section 71(3), and the charge must be registered under section 77.

The reserve. Under section 71(4) the company must create a debenture redemption reserve account out of profits available for payment of dividend, and may use that money for nothing but redemption. The quantum is as prescribed under section 71(13).

Trustees. Because the company is issuing a prospectus to the public, section 71(5) requires it to appoint one or more debenture trustees before the issue. The trustee's duty under section 71(6) is to protect the holders' interests and redress their grievances.

A clause in the trust deed says the trustee shall not be liable for any loss however caused. To the extent it exempts him from liability for breach of trust where he fails to show the required degree of care and due diligence, it is void under section 71(7). The holders themselves could relax his liability, but only by a three fourths in value majority at a meeting.

Trouble. Two years later the trustee concludes that the company's assets are likely to become insufficient to meet the principal at maturity. He does not wait for a default. He petitions the Tribunal under section 71(9), and the Tribunal, after hearing the company, may restrict the company from incurring further liabilities.

Default. The company then misses an interest payment. Under section 71(10) any or all of the debenture-holders, or the trustee, may apply to the Tribunal, which may direct the company to redeem the debentures forthwith on payment of principal and interest due.

A committed subscriber refuses to pay. An institution that contracted to take five crore rupees of the debentures walks away. Under section 71(12) the contract may be enforced by a decree for specific performance.

Nomination. Mr Fernandes holds ten thousand of the debentures and two thousand equity shares. He nominates his sister under section 72(1), in the prescribed manner. His will leaves everything to his son.

On his death the sister takes the securities, because section 72(3) gives the nominee all the rights notwithstanding any testamentary disposition and to the exclusion of all other persons, unless the nomination was varied or cancelled in the prescribed manner. Had the securities been held jointly by Mr Fernandes and his wife with a joint nomination, it would have operated only on the death of both: section 72(2). And had the nominee been a minor, he could have appointed under section 72(4) a person to become entitled if he died during the nominee's minority.

Distinctions that carry marks

What this does NOT mean

It does not mean every debenture issue needs a trustee. Only an issue by prospectus or public offer, or an offer or invitation to members exceeding five hundred: section 71(5).

It does not mean a debenture can be given a vote by agreement. Section 71(2) is absolute.

It does not mean the debenture redemption reserve is available capital. Section 71(4) ring-fences it for redemption alone.

It does not mean a nomination is a will. It overrides a will under section 72(3), and it is varied or cancelled only in the prescribed manner.

Quick revision

• 2(30): a debenture includes debenture stock, bonds or any other instrument evidencing a debt, whether or not constituting a charge on assets.
• 71(1): convertible debentures, wholly or partly, at redemption; special resolution required.
• 71(2): no voting rights, absolutely.
• 71(3): secured debentures on prescribed terms. 71(4): debenture redemption reserve out of profits available for dividend, usable only for redemption.
• 71(5): debenture trustees before any prospectus or public offer, or offer or invitation to members exceeding five hundred.
• 71(6): trustee protects interests and redresses grievances. 71(7): an exemption or indemnity for failure to show due care and diligence is void; the holders may relax it by three fourths in value at a meeting.
• 71(8): pay interest and redeem per the terms. 71(9): trustee may petition the Tribunal where assets are or are likely to become insufficient, and the Tribunal may restrict further liabilities. 71(10): on failure to redeem or pay interest, the Tribunal may order redemption forthwith. Sub-section (11) omitted w.e.f. 21 December 2020.
• 71(12): a contract to take up and pay for debentures is enforceable by specific performance. 71(13): Central Government may prescribe procedure, the trust deed form, inspection, and the quantum of the reserve.
• 72(1): every holder of securities may nominate at any time. 72(2): joint holders nominate together, operating on the death of all. 72(3): the nominee takes notwithstanding any testamentary disposition and to the exclusion of all other persons, unless varied or cancelled. 72(4): a person may be appointed where the nominee is a minor.

Test yourself

1. Define a debenture and state whether it can carry a vote. Section 2(30) defines a debenture to include debenture stock, bonds or any other instrument of a company evidencing a debt, whether or not constituting a charge on the assets of the company. No company shall issue any debentures carrying any voting rights: section 71(2).

2. What is required to issue convertible debentures? A special resolution passed at a general meeting: proviso to section 71(1). The debentures may be convertible wholly or partly into shares at the time of redemption.

3. What is the debenture redemption reserve, and out of what is it created? An account created under section 71(4) out of the profits of the company available for payment of dividend, the amount credited to which shall not be utilised except for the redemption of debentures. Its quantum may be prescribed by the Central Government under section 71(13).

4. When must a company appoint debenture trustees? Before issuing a prospectus, or making an offer or invitation to the public, or to its members exceeding five hundred, for the subscription of its debentures: section 71(5).

5. What may the Tribunal do before any default has occurred? On a petition by the debenture trustee, who has concluded that the assets of the company are insufficient or likely to become insufficient to discharge the principal when due, the Tribunal may, after hearing the company and any interested person, impose restrictions on the incurring of further liabilities in the interests of the debenture-holders: section 71(9).

6. A shareholder nominates his brother and later leaves his shares to his daughter by will. Who takes? The brother. Section 72(3) provides that, notwithstanding any other law and any disposition, testamentary or otherwise, the nominee becomes entitled to all the rights in the securities to the exclusion of all other persons, unless the nomination is varied or cancelled in the prescribed manner.