CS Executive · Company Law and Practice

Debt Instruments - Concepts: formula sheet

Full chapter guide

Key formulas

Definition of debenture: Debenture = debenture stock + bonds + any other instrument of a company evidencing a debt (charge on assets or not); Section 2(30). The word "includes" makes the definition inclusive, not exhaustive.
Exclusions from debenture: Not a debenture: (a) instruments under Chapter III-D of the RBI Act, 1934; (b) other instruments prescribed by the Central Government in consultation with the RBI; Proviso to Section 2(30). Do not forget it in a full definition answer.
Debenture holder's status: Debenture holder = creditor; shareholder = member (owner); Interest is a debt payable even without profit; dividend is paid out of profits as decided by the company.
Meaning of share: Share = a share in the share capital of a company, and includes stock; Section 2(84). Use it as the starting point for the contrast.
Meaning of member: Member = subscriber to the memorandum, a person who agrees in writing and is entered in the register, or a person holding shares who is a beneficial owner in a depository's records; Section 2(55). A debenture holder does not appear here merely by holding debentures.
Classification by security: Secured = charge on assets; Unsecured = no charge; A secured debenture holder can enforce the charge. An unsecured holder is an ordinary creditor.
Classification by convertibility: Convertible = may become shares; Non-convertible = stays debt; Convertible may be fully or partly convertible. The terms are fixed at issue.
Classification by redemption: Redeemable = repayable on a date; Irredeemable = no fixed date; Irredeemable is also called perpetual.
Classification by registration: Registered = name in register, transfer by instrument; Bearer = payable to holder, transfer by delivery; Say clearly how each is transferred.
Classification by priority: First debentures paid before second debentures from the same security; Priority between classes follows their terms of issue.
Workmen's portion of security (section 326): Workmen's portion = Value of security × Workmen's dues ÷ (Workmen's dues + Secured creditor's debts); Illustration in section 326: ₹1,00,000 × 1,00,000 ÷ 4,00,000 = ₹25,000.
Winding up priority (section 326(1)): Workmen's dues, and the secured creditor's shortfall or workmen's portion (whichever is less) pari passu, rank ahead of other debts; Rule applies where a secured creditor has realised the secured asset.
Voting rights: Debentures with voting rights: not allowed; Section 71(2). Debenture-holders are creditors, so no company can give debentures voting rights.
Convertible debentures: Option to convert into shares (wholly or partly) at redemption → special resolution at a general meeting; Section 71(1) and its proviso.
Trustee requirement: Public offer, or offer to more than 500 members → appoint one or more debenture trustees before the issue; Section 71(5). The word is 'exceeding five hundred', so exactly 500 is not covered.
Debenture redemption reserve: DRR created out of profits available for dividend; use only for redemption of debentures; Section 71(4). The quantum is as prescribed under Section 71(13).
Trustee exemption clauses: Clause exempting or indemnifying a trustee for breach of trust (no due care shown) → void; Section 71(7). Proviso: exemptions may be agreed by holders of at least three-fourths in value of debentures at a meeting held for the purpose.
Specific performance: Contract to take up and pay for debentures → enforceable by decree of specific performance; Section 71(12).
Who may hold special rights: Producers who are active Members + provision in the articles → special rights; Both conditions are needed. Without a provision in the articles, the company cannot give these rights under the section.
Issue of instruments (section 378ZC(1)): Producer Company may issue appropriate instruments in respect of the special rights; The word is "may". Issue is permitted, not compulsory.
Transfer of instruments (section 378ZC(2)): Board approval + transferee is another active Member of the same Producer Company; Transfer to a non-member or to a member who is not active is not allowed under this section.
Meaning of special right (Explanation): Special right = right relating to supply of additional produce by the active Member, or any other right relating to his produce conferred by the Board; Learn this wording. It shows the right concerns produce.
Voting contrast (section 378Z): One Member, one vote; casting vote to the Chairman or person presiding on a tie, except in the election of the Chairman; Special user rights do not change this. They are not extra voting rights.

Quick revision

A debenture is a debt of the company. The holder is a creditor, not a member.
Section 71(1): convertible debentures need a special resolution passed at a general meeting.
Section 71(2): no company can issue debentures carrying voting rights.
Section 71(3): secured debentures can be issued on prescribed terms and conditions.
Section 71(4): the company creates a debenture redemption reserve out of profits available for dividend, and uses it only to redeem debentures. The quantum is as prescribed.
Section 71(5): a debenture trustee must be appointed before an offer to the public, or to more than five hundred members, for subscription of debentures.
Section 71(6): the trustee protects the interests of debenture-holders and redresses their grievances.
Section 71(8): the company must pay interest and redeem as per the terms of issue.
Section 71(9) and (10): the trustee or holders can go to the Tribunal over insufficient assets or failure to redeem or pay interest.
Section 71(12): a contract to take up and pay for debentures can be enforced by specific performance.
Section 62(3): a conversion option approved by special resolution before issue needs no rights offer under Section 62.
Section 378ZC: active members of a Producer Company may have special rights if the articles provide for them. The instruments are transferable to another active member after Board approval.

Common mistakes

Saying a debenture must always be secured by a charge on assets. Fix: Quote the words "whether constituting a charge on the assets of the company or not" from Section 2(30). Unsecured debentures are also debentures.
Calling a debenture holder a member or part-owner of the company. Fix: A debenture holder is a creditor. Section 2(55) defines member by reference to the memorandum, the register of members or depository records of shareholding. Debenture holding is not shown there.
Treating debenture holders as members with voting rights. Fix: Write that the holder is a creditor and gets interest. Conversion into shares makes him a member only after conversion.
Saying a convertible debenture is the same as a share. Fix: State that it is debt until conversion on the terms of issue.
Saying debentures can carry voting rights if the articles allow it. Fix: Remember Section 71(2): no company shall issue debentures carrying voting rights. Articles cannot override it.
Saying a trustee is needed for every debenture issue. Fix: Section 71(5) applies to a prospectus, a public offer, or an offer to members exceeding 500. Quote the trigger.
Treating section 378ZC as a provision on debentures or debt instruments. Fix: Remember the section covers Producer Companies and rights relating to produce. Mention that the instruments only evidence special rights.
Saying any Member can get special rights. Fix: Write "producers who are active Members" every time.

Exam tips

Always quote Section 2(30) with the proviso. Examiners expect the section number and the key words 'evidencing a debt'.
For 'difference between shares and debentures', give 6 to 8 points on a clear basis: status, return, voting, repayment, security, risk, conversion.
Use a short example with rupee figures to show interest versus dividend. It makes the answer concrete.
Do not state section numbers you are unsure of. Use Section 2(30), 2(84) and 2(55) from the definitions and describe other rules in plain words.
Finish case-based answers with a one-line conclusion stating whether the person is a creditor or a member.
Answer 'classify' questions with the five bases as headings. This shows structure and earns marks quickly.
For 'distinguish' questions, give points of difference side by side in sentences: meaning, security or transfer, rights, example.
Use the precise words: creditor, charge, conversion, redemption, bearer. Avoid vague terms like 'safe' or 'risky'.