Redemption of Debentures

  • By ReamKoncept
  • 26 May, 2023
Redemption of Debentures

Redemption of Debentures

Table of Content

A debenture is an instrument issued by a company under its seal, acknowledging a debt and containing provisions as regards repayment of the principal and interest.

Under Section 71 (1) of the Companies Act, 2013, a company may issue debentures with an option to convert such debentures into shares, either wholly or partly at the time of redemption.
 
Provided that the issue of debentures with an option to convert such debentures into shares, wholly or partly, should be approved by a special resolution passed at a duly convened general meeting.

Section 71 (2) further provides that no company can issue any debentures which carry any voting rights.

Section 71 (4) provides that where debentures are issued by a company, the company should create a debenture redemption reserve account out of the profits of the company available for payment of dividend and the amount credited to such account should not be utilized by the company for any purpose other than the redemption of debentures.

Basic provisions

If a charge has been created on any asset or the entire assets of the company,
  • the nature of the charge
  • the asset(s) charged
are described therein.
  • Since the charge is not valid unless registered with the Registrar, his certificate registering the charge is printed on the bond.
  • It is also customary to create a trusteeship in favour of one or more persons in the case of mortgage debentures. The trustees of debenture holders have all powers of a mortgage of a property and can act in whatever manner they think necessary to safeguard the interest of debenture holders.
As per Rule 18(2) of the Companies (Share Capital and Debentures) Rules, 2014, the company shall appoint debenture trustees as required under sub-section (5) of section 71 of the Companies Act 2013, after complying with certain conditions mentioned in that rule.
 

2. REDEMPTION OF DEBENTURES

Debentures are usually redeemable i.e. either redeemed in cash or convertible after a time period.

Redeemable debentures may be redeemed:
  • after a fixed number of years; or
  • any time after a certain number of years has elapsed since their issue; or
  • on giving a specified notice; or
  • by annual drawing.
A company may also purchase its debentures, as and when convenient, in the open market. When the debentures are quoted at a discount on the Stock Exchange, it may be profitable for the company to purchase and cancel them.

As per Rule 18 (1) of the Companies (Share Capital and Debentures) Rules, 2014, a company shall not issue secured debentures, unless it complies with the following conditions, namely:

a. An issue of secured debentures may be made, provided the date of its redemption shall not exceed ten years from the date of issue:

Provided that the following classes of companies may issue secured debentures for a period exceeding ten years but not exceeding thirty years,
  1. Companies engaged in setting up of infrastructure projects;
  2. Infrastructure Finance Companies' as defined in clause (viia) of sub- direction (1) of direction 2 of Non-Banking Financial (Non-deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2007;
  3. Infrastructure Debt Fund Non-Banking Financial Companies' as defined in clause (b) of direction 3 of Infrastructure Debt Fund Non-Banking Financial Companies (Reserve Bank) Directions, 2011;
  4. Companies permitted by a Ministry or Department of the Central Government or by Reserve Bank of India or by the National Housing Bank or by any other statutory authority to issue debentures for a period exceeding ten years.
b. such an issue of debentures shall be secured by the creation of a charge on the properties or assets of the company or its subsidiaries or its holding company or its associates companies, having a value which is sufficient for the repayment of the amount due on debentures and interest thereon.

c. the company shall appoint a debenture trustee before the issue of prospectus or letter of offer for subscription of its debentures and not later than sixty days after the allotment of the debentures, execute a debenture trust deed to protect the interest of the debenture holders; and

d. the security for the debentures by way of a charge or mortgage shall be created in favour of the debenture trustee on-
  1. any specific movable property of the company or its holding company or subsidiaries or associate companies or otherwise.
  2. any specific immovable property wherever situate, or any interest therein:
    Provided that in case of a non-banking financial company, the charge or mortgage under sub-clause (i) may be created on any movable property.
Provided further that in case of any issue of debentures by a Government company which is fully secured by the guarantee given by the Central Government or one or more State Government or by both, the requirement for creation of charge under this sub-rule shall not apply.

Provided also that in case of any loan taken by a subsidiary company from any bank or financial institution the charge or mortgage under this sub-rule may also be created on the properties or assets of the holding company.


3. DEBENTURE REDEMPTION RESERVE

A company issuing debentures may be required to create a debenture redemption reserve account out of the profits available for distribution of dividend and amounts credited to such account cannot be utilised by the company for any other purpose except for redemption of debentures. Such an arrangement would ensure that the company will have sufficient liquid funds for the redemption of debentures at the time they fall due for payment.

An appropriate amount is transferred from profits every year to Debenture Redemption Reserve and its investment is termed as Debenture Redemption Reserve Investment (or Debenture Redemption Fund). In the last year or at the time of redemption of debentures, Debenture Redemption Reserve Investments are encashed and the amount so obtained is used for the redemption of debentures.

REQUIREMENT TO CREATE DEBENTURE REDEMPTION RESERVE

Section 71 of the Companies Act 2013 covers the requirement of creating a debenture redemption reserve account. Section 71 states as follows:
  1. Where a company issues debentures under this section, it should create a debenture redemption reserve account out of its profits which are available for distribution of dividend every year until such debentures are redeemed.
  2. The amounts credited to the debenture redemption reserve should not be utilised by the company for any purpose except for the purpose aforesaid.
  3. The company should pay interest and redeem the debentures in accordance with the terms and conditions of their issue.
  4. Where a company fails to redeem the debentures on the date of maturity or fails to pay the interest on debentures when they fall due, the Tribunal may, on the application of any or all the holders of debentures or debenture trustee and, after hearing the parties concerned, direct, by order, the company to redeem the debentures forthwith by the payment of principal and interest due thereon.
BALANCE IN DEBENTURE REDEMPTION RESERVE (DRR)

When the company decides to establish the Debenture Redemption Reserve Account, the amount indicated by the Debenture Redemption Reserves tables is credited to the Debenture Redemption Reserve account and debited to profit and loss account. That shows the intention of the company to set aside sum of money to build up a fund for redeeming debentures. Immediately, the company should also purchase outside investments. The entry for the purpose naturally will be to debit Debenture Redemption Reserve Investments and credit Bank.

If the debentures are purchased within the interest period, the price would be inclusive of interest provided these are purchased “Cum-interest”; but if purchased “Ex-interest”, the interest to the date of purchase would be payable to the seller additionally. In order to adjust the effect thereof the amount of interest accrued till the date of purchase, if paid, is debited to the Interest Account against which the interest for the whole period will be credited. As a result, the balance in the account would be left equal to the interest for the period for which the debentures were held by the company.
 
ADEQUACY OF DEBENTURE REDEMPTION RESERVE (DRR)

As per Rule 18 (7) of the Companies (Share Capital and Debentures) Amendment Rules, 2019, the company shall comply with the requirements with regard to Debenture Redemption Reserve (DRR) and investment or deposit of sum in respect of debentures maturing during the year ending on the 31st day of March of next year (refer para 3.4 below), in accordance with the conditions given below—
  1. the Debenture Redemption Reserve shall be created out of the profits of the company available for payment of dividend;
  2. the limits with respect to adequacy of DRR and investment or deposits, as the case may be, shall be as under:
S. No. Debentures issued by Adequacy of Debenture Redemption Reserve (DRR)
1 All India Financial Instittutions (AIFIs) regulated by Reserve Bank of India and Banking Companies for both public as well as privately placed debentures No DRR is required
2 Other Financial Institutions (FIs) within the meaning of clause (72) of section 2 of the Companies Act, 2013 DRR will be as applicable to NBFCs registered with RBI (as per (3) below)
3 For Listed Companie (other than AIFIs and Banking Companies as specified in Sr No. 1 above):
 
  1. All listed NBFCs (registered with Rbi under section 45-IA of the RBI Act,) and listed HFCs (Housing Finance Companies registered with National Housing Bank) for both public as well as privately placed debentures
  2. Otehr listed companies for both the public as well as privately placed debentures
 No DRR is required
4 For Unlisted Companie (other than AIFIs and Banking Companies as specified in Sr No. 1 above):
  a. All unlisted NBFCs (register with RBI under section 45-IA of the RBI (Amendment) Act, 1997) and unlisted HFCs (Housing Finance Compaies registered with National Housing Bank) for privately placed debentures No DRR is required
  b. Other unlisted companies DRR shall be 10% of the value of the outstanding debentures issued

INVESTMENT OF DEBENTURE REDEMPTION RESERVE (DRR) AMOUNT

Further, as per Rule 18 (7) of the Companies (Share Capital and Debentures)
Amendment Rules, 2019, following companies
  1. All listed NBFCs
  2. All listed HFCs
  3. All other listed companies (other than AIFIs, Banking Companies and Other FIs); and
  4. All unlisted companies which are not NBFCs and HFCs
shall on or before the 30th day of April in each year, in respect of debentures issued, deposit or invest, as the case may be, a sum which should not be less than 15% of the amount of its debentures maturing during the year ending on the 31st day of March of next year, in any one or more of the following methods, namely:
  1. in deposits with any scheduled bank, free from charge or lien;
  2. in unencumbered securities of the Central Government or of any State Government;
  3. in unencumbered securities mentioned in clauses (a) to (d) and (ee) of Section 20 of the Indian Trusts Act, 1882;
  4. in unencumbered bonds issued by any other company which is notified under clause (f) of Section 20 of the Indian Trusts Act, 1882.
The amount deposited or invested, as the case may be, above should not be utilised for any purpose other than for the redemption of debentures maturing during the year referred to above.
 
Provided that the amount remaining deposited or invested, as the case may be, shall not at any time fall below 15% of the amount of debentures maturing during the 31st day of March of that year.

In case of partly convertible debentures, DRR shall be created in respect of non- convertible portion of debenture issue in accordance with this sub-rule.

The amount credited to DRR shall not be utilised by the company except for the purpose of redemption of debentures.

Note: It should be noted that appropriation to DRR can be made any time before redemption and Investments in specified securities as mentioned above can be done before 30th April for the debentures maturing that year, however, for the sake of simplicity and ease, it is advisable to make the appropriation and investment immediately after the debentures are allotted assuming that the company has sufficient amount of profits (issued if allotment date is not given in the question). Also, in some cases, the date of allotment could be missing, in such cases the appropriation and investments should be done on the first day of that year for which ledgers accounts are to be drafted.

JOURNAL ENTRIES

The necessary journal entries passed in the books of a company are given below:

1. After allotment of debentures

(a) For setting aside the fixed amount of profit for redemption

Profit and Loss A/c Dr.
To Debenture Redemption Reserve A/c

(b) For investing the amount set aside for redemption

Debenture Redemption Reserve Investment A/c Dr.
To Bank A/c

(c) For receipt of interest on Debenture Redemption Reserve Investments

Bank A/c Dr.
To Interest on Debenture Redemption Reserve Investment A/c

(d) For transfer of interest on Debenture Redemption Reserve Investments (DRRI)
 
Interest on Debenture Redemption Reserve Investment A/c Dr.
To Profit and loss A/c

2. At the time of redemption of debentures

(a) For encashment of Debenture Redemption Reserve Investments

Bank A/c Dr.
To Debenture Redemption Reserve Investment A/c

(b) For amount due to debentureholders on redemption

Debentures A/c Dr.
To Debentureholders A/c

(c) For payment to debentureholders

Debentureholders A/c Dr.
To Bank A/c

(d) After redemption of debentures, DRR should be transferred to general reserve

DRR A/c Dr.
To General Reserve

Note: In case, the company purchases its own debentures in the market, additional set of accounting entries would be passed.


4. METHODS OF REDEMPTION OF DEBENTURES

Redemption of debentures must be done according to the terms of issue of debentures and any deviation therefrom will be treated as a default by the company.

Redemption by paying off the debt on account of debentures issued can be done in any one of the three methods viz:
 
BY PAYMENT IN LUMPSUM

Under payment in lumpsum method, at maturity or at the expiry of a specified period of debenture the payment of entire debenture is made in one lot or even before the expiry of the specified period.

BY PAYMENT IN INSTALMENTS

Under payment in instalments method, the payment of specified portion of debenture is made in instalments at specified intervals.

PURCHASE OF DEBENTURES IN OPEN MARKET

Debentures sometimes are purchased in open market. In such a case Own Debenture Account is debited and bank is credited.

Suppose a company has issued 8% debentures for ` 10,00,000, interest being payable on 31st March and 30th September every year. The company purchases ` 50,000 debentures at ` 96 on 1st August 20X1. This means that the company will have to pay ` 48,000 as principal plus ` 1,333 as interest for 4 months.

Own Debentures (50,000 x 96/ 100) Dr. 48,000  
Interest Account (50,000 x 8% x 4/12) Dr. 1,333  
To Bank  
49,333
 
 It should be noted that even though ` 50,000 debentures have been purchased for ` 48,000 there is no profit. On purchase of the debentures , profit does not arise; only on sale and in this case on cancellation of debentures, profit could arise.

These debentures may be cancelled on same date. The journal entries to be passed will be the following:

8% Debentures A/c Dr.
50,000
  
To Own Debentures A/c  
48,000
To Profit on cancellation of debentures  
2,000
(Cancellation of ` 50,000 Debentures)
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