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Issue of Unsecured convertible debentures by private co.

Karandeep Makkar (Student) (57 Points)

29 January 2011

Can a private company issue unsecured compulsorily convertible debentures? Please quote relevant sections of law.

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cs ashwini kumar (Company Secretary in Practice) (173 Points)
Replied 29 January 2011

Hi,

Issue of unsecured Debenture (convertible or not) shall be regarded as "Deposit" as per Rule 2(b) of The Companies (Acceptance of Deposits) Rules, 1975. A private Company can't accept deposit pursuant to provisions of Section 3(1)(iii) of the Companies Act, 1956 and as per restriction in the AOA. However, any deposit taken from the Directors, Directors Relatives and member of a private Company may be permissible as the same is exempted from the definition of the term "Deposit".

Regards

CS Ashwini Kumar

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Karandeep Makkar (Student) (57 Points)
Replied 29 January 2011

Companies (Acceptance of Deposits) Rules, 1975

2 (b) "deposit" means any deposit of money with, and includes any amount borrowed by, a company, but does not include-

"(x) any amount raised by the issue of bonds or debentures secured by the mortgage of any immovable property of the company or with an option to convert them into shares in the company provided that in the case of such bonds or debentures secured by the mortgage of any immovable property the amount of such bonds or debentures shall not exceed the market value of such immovable property"

The use of the word 'or' shows that convertible debentures are excluded from definition of deposits.

Please explain this.

Karandeep Makkar (Student) (57 Points)
Replied 29 January 2011

Companies (Acceptance of Deposits) Rules, 1975

2 (b) "deposit" means any deposit of money with, and includes any amount borrowed by, a company, but does not include-

The use of the word 'or' shows that convertible debentures are excluded from definition of deposits.

Please explain this.

Attached File : 26 caodr1975.pdf downloaded: 501 times

cs ashwini kumar (Company Secretary in Practice) (173 Points)
Replied 29 January 2011

Dear Mr. Makkar,

Thanks for the point you have raised and accordingly I have gone through the explanation given in the book of Chandratre and Ghosh, the same is reproduced for the benefit of all other professional:

Money raised by debentures/bonds. According to sub-clause (x) of rule 2(b) any amount raised by the issue of bonds or debentures secured by the mortgage of any immovable property of the company or with an option to convert them into shares in the company provided that in the case of the bonds or debentures secured by the mortgage of any immovable property, the amount of such bonds or debentures shall not exceed the market value of such immovable property.

This sub-clause seeks to exempt the amounts raised by the issue of two kinds of bonds or debentures; (i) bonds or debentures secured by mortgage of immovable property of the company; (ii) bonds or debentures (whether secured or unsecured) which are convertible into shares. In the case of the first kind of bonds and debentures, the exemption would be available only if the amount of bonds or debentures is less than or equal to the market value of the immovable property which is mortgaged to secure the bonds or debentures.

On the question whether unsecured debentures with an option to convert a part of them into shares, that is to say, unsecured partly convertible debentures, fall within the exemption provided for in sub-clause (x), or not, the Government had clarified that such debentures were not covered under sub-clause (x).[35] However, in the subsequent circular the Government has clarified that "only the convertible portion of the debentures is exempt in terms of the provision of rule 2(b)(x)".[36] In the earlier of the two circulars referred above, the Government had clarified that "only so long as option to convert unsecured debentures into shares remains in force such unsecured debentures shall not be subject to discipline of section 58A of the Companies Act, 1956 and the rules made thereunder". This point has been further clarified in the latter circular thus: " ....... in regard to the convertible portion of debentures, once the period of conversion is over, the unconverted portion of debentures would acquire a character of loan and would fall within the definition of deposits like other loans provided they are not secured by mortgage of immovable property of the company in terms of clause (x) of rule 2(b) of the Deposit Rules. Similarly, where the period for the exercise of option for conversion has expired, the convertible portion of the debentures in respect of which no option has been exercised for conversion by the debenture holders, will acquire the character of loan and will fall within the purview of deposits as defined in the Companies (Acceptance of Deposits) Rules, if these debentures are not secured in the manner mentioned above".[37]

best regards

CS Ashwini Kumar

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