Companies Act Section 71

Companies Act Section 71: Debentures

Overview of Section 71

Section 71 of the Companies Act provides a comprehensive framework for the issuance and management of debentures by companies. Debentures are a critical source of long-term financing for companies, allowing them to raise capital without diluting ownership. 

This section outlines the conditions and procedures for issuing debentures, including provisions for conversion to shares, the establishment of a debenture redemption reserve, and the responsibilities of debenture trustees. The aim is to ensure the protection of debenture holders' interests and maintain the integrity of corporate financing practices.

Key Provisions of Section 71

1. Issuance of Debentures with Conversion Options

Option to Convert: 

A company is permitted to issue debentures that come with an option for conversion into shares, either wholly or partially, at the time of redemption. This feature provides flexibility to both the issuing company and the debenture holders, allowing for a potential equity stake in the company.  

Special Resolution Requirement: 

Importantly, the issuance of debentures with conversion options must receive approval through a special resolution passed at a general meeting of the company. This provision ensures that shareholders are informed and have a say in significant financing decisions that may affect the company's capital structure.

2. Restrictions on Voting Rights

No Voting Rights: 

Under this section, companies are explicitly prohibited from issuing debentures that carry any voting rights. This restriction is designed to maintain a clear distinction between debt and equity holders, ensuring that debenture holders do not have influence over corporate governance decisions, which are reserved for equity shareholders.

3. Secured Debentures

Issuance Terms: 

Companies are allowed to issue secured debentures, subject to terms and conditions that may be prescribed by regulatory authorities. Secured debentures are backed by collateral, which offers additional protection to debenture holders in the event of a default.

4. Creation of Debenture Redemption Reserve

Redemption Reserve Account: 

When debentures are issued, companies are required to create a debenture redemption reserve account using profits available for the payment of dividends. This reserve is a safety net to ensure that funds are set aside for the future redemption of debentures, thereby protecting the interests of debenture holders.

Utilization of the Reserve: 

The amount credited to the debenture redemption reserve account is strictly designated for the redemption of debentures and cannot be utilized for any other purpose. This provision ensures that the company prioritizes its obligations to debenture holders.

5. Appointment of Debenture Trustees

Mandatory Appointment: 

Companies intending to issue debentures to the public or to more than five hundred members must appoint one or more debenture trustees prior to making any offer or invitation. This requirement enhances accountability and oversight in the issuance process.

Conditions for Appointment: 

The conditions governing the appointment of debenture trustees are to be prescribed by relevant authorities, ensuring that trustees are qualified and capable of safeguarding the interests of debenture holders.

6. Responsibilities of Debenture Trustees

Protection of Interests: 

Debenture trustees are tasked with taking steps to protect the interests of debenture holders and address any grievances that may arise. They serve as intermediaries between the company and the debenture holders, ensuring compliance with the terms of the debenture issuance.

7. Indemnity and Trustee Liability

Limitations on Exemptions: 

Any provision within a trust deed or contract with debenture holders that seeks to exempt a trustee from liability for breach of trust, or that indemnifies them against such liabilities, is considered void if it fails to meet the required standard of care and diligence. 

Exemptions by Majority Agreement: 

However, the liability of a debenture trustee may be subject to certain exemptions if agreed upon by a majority of debenture holders holding at least three-fourths in value of the total debentures during a meeting convened for this purpose.

8. Payment of Interest and Redemption

Compliance with Terms: 

Companies are obligated to pay interest and redeem the debentures in accordance with the specific terms and conditions set forth at the time of issuance. Adhering to these obligations is crucial for maintaining trust and credibility with debenture holders.

9. Actions in Case of Insufficient Assets

Petition to the Tribunal: 

If a debenture trustee determines that the company’s assets are insufficient or are likely to become insufficient to meet the principal repayment obligations, they have the right to file a petition with the Tribunal. 

The Tribunal may then impose restrictions on the company’s ability to incur further liabilities to protect the interests of the debenture holders.

10. Consequences of Default

Default on Redemption or Interest Payments: 

Should a company fail to redeem its debentures upon maturity or neglect to pay interest when due, the Tribunal can, upon application by the debenture holders or the debenture trustee, issue an order requiring the company to redeem the debentures and pay any outstanding principal and interest.

11. Enforcement of Contracts for Debentures

Specific Performance: 

Contracts between individuals and the company to subscribe for debentures may be enforced by a decree for specific performance, ensuring that parties adhere to their commitments.

12. Regulatory Authority

Central Government Regulations: 

The Central Government is empowered to prescribe procedures regarding the issuance of debentures, including the form of the debenture trust deed, the rights of debenture holders to inspect and obtain copies of trust deeds, and the required amount for the debenture redemption reserve. These regulations aim to ensure transparency and accountability in the management of debentures.