“Debenture Trustee”- Position, Powers and Duties

About Ms. Ria Jaiswal

Ms. Ria Jaiswal is currently pursuing BBA LLB from KIIT School of Law, Bhubaneswar. Her articles have appeared in a number of e-journal sites and most of her articles focus on Corporate Law.

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Abstract

A debenture trustee is a person or an entity who is responsible for issuance and distribution of debentures and that serves as the holder of debenture stock for the benefit of another party. He shall play a role of a guardian to the debenture holders. The debenture trustee shall be unbiased and shall maintain the principle of independence in exercising his duties. If the company is issuing secured debentures or making an offer, or issues a prospectus for more than 500 subscriptions of its debentures, it must appoint one or more debenture trustee as per the conditions laid down in the Companies (Share Capital and Debentures) Rules, 2014. The company issuing a debenture also benefits from using a debenture trustee in that it only has to work with one person as opposed to the hundreds of investors who purchased its debentures. To protect the interest of the debenture holder, market regulator Securities and Exchange board of India (SEBI) has proposed few changes in the existing regulation for the debenture trustee (DT).

What is a debenture?

Debenture is the most common form of long term loan and debt instrument that is not secured by physical assets or collateral and is used by large companies to borrow money. They are normally repayable on a fixed date and at a fixed rate of interest, acknowledging a loan to the company. It is a type of debt certificate executed under the common seal of a company. Debentures are advantageous in that they do not result in dilution of interest of equity shareholders as they do not have right either to vote or take part in management of the company. There is no security of any charge on the shares but debentures are secured and bear a floating or a fixed charge over the company’s assets[1]. It is an important source of finance and most common method of raising funds for the company. The interest paid to the debenture holders is a charge against profit in the company’s financial statements. The basic difference between shares and debentures is that the shares represent ownership in a company and a debenture acknowledges loan or debt to a company. Interest on debenture is tax deductible expenditure and thus it saves income tax for the company. Debentures are issued to trade on equity but too much dependence on debentures increases the financial risk of the company[2]. Under the Companies Act 2013[3], debenture being a security, it can be issued by a private company only through the route of private placement. In India, Debenture Trustees are regulated by SEBI[4]. The SEBI (Debenture Trustees) Regulations, 1993 govern the debenture trustees, monitoring and review, registration, appointment, code of conduct and inspection of debenture trustees by SEBI, amongst other things. In India, the issuer pays to the debenture trustee.

Issue and Redemption of Debentures

Debentures are issued in 3 ways:

  1. At par- debentures are said to have been issued at par when the amount collected for it is equal to the nominal value of debentures.
  2. At premium- debentures are said to have been issued at premium when the amount collected for it is more than the nominal value of debentures.
  3. At discount- debentures are said to have been issued at discount when the amount collected for it is less than the nominal value of debentures.

Debentures are redeemed in 3 ways:

  1. Redeemable at par- when debentures are said to be redeemed at their face value they are said to be redeemable at par.
  2. Redeemable at a premium- when debentures are said to be redeemed at an amount higher than their face value, they are said to be redeemable at a premium.
  3. Redeemable at a discount- when debentures are said to be redeemed at an amount lower than their face value, they are said to be redeemable at a discount.

Different types of debenture[5]

Redeemable debentures: those debentures which are redeemed at a predetermined date and at predetermined price.

Irredeemable debentures: those debentures which are not redeemed during the lifetime of the company. They are also termed as Perpetual Debt.

Convertible debentures: are those debentures which carry an option to be converted into equity shares.

They are of various forms:

  1. Partly convertible debenture- there is an option to convert part of the debentures into equity shares at the option of the debenture holders.
  2. Fully convertible debenture- debentures which are fully converted into equity shares at the option of the debenture holders.
  3. Optionally convertible debenture- convertibility available at the option of debenture holders.

Non-Convertible debenture: they are the debentures without the convertibility feature attached to them; there is no option for its conversion into equity shares. They carry higher interest rates than their convertible counterparts and the debenture holders remain debenture holders till maturity.

Other forms:

  • Secured and Unsecured debentures
  • Registered and Unregistered debentures

 

Who is a debenture trustee?

A debenture trustee is a person or an entity who is responsible for issuance and distribution of debentures and that serves as the holder of debenture stock for the benefit of another party. According to SEBI Rules, 1993- “debenture trustee” means a trustee of a trust deed for securing any issue of debentures of a body corporate [section 2(bb)] (Applicable to public companies only). The trustee serves as the liaison between the company that issued the debentures, when debenture stock is issued to a large number of investors and the debenture holders that are collecting interest payments. The debenture trustee serves as the official representative for the debenture investors and is responsible for liquidating the collateral of the trust in the event the company defaults on its debentures.

Benefits of having a debenture trustee:

A professional trust company will have extensive experience with this form of investment structure and will know what information is needed from the issuing company in order to make an informed decision about the debenture investment. The trustee will also be able to determine if a company is in compliance with the terms and agreements set forth by the debenture offering. The company issuing a debenture also benefits from using a debenture trustee in that it only has to work with one person as opposed to the hundreds of investors who purchased its debentures.

In Baroda Rayon Corporation Ltd vs. ICICI Ltd[6].

The Bombay H.C. upheld the right of the debenture trustee, i.e. ICICI Ltd. to sell off an unit of Baroda Rayon for the benefit of the debenture holders in respect of certain debentures.

Duties of a debenture trustee:

  1. The trustee ensures that there is no breach in the terms of issue of debentures.
  2. The trustee can take steps to remedy the breach (above mentioned).
  3. The trustee is the person who informs the debenture holders about such breach.
  4. The trustee ensures that all the conditions regarding creation of security for debentures is met.
  5. The trustee convenes the meeting between the company and the debenture holders
  6. The trustee is the person who ensures that the debentures are redeemed as per the conditions agreed upon.
  7. The trustee can take steps to resolve the dispute between the company and the holders
  8. The trustee has to take necessary steps to ensure the interest of the debenture holders

Rights and liabilities of debenture trustee:-

Rights:

  1. Section 18 (c) a company in no cases can issue debentures before appointment of a debenture trustee.
  2. The company cannot issue debentures before obtaining the consent of the debenture trustee.
  3. The company has to specify the name of the debenture trustee in the offer letter.
  4. The debenture trustee can call for periodical performance report of the company
  5. The trustee can call for reports regarding the use of funds raised through issue of debentures.
  6. The trustee can communicate promptly to the debenture holders about defaults, if any, with regard to payment of interest or redemption of debentures and action taken by the trustee there for.
  7. The trustee can appoint a nominee to the Board of Directors of the company.
  8. Before the trustee appoints the nominee the following conditions must be satisfied:
  • Two consecutive defaults in payment of interest to the debenture holders; or
  • Default in creation of security for debentures; or default in redemption of debentures.

Liabilities:

  1. No one can be appointed as a debenture trustee if he has a share ownership in the company.
  2. He cannot be appointed if he is a promoter of the company, employee or the manager.
  3. No appointment for creditor to the company.
  4. The vacancy of a debenture Trustee can be filled by the company by the consent of the other trustees.

Duties of debenture trustee[7]:

In Administrator of the specified undertaking of the Unit Trust of India vs Bank of Baroda

Gujarat H.C. upheld the right of UTI as debenture trustee to draw Rs.4 crore from the liquidation proceeds of Sri Vallabh Glass Works Ltd., a company in liquidation.

It shall be the duty of every debenture trustee to-

  1. Ensure that there is no breach in the terms of issue of debentures.
  2. Perform such acts as are necessary for the protection of the interest of the debenture holders
  3. Inform the debenture holders about such breach.
  4. Ensure that all the conditions regarding creation of security for debentures is met
  5. Convene the meeting between the company and the debenture holders
  6. To ensure that the debentures are converted or redeemed as per the conditions agreed upon.
  7. Resolve disputes between the company and the holders
  8. Call for reports on the utilization of funds raised by the issue of debentures
  9. Appoint a nominee director on the Board of the company in the event of—
  • Two consecutive defaults in payment of interest to the debenture holders; or
  • Default in creation of security for debentures; or
  • Default in redemption of debentures.
  1. Call for periodical status or performance reports from the company
  2. Satisfy himself that the letter of offer does not contain any matter which is inconsistent with the terms of the issue of debentures or with the trust deed

 

Contents of debenture trustee agreement[8]

Every debenture trustee shall ensure that the trust deed executed between a body corporate and debenture trustee shall amongst other things provide for the following matters namely: —

  1. Preamble
  2. Description of instruments
  3. Details of Charged Securities (Existing or future)
  4. Nature of charge, examination of title.
  5. Rank of charge of assets viz. first, second, pari passu, residual etc.
  • Charging of future assets.
  1. Time limit within which the future security for the issue of debentures shall be created as specified in SEBI (Disclosure and Investor Protection) Guidelines, 2000.
  2. Minimum security cover required
  3. Valuation of security
  • Circumstances when security becomes enforceable
  • Methods and preparation of secured property
  1. Events of default
  2. Rights of debenture trustee
  3. Obligations of the body corporate

Apart from the above the agreement will have to include the following provisions:

  1. Definition and interpretation
  2. Appointment of debenture trustees and its powers
  • Remuneration of debenture trustee
  1. Appointment of debenture trustee as attorney
  2. Negative pledge i.e. not to create additional encumbrances on the secured asset.
  3. Description of events of default, which may arise due to non payment to debenture holders, breach of any undertaking, avoidance or repudiation
  • Notice of exercise of trustee powers

Code of conduct for debenture trustee (Regulation 16 and Schedule III)[9]

  1. A Debenture Trustee shall make all efforts to protect the interest of debenture holders.
  2. A Debenture Trustee shall maintain high standards of integrity, dignity and fairness in the conduct of its business.
  3. A Debenture Trustee shall fulfil its obligations in a prompt, ethical and professional manner.
  4. A Debenture Trustee shall at all times exercise due diligence, ensure proper care and exercise independent professional judgment.
  5. A Debenture Trustee shall avoid conflict of interest and make adequate disclosure of its interest.
  6. A Debenture Trustee shall make appropriate disclosure to the client of its possible source or potential areas of conflict of duties and interest while acting as debenture trustee which would impair its ability to render fair, objective and unbiased services.
  7. A Debenture Trustee shall not indulge in any unfair competition, which is likely to harm the interests of other trustees or debenture holders or is likely to place such other debenture trustees in a disadvantageous position.
  8. A Debenture Trustee shall share information available with it regarding client companies, with registered credit rating agencies.
  9. A Debenture Trustee shall endeavour to ensure that—

(a) inquiries from debenture holders are adequately dealt with;

(b) grievances of debenture holders are redressed in a timely and appropriate manner;

(c) where a complaint is not remedied promptly, the debenture holder is advised of any further steps which may be available to the debenture holder under the regulatory system.

Debenture redemption reserve (DRR):

The company issuing debenture must create a DRR Account of the profits of the company which will be utilised only for the redemption of debentures. However All Indian Financial Institutions (AIFIs) regulated by Reserve Bank of India and banking companies are not required to maintain DRR Account for both public as well as private placed debentures. NBFCs and companies engaged in manufacturing and infrastructure enjoy certain relaxations regarding maintenance of DRR Account services. If the company is issuing secured debentures or making an offer, or issues prospectus for more than 500 subscriptions of its debentures, it must appoint one or more debenture trustee as per the conditions laid down in the Companies (Share Capital and Debentures) Rules, 2014[10]. It is the obligation of the body corporate to create DRR as per SEBI DIP GUIDELINES and SEBI (Debenture Trustees) Regulation, 1993. The Debenture Trustee has to ensure that the issuer furnishes an auditors certificate to it for the same. The amount credited in DRR cannot be utilized except for the redemption of debentures[11].

Appointment of debenture trustee[12]

All appointment to be made of the debenture trustee’s should be made under section 71 of the Companies Act, 2013.

The company shall appoint debenture trustees under sub-section (5) of section 71, after complying with the following conditions, namely:-

(a) the names of the debenture trustees shall be stated in letter of offer inviting subscription for debentures and also in all the subsequent notices or other communications sent to the debenture holders;

(b) before the appointment of debenture trustee or trustees, a written consent shall be obtained from such debenture trustee or trustees proposed to be appointed and a statement to that effect shall appear in the letter of offer issued for inviting the subscription of the debentures;

(c) A person shall not be appointed as a debenture trustee, if he—

(i) beneficially holds shares in the company;

(ii) is a promoter, director or key managerial personnel or any other officer or an employee of the company or its holding, subsidiary or associate company;

(iii) is beneficially entitled to moneys which are to be paid by the company otherwise than as remuneration payable to the debenture trustee;

(iv) is indebted to the company, or its subsidiary or its holding or associate company or a subsidiary of such holding company;

(v) has furnished any guarantee in respect of the principal debts secured by the debentures or interest thereon;

  1. vi) has any pecuniary relationship with the company amounting to two per cent or more of its gross turnover or total income or fifty lakh rupees or such higher amount as may be prescribed, whichever is lower, during the two immediately preceding financial years or during the current financial year;

(vii) is relative of any promoter or any person who is in the employment of the company as a director or key managerial personnel.

(d) the Board may fill any casual vacancy in the office of the trustee but while any such vacancy continues, the remaining trustee or trustees, if any, may act: Provided that where such vacancy is caused by the resignation of the debenture trustee, the vacancy shall only be filled with the written consent of the majority of the debenture holders.

(e) any debenture trustee may be removed from office before the expiry of his term only if it is approved by the holders of not less than three fourth in value of the debentures outstanding, at their meeting. SEBI (Debenture Trustee) Regulations, 1993[13] additionally provide that no entity shall be entitled to act as debenture trustee unless at is either a scheduled bank carrying on a commercial activity or a public financial institution within the meaning of Section 4A of the Act or an insurance company, or a body corporate. It is also necessary that such an entity should have capital adequacy of net worth one crore of rupees and have been licensed by SEBI to act as debenture trustee.

Where at any time the debenture trustee comes to a 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 debenture trustee may file a petition before the Company Law Board and the Company Law Board may, after hearing the company and any other person interested in the matter, by an order, impose such restrictions on the incurring of any further liabilities as the Company Law Board thinks necessary in the interests of holders of the debentures[14].

As per the provisions of Companies Act, appointment of debenture trustee is mandatory. However issue of debentures with maturity of 18 months or less are exempt from the requirement of appointment of trustee.

  • In case of debenture with maturity beyond 18 months, a trustee or an agent, by whatever name called shall be appointed to take care of the interest of the debenture holders irrespective of whether or not the debentures are secured.
  • Where the debentures are unsecured, these are treated as fixed deposits, if received from individual investors.

SEBI proposes changes in the debenture trustee rules[15]

In Central Bank of India vs Tadepalli Padmaja and Ors.

The National Consumer Dispute Forum on July 4, 2008 held that the petitioner bank failed to discharge its fiduciary duty with special care and skill as is expected from professional corporate trustee and had not taken appropriate steps as contemplated under the SEBI Regulation.

To protect the interest of the debenture holder, market regulator Securities and Exchange board of India (SEBI) has proposed a slew of changes in the existing regulation for the debenture trustee (DT).

According to it, a person cannot be appointed as a DT if he beneficially owns shares in the company, is a promoter, director or key managerial person (KMP) or an employee of the company or its holding, subsidiary or associate company. To enable the DTs to perform the task of securing investors’ interest more effectively, SEBI had set up a task force comprising of SEBI officials and representative of (DTs) for examining the “challenges in performing the obligations and duties as Debenture Trustees to protect the interests of the debenture holders”.

Among other changes, SEBI has also proposed to change the definition of the principal officer, who is entrusted with overseeing the activities of the DT, to include key management personnel who in turn can be a chief executive officer, managing director, company secretary, whole-time director or such other officer. At present, a person cannot act as a DT in the case of any issue of debentures by an associate. Besides, it has also proposed changes in the provisions relating to the liability for action against the DTs with regard to default or non- compliance required to be modified to streamline them with other SEBI regulations so as to have consistency.

Key amendments proposed

Set out below are the key changes proposed to be introduced by the amendments:

  • Single form of Trust Deed – The amendments seek to do away with Schedule IV of the DT Regulations which set out the contents of the debenture trust deed leaving only a cross reference to the contents of the form of the debenture trust deed set out in Form SH-12 under the Companies (Share Capital and Debentures) Rules 2014.
  • Eligibility criteria of Debenture Trustee aligned – The amendments seek to specifically align the DT Regulations to Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014 (Debenture Rules) which sets out several restrictions on who can be appointed as a debenture trustee for a given debenture issue.
  • Enhanced Liability in respect of defaults by debenture trustee: In addition to the existing liability in case of default, the scope has been widened to include the failure by the debenture trustee to furnish any information relating to its activity as required by SEBI or furnishing incorrect or misleading information to SEBI. Further, failure by the debenture trustee to resolve the complaints of the investors or providing unsatisfactory responses to SEBI in this regard shall make the debenture trustee liable for actions under Securities and Exchange Board of India (Intermediaries) Regulations, 2008 which shall include suspension and cancellation of certificate of registration of the debenture trustee.
  • Certification by the Compliance Officer: The compliance officer appointed by the debenture trustee to monitor, inter alia, compliances of the debenture trustee with the various rules and regulations framed by the SEBI will now need to obtain a certificate in terms of SEBI (Certification of Associated Persons in the Securities Markets) Regulations, 2007 (Certification Regulation).
  • Duties and Obligations of the Debenture Trustee streamlined – In the proposed amendments, SEBI has sought to harmonise the duties and obligations of the debenture trustee with the provisions of the Companies Act, 2013 and Rule 18 of the Debentures Rules.
  • Definitions aligned with Companies Act, 2013 – A number of definitions under the DT Regulations will be aligned with those under the new Companies Act, 2013. Definitions like ‘associate’, ‘debenture’ and ‘Companies Act’ are proposed to be amended to synchronise it with the new Companies Act, 2013. The definition of ‘body corporate’ is sought to be amended to include non-banking financial companies and public sector undertakings under central and state enactments.
  • Fixed timeframe for document submission – In terms of submission of information by the issuers to the debenture trustees, the proposed amendments mandate that they be submitted within crystallised timelines, for example periodical reports / performance reports are now required to be obtained within 7 days of the relevant board meeting of the issuer or 45 days of the respective quarter, whichever is earlier.
  • ‘Change in Control’ aligned with Takeover Code – The definition of ‘change in control’ is sought to be modified to bring it in line with the new Takeover Code. As such, Regulation 2(ae)(i) will now refer to the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 instead of the repealed regulation of 1997.
  • Definition of ‘insurance company’ aligned with Insurance Act – Whilst the Companies Act, 1956 contained a definition of ‘insurance company’, there is no corresponding definition in the new Companies Act, 2013 and hence the definition of ‘insurance company’ in the proposed amendments has been aligned to Insurance Act, 1938.
  • Maintenance of records by Debenture Trustee – To further safeguard the interest of the debenture holders, a debenture trustee will henceforth be required to maintain books of accounts, records, documents, etc. in respect of the debentures for a period of not less than 5 financial years from the date of redemption of debentures (this was previously taken as 5 financial years preceding the current financial year).

[1] https://efinancemanagement.com/sources-of-finance/how-is-debenture-different-from-bank-loans-equity-shares-and-bond.

[2] http://www.yourarticlelibrary.com/financial-management/debentures-meaning-features-advantages-disadvantages.

[3] http://ebook.mca.gov.in.

[4] http://indianexpress.com/article/business/banking-and-finance/sebi-provides-clarity-to-boi-on-debenture-trustee-norms-2985680.

[5] http://www.gktoday.in/blog/debentures.

[6] 2002(2) BomCR 608, 2002(2) BOMLR 915

[7] Companies (Share Capital and Debentures) Rules, 2014.

[8] Schedule IV Securities and Exchange Board of India (Debenture Trustees) Regulations, 1993 [Regulation 14]

[9] Schedule III Securities and Exchange Board of India (Debenture Trustees) Regulations, 1993 [Regulation 16]

[10] http://www.sebi.gov.in/legal/rules/apr-2014/companies-share-capital-and-debentures-rules-2014.

[11] D.K. Prahlada Rao : All about debentures : An appraisal extracted on Feb 25,2015.

[12] Companies (Share Capital and Debentures) Rules, 2014.

[13] SEBI (Debenture Trustee) Regulations, 1993.

[14] Sec 117B – Appointment of debenture trustees and duties of debenture trustees, Companies Act, 1956

[15] http://www.business-standard.com/article/markets/sebi-proposes-changes-in-the-debenture-trustee-rules

AA-00004-13/10/2017

2017-10-13T18:33:24+00:00 October 13th, 2017|Tags: , , , , |