Comparison between convertible and non convertible debentures

1. DEBENTURES: INDIAN FDI POLICY
CA. Sudha G. Bhushan and CS. A. Sekar, assisted by CS. Rashmi Saroiaya
Debentures are defined under Section202) are issued as either preference shares
of the Companies Act, 1956. Debenture or debentures to begin with and are
includes debenture stock, bonds and any convertibleinto equity sharesof the Indian
other securities of a company, whether company at a later date. The conversion
constituting a charge on the assets of the may occur in one of two ways: either at
Company or not. In other words, it is a the option of the investor, or compulsorily
type of loan issued by a company that (without any option whatsoever). Such
may or may not be be converted into instruments cany characteristics of
stock by the holder and, under certain multiple securities and hence take on
circumstances, the issuer of the bond. nomenclatures such as "hybrids" and
B adding the convertibility option the
y "quasi-equity".
issuer pays a lower interest rate on the Fare& Dlred Investment From a legal and regulatory (more
loan compared to if there was no option tc specifically, foreign direct investment)
convert. These instruments are used by companies to obtain standpoint, I ever, the question is whether such
the capital they need to grow or maintain the business. / convertible instruments constitute debt, thereby falling
There-arema* types of debentures. This article concentrates within the purview of regulations governing- extemd
on the debentures issued to the non-residents. Broadly commercial borrowings (ECBs), or whether they constitute
debentures can be classified in two types equity, thereby falling under the guidelines pertaining to
- Fully, mandatorily convertible debentures foreign direct investment (FDI).As per the FEMA regulations
- Partially/optionally debentures and FDI policy, where fully/compulsorily convertible
Going forward we have discussed the difference between the debentures are considered as equity, the partially/optionally
fully/compulsorily convertible debentures and partially/ convertible debentures are considered as debt.Where fully/
optionally convertible debentures from the perspective compulsorily convertible debentures are considered as
of Foreign Direct Policy in India. The transaction between equity, the partially/optionally convertible debentures are
resident and nonresident are regulated by Foreign Exchange considered as debt.
Management Act , 1999 (FEMA) and the foreign direct As per Consolidated FDI Policy
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investment policy. "Other types of Reference shares/Debentures i.e. non
Not only regulatory but also from taxation point of view the convertible, optionally convertible or partially convertible
two type of debentures are different therefore before issuing for issue of which funds have been received on or after May 1,
the either fully/compulsorily convertible debentures or 2007 are considered a debt. Accordingly all norms applicable
partially/optionally convertible debentures organization for ECBs relating to eligible borrowers, recognized lenders,
should keep in mind its objective. While in partially/ amount and maturity, end use stipulations etc. shall apply.
optionally convertible debentures organization will have to Since these instruments would be denominated in rupees,
pay interest which shall be tax deductible in case of fully/ the rupee interest rate will be based on the swap equivalent
compulsorily convertible debenture although it will provide of London Interbank offered rate (LIBOR) plus the spread as
for long term capital but the pricing guidelines shall be permissible for ECBs of correspondingmaturity."
required to be met. We have below discussed in detail the difference between
It is quite common for foreign investors to take up convertible the two types of debentures . For the ease of comparison the
instruments in Indian companies. These instruments tabular form has been used.
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Q
1
Debentures
Fully and mandatorily Convertible Debentures Non-Convertible/Optionally Convertible Debentures 4
A type of debt security where the whole value of the A type of debt s6curity where the whole value of the
debenture is convertible into equity shares. debenture is not convertible into equity shares or convertible
at the issuer's notice.
I If ebentures are fully and mandatorily convertible in that I debentures are Non-Convertible/Optionally Convertible
c !$e'e~?!s 3rl~idered Equity.Investment.
as
f
Debentures in that case it is considered as Extemal
I Commercial Borrowings. I
I Redatorv framework I
I Master Circular on Foreim Investment in India I Master Circular on External CommercialBorrowinas I
Foreign ExchangeManagement (Transfer or Issue of Security Foreign Exchange Management (Borrowing or Lending in
by a Person Resident Outside India) Regulation, 2000 Foreign Exchange) Regulations, 2000
I
Section 292(1)@)of the Companies Act, 1956)
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)ecember, 2012 &&& , ',

2. Companies Act, 1956 (Section 293(1)(d))- only in case of Companies Act, 1956 (Section 293(1)(d)) - only in case of
Public Company Public Company.
Public Companies (Terms of Issue. of Debenturk and
Raising of Loans with Option to Convert,such Debentures
or Loans into Shares) Rules, 1977 - Applicable only in case
of Public Company
Who can Invest
A person resident outside India (other than a citizen of Company can issue debentures to internationally recognized
Pakistan) and Entity incorporated outside India, (other than sources, such as
an entity incorporated in Pakistan) (i) international banks,
Indian Company can receive consideration by (ii) international capital markets,
(i) Debiting the NRE / FCNR account of a person concerned (iii) multilateral financial institutions (such as IFC, ADB,
maintained with an AD category I bank. CDC, etc.) / regional financial institutions and
(ii)through normal banking channels. Government owned developmentfinancial institutions,
(iii) conversion of royalty / lump sum / technical know how (iv) export credit agencies,
fee due for payment or conversion of ECB, shall be treated (v) suppliers of equipment,
as consideration for issue of shares. (vi) foreign collaborators and
(iv) conversion of import payables / pre incorporation (vii)Foreign equity holders [other than erstwhile Overseas
expenses / share swap can be treated as consideration for Corporate Bodies (OCBs)].
issue of shares with the approval of FIPB. (i) If paid-up equity capital of 25%directly held - avail
(v) debiting to non-interest bearing Escrow account5 in ECB upto USD 5 million under automatic route;
Indian Rupees in India which is opened with the approval (ii) . If paid-up equity capital of 25% directly held
from AD Category - I bank and is maintained with the AD and ECB liability- equity ratio does not exceed
Category I bank on behalf of residents and non-residents 4:1 - avail ECB more than USD 5million under
1 tow&dipayment of share purchase consideration. 1 automatic route.
Maximum Permissible Amount
Since it is considered to be FDI. Therefore the Sectoral caps Since non convertible debentures are considered as external
prescribed under the FDI policy as applicable to it. Sectoral commercial borrowing therefore as mentioned above it is
cap have to be seen i t the time of allotment of convertible governed by the terms and conditions mentioned in ECB
d&benturesonly. 1 regulations-viz. Recognised lender, recognized borrower I
The maximum amount of ECB which can be raised by
a corporate other than those in the hotel, hospital and
software sectors is USD 750 million or its equivalent

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4. Compliance Requirements
(1) Ensure that Articles of the Company allows issue of (1) Ensure that &cles of the Company allows issue of
debentures, if not then alter articlg of associatiop by debentures, if not then alter articles of association by
passing Special Resolution passing Special Resolution
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r
(2) Drafting of Investor Agreement (2) Drafting of Debenture Agreement
(3) Board Resolution under Section 292(1)(b) of the (3) Board Resolution under Sedion 292(1)@) of the
Companies Act, 1956* Companies Act, 1956*
(4) In case of Public Company, borrowing should not (4) In case of Public Company, borrowing should not
exceed aggregate of paid-up capital and free reserve as exceed aggregate of paid-up capital and free reserve as
per Section 293(l)(d)* per Section 293(1)(d)**
(5) Board Resolution for allotment of Debentures (Note :It (5) Submit Form 83 (in duplicate) certified by CA/CS to
has to be dotted within 180 days of receipt of funds) Authorised Dealer within 7 days from the date of
-'.; signing agreement to obtain Loan Registration Number
from RBI
(6) Issue of duly signed, stamped and sealed Debenture (6) Board Resolution for allotment of Debentures
Certificate to Investorm
(7) Advance Reporting for receipt of funds (7) Issue of duly signed, stamped and sealed Debenture
Indian companies are required to report the details Certificate to Investor-
of the receipt of the amount of consideration for issue
of convertible debentures, through an AD Category
- I bank, together with a copy/ies of the FIRC/s
evidencing the receipt of the remittance along with
the KYC report as specified in the regulation on the
nonresident investor from the overseas bank remitting
the amount within 30 days of receipt of fund.
(8) FC-GPR filing (8) Updation of Register of Debentureholders""
Indian companies are required to file Form FC-GPR of
FEMA through AD Category I bank, not later than 30
davs from the date of issue of shares.
(9) Updation of Register of Debentureholders"** (9) Transfer to Debenture Redemption Reserve till the date
of conversion
(10) Submit ECB-2 (Reporting of actual transactions of
External Commercial Borrowings (ECB) under Foreign
Exchange Management Act, 1999) Return certified
by the designated AD b g k on monthly basis so as to
and Information Management (DSIM), Reserve Bank
of India within seven working days from the close of
month to which it relates.
* As per Section 292(1)(b) of the Companies Act, 1956, the Board can exercise pofler of issue of Debentures in Board
Meetim. Thus, the Board cannot take decision for issue of debentures through circular.
*Public limited company/ a private company which is a subsidiary of a public compyy cannot borrow moneys (through
loan or issue of debt instrument) in case proposed borrowing together with the moneys already borrowed by the company
(apart from temporary loans obtained from the company's bankers in the ordinary course of business) exceeds aggregate
of the paid- up capital of the company and its free reserves except with the consent of such public company or subsidiary
in ge@r,?&n@ting. (Section 293(1)(d)of the Companies Act, 1956)
*** &tion 113 of the ~ o m ~ a n i e s ~ c t .provides for issue of debenture certificate within tkee months from the date
1956
of allotment of debentures.
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December,: .---A