MCA Circular: Secured Corporate Debentures and Public Deposit Norms – Part 1

[The following is
a guest post from Vinod Kothari and Nidhi Ladha of Vinod Kothari &
Company. The authors can be contacted at vinod@vinodkothari.com
and nidhiladha@vinodkothari.com
respectively]
The Ministry of Corporate Affairs, vide a
notification
dated 21st March 2013  (“Notification”), has made a change in
Companies (Acceptance of Deposits) Rules 1975 (“Deposit Rules”). The apparent purpose of the Notification is to
widen the scope for companies to issue secured debentures, thereby widening the
bond market. This seems to be a part of the recent measures[1]
to widen the bond market in the country.
However, first of all, the language of
the Notification is itself flawed and may lead to confusion – as illustrated
later in this post. Second and more significant, the insistence of the
lawmakers on “secured debentures” needs to go away completely, as corporate
debentures are essentially used world-over as unsecured debt instruments.
The bond market in India is far from
developed. Despite considerable interest in bond market development, the
corporate bond market accounted for only 3.9% of the sources of funds of large
Indian companies. A perusal of the various sources of raising resources in the
domestic market reveals that the large non-financial corporates have been
raising only about 4% through the debt route while the bank borrowings and
foreign currency borrowings account for 17.8% and 3.2% respectively as on March
31, 2011. The share of bonds as a percentage of total debts in India account
for only 4% whereas in countries like in China, the size is 17%, in US, it is
11% and in Japan the bonds constitutes 7% of its total debt market for the FY
2010-11. In addition, the bond market is primarily dominated by banks and
NBFCs; hence, bonds have hardly been used by corporates[2].

Why are debentures “public deposits”?

It may sound queer as to how debentures
are treated as public deposits at all. However, the definition of the term
“deposit” in corporate laws in India is much wider than what is commonly
thought. Any amount received, refundable with or without interest, is a
deposit. There are certain exceptions laid down in Rule 2 (b) of the Deposit
Rules. Hence, even if an amount is raised by issue of debentures, it is still a
deposit, unless it falls in one of the exceptions listed in Rule 2 (b).

The change in law

Prior to the Notification, Rule 2(b)(x)
of the Deposits Rules exempted debentures if:

“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.”
As is evident, there were two exceptions
– debentures secured by mortgage of immovable property, and convertible
debentures.
However, with this Notification, Ministry
has reworded and replaced the said Rule with the following:
“any amount raised by the issue of bonds or debentures
secured by the mortgage of any fixed assets referred to in Schedule VI of the
Act excluding intangible assets 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 fixed assets referred to in Schedule VI or of
the Act excluding intangible assets the amount of such bonds or debentures
shall not exceed the market value of such fixed assets.”
           
As an effect of the Notification, now,
the issue of debentures or bonds will be exempt from the Deposit Rules if: a)
the issue is secured by mortgage of any
fixed asset of the company as referred in Schedule VI having market value more
or equal to the value of the issue
; or b) the issue is of the convertible
debentures.
Since the law has been changed from “mortgage of immovable property” to “mortgage of fixed assets”, it appears
that the charge may be created on any of the fixed assets of the company.
However, there is a significant distinction between charge and mortgage. In
common parlance, the word “mortgage” is associated with immovable property.
Technically, there is nothing in law to prevent a mortgage being done with
respect to movable property as well; however, mortgages of movable property are
rare. So much so, that many people even fail to realize that there is anything
called mortgage of movables. In fact, the word chattel mortgage is as old as the whole concept of mortgages[3].
It was not important for the MCA to use
the expression “mortgage of fixed assets”, as the idea may not have been to
limit the issue of debentures to only mortgage, and not charge, over fixed
assets. Mortgages of movable property are so common that such an intent could
not have existed. The error perhaps occurred only because someone was replacing
words in the old definition, and simply ended up replacing “immovable property”
by “fixed assets”. In result, most users will keep wondering as to how to
create a mortgage of fixed assets. Stamp duty implications will also be a
challenge.
– Vinod Kothari & Nidhi Ladha
[In a continuation
of this post, the authors deal with the legal implications of a mortgage
of movable property (here) and with other laws affecting debentures generally (here)]


[1]
The Finance Minister in course of his Budget speech referred to several
measures for promoting the bond market, primarily being the starting of debt
segment in stock exchanges. Recently, debenture redemption reserve requirements
have also been changed. On DRR requirements, as amended, see our article at http://india-financing.com/staff-publications-corporate-law.html
[2] See our article on “‘Corporate
Bond Market-Removing the Bottlenecks’ at http://india-financing.com/Corporate_Bond_Market-Removing_the_Bottlenecks.pdf

[3] For a brief description of mortgages
of movable properties, see Vinod Kothari; Securitisation,
Asset Reconstruction and Enforcement of Security Interests
, 2010, p. 530,
598

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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