MCA Circular: Secured Corporate Debentures and Public Deposit Norms – Part 3

[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.
This is the
final post in the series. The first two posts can be accessed here and here]

Other laws affecting debentures

Following are the other
guidelines, rules or directions attracting issue debentures:
Issue
of debentures by listed companies:
Issue of convertible debentures
by listed companies attracts provisions of SEBI (Issue of Capital and Disclosure
Requirements) Regulations, 2009 along with provisions of Companies Act. Issue
of short term non-convertible debentures (having an initial maturity up to 12 months) will require
compliance of Issuance of
Non-Convertible Debentures (Reserve Bank) Directions, 2010. If the issue of
NCDs is to be listed (whether public or privately placed issue) or is a public
issue, SEBI (Issue and Listing of Debt Securities) Regulations, 2008 is
required to be complied with.
Issue
by unlisted public companies:
The issue of convertible
debentures by unlisted public companies on preferential basis is governed by
Unlisted Public Companies (Preferential Allotment) Rules, 2003, amended from
time to time. Issue of short term non-convertible debentures (having an initial maturity up to 12 months)
will require compliance of Issuance of
Non-Convertible Debentures (Reserve Bank) Directions, 2010. If the issue of
NCDs is to be listed (whether public or privately placed issue) or is a public
issue, SEBI (Issue and Listing of Debt Securities) Regulations, 2008 is
required to be complied with.
Issue
of debentures by private companies:
Private companies are prohibited
from accepting deposits, hence, such companies can issue only either
convertible debentures or non convertible secured debentures as per the Notification.
As such, no regulations have been
provided for issue of debentures, whether convertible or non convertible, by
private companies. However, private companies can issue to a maximum of 49
people as beyond which the issue will be deemed public issue and SEBI (Issue
and Listing of Debt Securities) Regulations, 2008 will be required to be
complied with. If private companies are to get its issue of NCDs listed, then
also, it needs to abide by the SEBI (Issue and Listing of Debt Securities)
Regulations, 2008.


Implications of stamp laws in case of
mortgage debentures

The mortgage debentures may
attract duty as payable on: (a) creation of the mortgage; and (b) the issuance
of debenture certificate.
As the debentures certificate is
a debt certificate and hence, is liable to stamp duty as applicable in the
state where the registered office of the issuing company is situated. In
addition, in case of debentures secured by mortgage of specific property,
applicable stamp duty on mortgage deed shall also be required to be paid.
Generally, mortgage is created on
immovable property, however, the definition of ‘mortgage deed’ as defined in
Indian Stamp Act, 1899 reads as:
Mortgage-deed includes every
instrument whereby, for the purpose of securing money advanced, or to be
advanced, by way of loan, or an existing or future debt, or the performance of
an engagement, one person transfers, or creates, to, or in favour of, another,
a right over or in respect of specified property”.
The
definition, as is evident, is not limited to immovable property – hence, even a
mortgage of movable property, if done by way of a mortgage deed, may be liable
to stamp duty. It is a different, and contentious, issue, whether a mortgage of
movable property requires a deed at
all, since there are no mandatory provisions requiring a written instrument in
case of a mortgage of movable property, unlike section 59 of the Transfer of
Property Act.
The
definition is quite clear that the mortgage debentures shall be chargeable,
however, subject to applicable stamp acts in different states. In terms of
Article 23A of the said Act, instruments of mortgages of marketable securities
are to be charged with such stamp duty as applicable on normal agreements.
However,
different states have different stamp duties and different charging rule, so
issuer has to carefully see the stamp duty implications before considering
mortgage debentures. For example, Article 27 of Schedule IA of the West Bengal
Stamp Act includes mortgage debentures also within the article specified for
the marketable debentures and also provides duty for mortgage deeds. Delhi
Stamp Act also has the same provision as there in West Bengal Stamp Act.
Schedule I of Bombay Stamp Act provides Article 54 under which security bonds
or mortgage deeds are stamp able as per the specified rates.
While
the intent of the MCA in extending the benefit of issuing secured debentures to
all fixed assets of the company is laudable, the unwarranted use of the word mortgage may greatly curtail the
extension of the benefit, particularly due to the stamp duty unclarity
highlighted above.

 

Practical implications of the
Notification

The
Notification has provided that the issue of bonds or debentures secured by
fixed assets having same or more value as of the issue shall be exempted from
the Deposit Rules. Below we discuss the applicability of the exemption in some
practical situations:
– A
company is issuing NCDs for Rs 100, secured by fixed assets of Rs 100, this
will be exempted from Deposit Rules.
– An
issuer is issuing NCDs of Rs 100, secured by fixed assets having book value of
Rs 80 but market value of Rs 100. This will be exempted as the Notification
exempts the issues secured by fixed assets having same or more market value.
– Issuer
is issuing NCDs of Rs 100, secured by fixed assets having book value of Rs 100
but the market value of such assets is Rs 80. This will not be exempted as
Notification speaks about market value of secured assets.
– Issuer
is issuing NCDs of Rs 100, secured by fixed assets having market value of Rs
100, however, there are other charge holders holding floating charge over the
same fixed assets – in our view, the creation of a floating charge (such as
“all present and future assets of the company” ) does not prevent the company
from creating a fixed charge. If the debentures in question are secured by
fixed charge, the fixed charge takes priority over the floating charge, and the
conditions of the Notification stand satisfied, hence, exempted.
– Issuer
is issuing NCDs of Rs 100, secured by fixed assets having market value of Rs
100, however, there are other charge holders holding fixed charge over the same
fixed assets. First of all, charge cannot be created in favour of debenture
holders, unless existing creditors cede a charge. Even if charge is ceded, the
amount of claims exceeds the market value of the assets – hence, such issue
will not be exempted.
– Company
is issuing NCDs of Rs 100, secured by fixed assets having market value of Rs
500, however, there are other charge holders holding fixed charge over the same
fixed assets, with claims amounting to Rs 300. Assuming charge is ceded by the
existing charge holders, the amount of claims is within the market value of the
assets – hence, exempted. We advise that a secured debenture issuance should
typically have an “asset cover” clause whereby the trustees will monitor the
adherence of the asset cover condition by the issuer.
– NCDs of
Rs 10, secured by fixed assets having market value of Rs 100. However, after
issue, the market value declines to Rs 80- exempt. As the Notification requires
equal or more market value at the time of issue of debentures. Hence,
debentures exempted at the time of issue will not be again treated as deposits
if market value of security falls.

 

Conclusion

The Notification is to come into
effect from the date of its publication in Official Gazette and as such the
Notification has only been placed on MCA Portal, publication in Official
Gazette is awaited. There is no doubt that the Notification will widen the
scope of corporate bonds by exempting debentures secured by mortgage of ‘fixed
assets’ instead of mortgage of ‘immovable property’. Though the government is
making continued efforts to improve the bond market of India and the issue of
this Notification is yet another example of such efforts, however, such flawed
language of the Notification will create confusion and uncertainty only until
proper clarifications are issued in this regard.
– Vinod Kothari & Nidhi Ladha
[This
series is concluded]

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.

8 comments

  • In my view, private companies may issue unsecured NCDs which would not be held as deposit since they would fall into inter company deposit exmeptive category provided under Rule 2 of non-acceptance of Deposit Rules.

  • Please let me know… i am doing audit of construction co. They have issued NCD against which they have mortgaged their 4 projects. But these 4 project are there stock not fixed asset. Confirm whether still this issue is not covered under deposit rules

  • But Artilce 27 of Indian Stamp Act provides that stamp duty is payable only on debenture certificate issued as a 'marketable security'. Marketable security is defined to mean only listed securities. Therefore, when the debentures are not listed in the stock exchange, there is no requirement for payment of stamp duty. Let me know if you disagree.

    • Don't think that was what was meant. Reference to Article 27 was made in the context of the entry in the WB Stamp Act. The entry of mortgage debentures have been put under the same category as marketable security. Therefore, the duty prescribed for marketable securities will also apply to mortgage securities.

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