Guest Post: The Changing Definition of Debentures

[The following post is contributed
by Nidhi Bothra of Vinod Kothari
& Co. She can be contacted at]
The new Companies Act, 2013 has changed
the regulatory face of the corporate India; “raising the bar on Corporate Governance.” The new regulatory
changes including need for CSR activities, increased investor protection,
greater transparency in business and have been the larger issues of discussion
with the elite section of the corporate sector. However smaller refinements in
the new Act against the old one have also created quite a buzz.
Recently an issue was raised by some
members of the legal fraternity on an age old settled issue of the difference
between negotiable instruments and transferable/ marketable instruments and
whether the new definition of “debentures
u/s 2 (30) of the Companies Act, 2013 now includes instruments such as
commercial paper as well. Some of the counsels are holding the view that
commercial paper will now be included within the ambit of the definition of
debentures forcing people to re-think on a question that must have been
concluded some hundreds of years ago. This post aims to discuss the merit in
the thought.

What is the change?

To be able to see the genesis of the
discussion one needs to see the change that has been introduced vis-à-vis the
Act, 1956. Textually the changes are small but none the less it is extremely
crucial to address their interpretation so as not to start on the wrong foot
from the very beginning.
Section 2 (12) of the Companies Act, 1956
debentures were defined as-
‘debenture’ includes debenture stock,
bonds and any other securities of a
company, whether constituting a charge on the assets of the company or not
Under the Act, 2013 the definition of
debentures u/s 2 (30) has been changed to:
‘debenture’ includes debenture stock,
bonds and any other instrument
evidencing a debt
, whether constituting a charge on the assets of the
company or not
Syntactically the new definition
replaces “any other securities” with
any other instrument evidencing a debt”.
Debenture is creation or acknowledgment of debt instrument whether or not it
constitutes charge over the assets of the company. The intent of the law makers
with the change seemingly is to include any such instrument which is in garb is
nothing but an instrument evidencing debt, i.e. debentures even if by
nomenclature it may be any different[1]. Commercial
paper on the other hand is in the form of usance, a promissory note[2] negotiable by endorsement
and delivery. It is a short-term unsecured promissory note sold by large
business firms to raise funds.
At the first blush, if commercial paper
being a promissory note can be included in the definition of debentures then
any negotiable instrument could be included in the definition of debentures as
well. The intent of the lawmakers could not have been to include negotiable
instruments within its periphery at all.
the case of Essar Steel Ltd. vs. Gramercy Emerging Market Fund[3],
judgment dated 17 October, 2002, the company had issued floating rate notes
(FRNs) and the issuer company defaulted in paying the dues in connection with
the notes and hence the note holders took the company for winding up. The
defence by the issuer company among other things also included that the FRN
holders were not debenture holders or
holders of any
security as contemplated by the Companies Act read with the Securities
Contracts (Regulation) Act, 1956. The relevant extracts of the ruling are
reproduced below –
The fundamental purpose underlying Securities Acts is to
eliminate serious abuses in a largely unregulated securities market. There is
virtually limitless scope of human ingenuity especially in the creation of the
numerous schemes devised by those who seek the use of money of others on
promise of profits. The inclusive definition of the term ‘security’ is wide
enough to include within that definition many types of instruments that might
be sold as an investment.
The term ‘Note’ is relatively broad to encompass instruments
having different characteristics depending on whether issued in a consumer
context as a commercial paper or in some other investment context. If the notes
are issued in a commercial or consumer context, they will not be treated as
securities while those issued in investment context would be securities.
Whether the Note is issued in investment context can be
ascertained on the basis of the circumstances surrounding the transactions. In
order to determine whether a transaction involves a ‘security’, the transaction
has to be examined to assess the motivations that would prompt a reasonable
seller and buyer to enter into it. If the seller’s purpose is to raise money
for the general use of a business enterprise or to finance substantial
investments and the buyer is interested primarily in the profit the note is
expected to generate, the instrument is likely to be a ‘security’. On the other
hand, if the note is exchanged to facilitate the purchase and sale of a minor
asset or consumer goods, or to advance some other commercial or consumer
purpose, such note cannot be classified as ‘security’. One other factor to be
examined would be whether the Note in question is an instrument in which there
is common trading for speculation or investment and how is it views by the
investing public [See Reves v. Ernst & Young 494 US 56 (1990)]
The ruling clearly explains that any instrument cannot be
considered to be a security, one has to look at the intent whether the
instrument was representing commercial loan or was it issued for investment and
trading. In several Indian and U.S. rulings the question has been considered
but in the context of U.S. law the purpose of debentures being defined in the
Indian law is completely different. The intent in India it is to regulate issue
of debentures by companies and provide for debenture redemption reserve, debenture
trustees etc to ensure that the investors interest is protected at all times.
Commercial paper on the other hand is a money market
instrument, largely issued for working capital needs of the business houses.


If for the sake of argument one had to include commercial
paper within the periphery of debentures, any issuance of commercial paper
would also require maintenance of DRR, liquid funds for yearly redemption (not
to forget these are less than a year instrument), trustee and so on, apart from
the RBI guidelines existing on the instrument already. Money market instruments
are regulated by RBI as per the powers vested in RBI by virtue of Section 45W
of the RBI Act and there are already elaborate guidelines laid down with regard
to issuance of commercial paper already. Such onerous compliance requirements
surely would neither have been envisaged by the lawmakers nor could have been
required considering the short-term nature of the instrument.
Further, Section 1 (4) (e) of the Companies Act, 2013 states
that the provisions of the Special Act shall prevail over the provisions of the
Companies Act, 2013. Considering the fact that commercial paper issuance is
regulated by RBI under the powers derived from the RBI Act which is a special
Act, commercial paper shall continue to be regulated by RBI and cannot be
considered under the so called inclusive and expansive definition of debentures
under the Companies Act, 2013.
Commercial paper has
existed for almost 500 years and nay, debentures have also existed for 500
years. There is nothing new in the definition of debentures in the Act, 2013
and the definition was substantively the same earlier as well. One
cannot interpret the law so as to disturb age old notions which are established
by custom. So by merely trying to twist the language of the definition of
debentures to try and include any sort of instrument is trying to reinvent the
wheel which is an age old invention anywa
– Nidhi Bothra

[1] In its judgment in Narendra
Kumar Maheshwari
vs Union of India,
1990 case, Supreme Court has defined debentures to mean essentially as an
acknowledgement of debt, with a commitment to repay the principal with

[2] Section
4 of the Negotiable Instruments Act, 1881 defines a promissory note as – an instrument in writing (not being a
bank-note or a currency note) containing an unconditional undertaking signed by
the maker, to pay a certain sum of money only to, or to the order of, a certain
person, or to the bearer of the instrument.

[3] 2003 116 CompCas 248

[4] In case of Reves v. Ernst & Young, Fletcher International Ltd vs. ION Geophysical Corp., Pollack v. Laidlaw Holdings, Inc., 27 F.3d
808, 813 (2d Cir. 1994), the Courts held that all notes are presumptively securities, unless presumption is
The Courts used the ‘family resemblance test’ to examine the question whether a
in question is an investment or whether the note
represents a commercial or consumer loan transaction. The Court held that
short-term notes that are situational to the particular lender and borrower,
and not the types of instruments that are easily traded. if the note in
question looks more like a corporate bond, debenture, or other instrument the
value of which rises and falls with the success of the issuer’s business, has a
term of several years, and is easily traded, then that presumption will not be
rebutted, because the note will not bear a strong resemblance to any of the
notes listed in Reves for the basic reason that such a note is easily
characterized as an investment, and thus a security.

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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