Bonus Debentures: A New Perspective on Certain Issues and Concerns

[The following post is contributed by Priya Garg, who is a student at the
West Bengal National University of Juridical Sciences (WB-NUJS).
An earlier post on this Blog discussing the features
and implications of bonus debentures is available here.]
Bonus debentures
are those debentures which a company issues to its shareholders by using its
reserves’ balance. Their issue does not require cash inflow from the
shareholders, making these debentures free of cost for the shareholders. There
is no specific provision under the Indian Companies Act, 2013 dealing with the
issue of bonus debentures due to which companies issuing bonus debentures rely
upon a scheme of arrangement under Sections 391-394
of the Companies Act, 1956
to establish the validity of such issue.[1]
This gives rise to several questions relating to the issue of bonus debentures
which remain unanswered. Some of these issues and concerns related to the issue
of bonus debentures have been identified here, and the possible answers to some
of the issues have also been elaborated upon.
First, due to the
lack of a provision dealing specifically with the issue of bonus debentures, on
account of an immensely broad scope of Section 391 of the Companies Act,
1956
regarding the arrangements that can be arrived at among the
shareholders and the creditors, as well as because of the wide discretionary
powers that the Court possesses while arriving at its decision to sanction the
resolution passed at the meeting convened upon its order under Section 391,
there has been ambiguity with respect to the legal position on different
aspects pertaining to the issue of bonus debentures. However, concerns over
several such ambiguities have not been raised in Indian scenario. This is
because hitherto the bonus debentures
issued in India have been the simplest cases of debentures issue as the
debentures so issued have been non-convertible debentures and they have been
issued out of general reserves and to all the shareholders. Hence, the position
of law with respect to the more complicated cases some of which have been
stated here remain unclear:
a.   Whether bonus debentures can be issued
out of capital redemption reserve (CRR) or securities premium reserve (SPR)
besides their issue from the undistributed profits/general reserves/free
reserves?
Though it is a settled that bonus debentures can be
issued out of the company’s general reserves, Indian courts did not get the
opportunity to determine if such debentures, like in case of bonus shares, can
also be issued out of Capital Redemption Reserve or Securities Premium Reserve.
Under Section 69(1) of the
Companies Act, 2013
, Capital Redemption Reserve is credited whenever the
company reduces its share capital by making payment out of its distributable
profits. This is to ensure that the creditors’ interest stay protected despite
the reduction of company’s share capital. This explains the reasons behind
statutorily restricting the use of Capital Redemption Reserve to the issue of
bonus shares, etc. and also for providing that unless explicitly stated otherwise,
the balance of the Capital Redemption Reserve can be reduced only in the manner in
which share capital can be reduced
. Similarly, under Section 52(1) of
Indian Companies Act, 2013, Securities Premium Reserve balance can be decreased
only in the manner in which share capital can be reduced.
Under, Section 100 of Indian Companies
Act, 1956
, reduction of share capital has three pre-conditions: first,
company’s articles of association should provide for such reduction, second, a
special resolution is passed by the shareholders approving the reduction; and
third, the Court sanctions the resolution so passed. The Court while
sanctioning the resolution is required to ensure that no creditor (creditors
being the affected party) opposes the reduction. The same procedure has to be
followed for debiting the balance of Capital Redemption Reserve and Securities
Premium Reserve. Therefore, ideally, bonus debentures could be issued by
debiting the Capital Redemption Reserve and Securities Premium Reserve,
provided that for the meeting which the Court orders to convene under Section 391, all the creditors
and not merely the shareholders are invited, and in such meeting no creditor
opposes the motion and later, the Court’s sanctions of such resolution.
Alternatively, the Court can sanction the special resolution passed by the
shareholders supporting the reduction of Capital Redemption Reserve/Securities
Premium Reserve to issue bonus shares under Section 391, provided no
creditor expresses disapproval to the proposal. Similarly, these two reserves
can be utilized to issue bonus debentures in cases where the company does not
have any creditors. 
Therefore, though this position has not been
pronounced by law yet, nevertheless, by application of legal principles, it can
be stated that debentures can be issued out of the Capital Redemption Reserve
and Securities Premium Account.  Further,
business prudence demands that the law is interpreted with the possibility of
using Capital Redemption Reserve and Securities Premium Reserve in this manner
because that would enable bonus debentures to become a real alternative to issue
of bonus shares as a source of finance.
b.   In the areas of ambiguity, can the Court
apply the principles related to the issue of bonus shares?
There are
several questions related to bonus debentures such as:
(a)        Whether or not the
company which has once announced the decision recommending a bonus issue can
subsequently withdraw the same?, or
(b)        What
happens when an individual shareholder refuses to accept the bonus debentures
issued to him?, or
(c)        Whether
or not the issuing company is required to make a reservation of bonus
debentures in favour of the holders of outstanding [compulsorily] convertible
debt instruments, in proportion to the convertible part thereof, etc.
The answers to these questions have not been clearly
provided by the law yet.
Since,
bonus debentures and bonus shares share some similarities; there remains
ambiguity whether or not
the Courts can apply the general
principles applicable to the issue of bonus shares while deciding under Section 391 of the Companies Act,
1956
whether or not to sanction the issue bonus shares, or even while
adjudicating upon any matter related the bonus debentures.
Further, another issue is that unlike
in case of bonus shares
, there is no express pre-condition to the issue of
bonus debentures that the latter cannot be issued in lieu of the payment of
dividends. On one hand, it may be argued that there is no need for having such
provision for the issue of bonus debentures. This is because, unlike in case of
bonus shares, with respect to the bonus debentures there is an in-built check
for the company against issuing bonus debentures in lieu of dividends due to
the prospects of having its obligations to pay Dividend Distribution Tax,
regular and compulsory payment of interest and redemption amount upon maturity.
However, this argument is flawed. This is because had this been the case, there
would have been no need for imposing such restriction upon the issue of bonus
shares because in a way such an in-built test also exists w.r.t the bonus
shares in the form of the apprehension of lowering of Earning per Share upon
the expansion of equity base. Therefore, it is important to impose
pre-condition upon the issue of bonus debentures that such debentures cannot be
issued in lieu of the payment of dividends. This would protect the interest of
those shareholders whose interest lies in being paid by way of dividends
instead of waiting for the long term benefits. Furthermore, such a
pre-condition regarding the issue of bonus debentures is needed to complement
the function of Section
63(3) under the Companies Act, 2013
or to ensure that the reason behind
enacting Section
63(3)
does not get defeated. Under
­­­Section 63(3)
, a company cannot issue bonus shares in lieu of its
payment of dividends. This has been done to protect the investors’ interest by
ensuring that the company does not abstain from paying dividends even in
instances of profitability by pacifying the shareholders by issuing the bonus
shares instead. In absence of a similar restraining pre-condition to the issue
of bonus debentures, the company may end up issuing bonus debentures in lieu of
payment of dividends because it is aware that it cannot issue bonus shares by
evading the payment of dividends. This would partially defeat the objective
that Section
63(3) of the Indian Companies Act, 2013
seeks to fulfill. Therefore, in
order to assist Section
63(3)
in fulfillment of its purpose, it is crucial that an explicit
pre-condition is enacted to the issue of bonus debentures that such debentures
cannot be issued in lieu of the payment of dividends.
In conclusion, it is important to address the issues
and concerns that are presently in existence and which in certain cases explain
the reasons behind the infrequent use of bonus debentures. Two major changes
which need to be brought are to simplify the procedure related to the issue of
debentures and to incorporate direct provisions under the Companies Act dealing
specifically with the issue of bonus debentures so that the ambiguities of law
in the matter can be solved substantially, if not fully.
Priya Garg



[1]
In the present post, the provisions
of Companies Act, 2013 have been analyzed. However, with respect to the
provisions of Companies Act, 1956 whose corresponding provisions under
Companies Act, 2013 have not been enforced yet, the former have been cited.

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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