Pre-requisites for Issue of Debt Instruments
Creation of Debenture Trust
Under section 117B of the Companies Act, any company whether listed or unlisted cannot make an issue of debenture to the public without constituting a trustee mechanism. The Debenture trustee is constituted by the registration of a private trust under the Indian Trusts act 1881 and a trust deed is prepared. The trust deed points out the following:
Time limit for creation of security for issue of debentures.
Any change in the trust property would require approval of the trustee.
Rights of the debenture holders in the event of default by the issuer company.
Terms of redemption of the securities.
Debt-Equity ratios and Debt service coverage ratio.
Obligation to inform the company about the change in the nature and conduct of the business of the company.
Quarterly updates to the trustee about the servicing of the debenture holders and asset-liability profile of the company.
Functions of the Debenture Trustee
To ensure that the assets of the company and each of the guarantors are sufficient to discharge the principal amount of the debentures at all times.
To verify that the prospectus or the offer letter is consistent with the terms of the debentures or the trust deed.
To ensure that the company does not commit any breach of the terms of the issue of debentures and take remedy steps in case of any breach.
To take all steps to call for a meeting of debenture holder as and when required.
To petition the NCLT at any time when the trustee concludes that the assets of the company are insufficient to discharge the principal amount of the debentures as and when it falls due.
Credit Rating
Under DIP guidelines, no public or rights issue of debt instruments, including convertibles irrespective of their maturity or conversion period shall be made unless credit rating from a credit rating agency ha already been obtained and disclosed in the offer document.
If the issue size exceeds Rs 100 Cr two credit ratings need to be obtained.
Where there are multiple ratings all the ratings need to be disclosed.
All the ratings obtained for public or rights issues of debt instruments and convertibles during the three years preceding the current issue should also be disclosed.
It would enhance the investor confidence
It would help in fine pricing as well.
Creation of Debenture Redemption Reserve (DRR)
Under section 117c of the Companies Act, every company that issues debentures has to create a DRR to which adequate amounts will be credited out of the company’s profits every year until such debentures are redeemed and it cannot be used for any other purpose.
This reserve shall form a part of the general reserve and it enables a company to conserve that much of cash resources after distribution of dividends.
The amount of reserve is normally the face value of the debentures to be redeemed which is built progressively y-0-y.
DRR requirement does not apply to infrastructure companies.
The trustee shall supervise the implementations of conditions regarding creation of DRR.
Creation of Security
Debentures to be issued by companies have to be secured against the assets of the company.
Hence according to DIP guidelines security shall be created within six months of the close of issue of debentures. However if the company does not create any security within 12 months it will have to pay a penalty of 2% interest on the debentures.
If the security is not created within 18 months then a meeting for within 21 days to explain the reasons regarding the non creation of the security and the completion date for the same.
The debenture trustee shall supervise the implementation of the conditions regarding the creation of the security for the debenture holders.
It is necessary for the company to secure the debt securities by way of mortgage of fixed assets or by any other means which needs the approval of the shareholders.
Disclosures in the offer Document
Apart from the normal disclosures to be made in the offer document which has been discussed in the previous lectures additional requirements have to be met with:
The terms of conversion of a convertible into an equity such as the conversion price and time of conversion shall be disclosed.
In case of non-convertible debt the redemption amount, period of maturity and yield to maturity shall be disclosed.
The existing and future equity and long term debt ratio.
The offer document should specifically state the assets on which security shall be created and the security cover to be maintained.
Additional Statutory requirement for Debt Offers
Requirements under the Companies Act
The power to issue debentures can be exercised only at a board meeting.
Issue of debt instruments by a company adds to the borrowings of the company, hence these must be made within the limits approved by the company shareholders. Requirements under the DIP Guidelines
Debenture issues by companies belonging to the same group shall not be permitted if the proceeds thereof are used for replenishment of funds (i.e. to provide loans) or for acquiring shareholding of other companies belonging to same group.
No debt instrument including convertibles can be issued either through public or rights issue unless it is rated by a rating agency.
No convertibles with a conversion period of more than 36 months can be issued unless the conversion is made optional with “put” and “call” options
Conversion price and period of conversion shall be determined at the time of issue and shall be disclosed in the offer document.
The interest rate for the debt instruments can be freely determined by the issuer company.
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