Debt Funding under the Companies Act, 2013

The article 'Debt Funding under the Companies Act, 2013' discusses the key aspects of debt funding under the Companies Act, 2013, including the rules and regulations governing debt issuance, the requirements for raising debt capital, and the obligations and responsibilities of companies and lenders. It highlights the importance of compliance with the Act and its provisions to ensure transparency and investor protection in debt financing transactions.

Introduction

The word “Debt” is referred to something that is owed to someone. Meaning thereby, a debt is owed in the form of money or its equivalent in cases of emergent circumstances or any other cause. A company can borrow debt from the market by issuing debentures, bonds, deposits, etc. Usually, debts are secured by creating a charge on the assets of the company this is not the case in equity funding by companies.

A Charge can be created over a single asset for two or more debts. In other words, if an asset of the Company has more value than a debt owed by it, the company can create a charge over the same asset for any subsequent debt borrowed by it subject to the consent of the earlier charge holder of the debt who may allow it or not as the case may. For a well-functioning company, there shall be an ample mix of both equity and debt. In India, Companies who want to issue debt securities shall abide by:

a) Companies Act, 2013 and Rules made thereunder.

b) Securities and Exchange Board of India Act, 1992, and the Rules and Regulations made thereunder.

There are the following ways through which a Company borrows funds under the Companies Act, 2013:

1. Debentures

2. Deposits

3. Loans by a Company from another

1. Debentures or Bonds

A debenture is an instrument acknowledging the debt that a Company owes from Debenture holders. A Company that needs financial assistance but does not want to raise funds by issuing shares, can borrow funds by issuing debentures or bonds in the financial market. The nature of Bonds and debentures are similar the only difference is that bonds are issued by the Government of India or Government Public Sector Undertaking and the interest rates carried by bonds are relatively high in comparison to Debentures.

Comparative Study amongst Shares, Debentures, and Bonds

Procedure to Issue Debentures:

The procedure for Debentures has been enunciated under Chapter IV of the Companies Act, 2013, it is summarised below:

• A Company that desires to borrow funds by way of issuing debentures is required to appoint a debenture trustee to protect the interest of the debenture holders.
• The debenture trustee appointed above, shall not in any manner be associated with the Company or its holding or subsidiary or its associate or another subsidiary of such holding company.
• After, the appointment of the debenture trustee prospectus shall be issued through which applications money is being received by the Company.
• The allotment is made to the consented debenture holders.
• After the allotment is made Debenture trust deed shall be executed in favour of the Debenture trustee by the Company wherein the loan amount (principal as well as interest) is secured by creating the charge over the assets of the Company. The debenture trustee shall in case of failure of the company to repay the debenture holders, debenture trustee directly by making an application to the tribunal along with executed trust deed to secure the interest of debenture holders.
• The company is required to create Debenture Redemption Reserve out of the profits available to distribute the dividend to the shareholders forthwith the issue.
• In case where convertible debentures are issued, subject to such percentage as may be prescribed shall be invested in specified securities.

Note: In case where company opts to issue convertible Debentures it is required the Consent of Shareholders by passing SPECIAL RESOLUTION.

2. Deposits

Deposit is another method by which a Company can borrow debts from the public or members. The word “Members” shall include other companies (Private as well as Public companies) from which a Company can borrow funds. Deposits contain generally higher interest. These are issued in an unregulated market. Every company cannot borrow funds by way of Deposits from the public there are certain eligibility criteria that a company is required to satisfy.

Procedure to Issue Debentures by Private Companies:

A private company can borrow money by way of deposits only to its Employees or Members. The procedure of Deposit issue has been enunciated under Chapter IV of the Companies Act, 2013, it is summarised below:

• A company is required to pass an ordinary Resolution. 
• A Company that desires to borrow funds by way of issuing deposits is required to appoint a deposit trustee to protect the interest of the deposit holders.
• The deposit trustee appointed above, shall not in any manner be associated with the Company or its holding or subsidiary or its associate or another subsidiary of such holding company.
• Deposits may be secured by the principal as well as the interest. In case of unsecured deposits, every document shall contain a quote “Deposits are Unsecured.”
• A Company that wants to issue deposits is required to create deposit insurance covering the amount of deposits. The premium of such insurance shall not be demanded from deposit holders.
• The deposit trust deed shall be executed in favour of the deposit trustee by the Company wherein the loan amount (principal as well as interest) is secured by creating the charge over the assets of the Company. The deposit trustee shall in case of failure of the company to repay the deposit holders, deposit trustee directly by making an application to the tribunal along with executed trust deed secure the interest of the deposit holders
• After that, the Company is required to issue a circular containing the terms of the issue of deposits to the members or employees.
• The copy of such circular is to be filed with the Registrar of Companies and required to be published in the regional and English newspaper having wide circular.
• There shall not be any subsisting default by the company in repayment of earlier issued deposits.
• An allotment is made to the consented deposit holders.
• The company is required to create Deposit Redemption Reserve out of the profits available to distribute the dividend to the shareholders forthwith the issue.

Procedure to Issue Debentures by Public Companies:

A public company can borrow money by way of issuing deposits to the public. The procedure of Deposit issue has been enunciated under Chapter IV of the Companies Act, 2013, it is summarised below:

• A public company can only issue deposits to the public if it has any of the following

     a) Net worth of Rs. 100 Crore or more or

     b) Turnover of Rs. 500 Crore or more

• A company is required to pass ORDINARY RESOLUTION.
• The company is required to obtain a Credit Rating from a Credit Rating Agency.
• A Company that desires to borrow funds by way of issuing deposits is required to appoint a deposit trustee to protect the interest of the deposit holders.
• The deposit trustee appointed above, shall not in any manner be associated with the Company or its holding or subsidiary or its associate or another subsidiary of such holding company.
• Deposits shall always be secured by the principal as well as the interest.
• A Company that wants to issue deposits is required to create deposit insurance covering the amount of deposits. The premium of such insurance shall not be demanded from deposit holders.
• The deposit trust deed shall be executed in favour of the deposit trustee by the Company wherein the loan amount (principal as well as interest) is secured by creating the charge over the assets of the Company. The deposit trustee shall in case of failure of the company to repay the deposit holders, deposit trustee directly by making an application to the tribunal along with executed trust deed secure the interest of the deposit holders
• After that, the Company is required to issue an Advertisement in the form of a circular containing the terms of the issue of deposits to the members or employees.
• The copy of such circular is to be filed with the Registrar of Companies and required to be published in the regional and English newspaper having wide circular.
• There shall not be any subsisting default by the company in repayment of earlier issued deposits.
•  An allotment is made to the consented deposit holders.
• The company is required to create Deposit Redemption Reserve out of the profits available to distribute the dividend to the shareholders forthwith the issue.

3. Loans by a Company from another

A company can make investments in any other company by making it as its subsidiary not more than two layers of subsidiaries subject to such conditions as may be specified. However, in the case where a company wants to borrow funds from another company it is not that easy.

A Company can borrow funds from members or its employees or other companies or the public, or any financial institution. However, in the case where a company borrows funds from another corporate entity, it is not unregulated, unlike the deposit market. A company is not entitled to obtain loans from any other Company however, if certain conditions are satisfied, it is allowed.

Procedure to Make Loans by a Company:

The Procedure of loans by a Company has been enunciated under Chapter XII of the Companies Act, 2013, it is summarised below:

• A company making investments shall not be defaulted in payments of deposits or interest thereon.
• A company can give Loan or Guarantee or Acquire securities in any body corporate by passing a Resolution having No vote cast against it in its Board meeting if case the following conditions are satisfied:

   a) Upto its Paid-up Capital, Free Reserves, and Securities Premium Account or,

   b) Upto 100% of its Free Reserves and Securities Premium Account,

    Whichever is more

• In the above case, where a company has obtained the loan and its repayment of amount or interest or any installment is pending, it is required to obtain prior approval from the financial institution.
• A company can give Loan or Guarantee or Acquire securities in any body corporate by passing a SPECIAL RESOLUTION if case the following conditions are satisfied:

   a) Exceeding its Paid-up Capital, Free Reserves, and Securities Premium Account or,

   b) Exceeding 100% of its Free Reserves and Securities Premium Account,

     Whichever is more

In the above case, it is mandatory to obtain the prior approval of the financial institution whether there is any default in the loan and its repayment of amount or interest or any installment or not.

The borrowings or investments shall be by the company at an arms-length price.

References

[1] The Companies Act 2013

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