Debentures are debt instruments which may or may not be secured. It is a means of raising finances, one of the most common forms of long-term loans. But still, it is not a loan, as the names suggest, convertible debentures are instruments that gets converted into shares of the issuing company after a pre-defined period. These instruments are for a fixed period and paid interest at a fixed rate; the interest paid on debentures takes preference over the dividends paid to the company’s shareholders. Thus, Compulsorily Convertible Debenture, also known as CCD, is a type of debenture in which the entire value of the debenture must be converted into shares by a specified time. The issuing company decides the ratio of conversion of CCDs at the time of issue of these instruments itself. CCD is a type of hybrid instrument, meaning it is neither considered a pure debt nor pure equity.
Applicability Cases of Compulsorily Convertible Debentures
Analysis of applicable provisions of the Companies Act, 2013
Section 71 of the Companies Act, 2013 (Act) along with Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014 deals with debentures. Section 71(1) permits companies to issue debentures with an option to convert such debenture into shares, either wholly or partly at the time of redemption, provided that it shall be approved by a special resolution passed at a general meeting. Companies can issue CCDs through a private placement offer u/s 42 of the Companies Act, 2013.
While issuing Debentures one must also follow the provisions of “Deposits” under Section 73 of the Act and the Companies (Acceptance of Deposits) Rules, 2014. As per the provisions of Section 73 and Deposit Rules, no private company is allowed to accept deposits from public. Section 2(31) of the Act defines the term ‘deposit’ and states that “deposit” includes any receipt of money by way of deposit or loan or in any other form by a company, but does not include such categories of amount as may be prescribed in consultation with the Reserve Bank of India. Thus, the definition of the term ‘deposit’ under the Companies Act is an inclusive definition and covers all receipts except such categories of amounts as may be prescribed in consultation with the Reserve Bank of India
Accordingly, issuance of Debentures will be categories as acceptance of Deposit under the provision of Companies Act, 2013. However, there are certain categories of transactions which does not fall under the definition of Deposit and therefore will not be required to comply with provisions of Deposit Regulations. As per clause (ix) of Rule 2(1)(c) of the Companies (Acceptance of Deposits) Rules, 2014, any amount raised by the issue of bonds or debentures secured by a first charge or a charge ranking pari-passu with the first charge on any assets referred to in Schedule III of the Act excluding intangible assets of the Company or bonds or debentures compulsorily convertible into shares of the company within ten years – will not be treated as Deposits.
Therefore, the CCDs, which are to be converted into shares, within a maximum period of ten years, are allowed to be accepted as such and not prohibited as Deposit under the Companies Act, 2013.
While issuing CCDs to a Resident Indian or Non-Resident Indian investor provisions of Section 71 read with section 42 of the Companies Act, 2013 and the Companies (Prospectus and Allotment of Securities) Rules, 2014 in respect of “Private Placement” need to be followed.
Analysis of applicability of Foreign Exchange Management Act (FEMA) to CCDs
Foreign Direct Investment (FDI) Regulation defines ‘Capital Instruments’ are equity shares, debentures, preference shares and share warrants issued by an Indian company. Debentures: Debentures are fully, compulsorily and mandatorily convertible debentures. And amendment of the tenure of compulsorily and mandatorily convertible debentures shall be in compliance with the Companies Act, 2013.
Non-convertible/ optionally convertible/ partially convertible instruments, for which funds have been received on or after May 1, 2007, shall be treated as debt and shall confirm to External Commercial Borrowing (ECB) guidelines framed under Foreign Exchange Management (Borrowing and Lending in Foreign Exchange) Regulations, 2000. ECB requires prior approval confirming Loan Registration Number (LRN). Accordingly, under the Foreign Direct Investment (FDI) regime, investment on repatriation basis can only be made into equity shares, compulsorily convertible preference shares and compulsorily convertible debentures (“CCDs”). Instruments which are not fully convertible instruments are considered to be External Commercial Borrowing (“ECB”) and therefore, are governed by ECB regime.
There are Pricing Guidelines Fresh issue of CCDs. Price of fresh issue of CCDs to persons resident outside India under the FDI Scheme, shall be on the following basis:
- the price worked out in accordance with the relevant SEBI guidelines in case of a listed Indian company or in case of a company going through a delisting process as per the SEBI (Delisting of Equity Shares) Regulations, 2009; or
- the valuation of capital instruments done as per any internationally accepted pricing methodology for valuation on an arm’s length basis duly certified by a Chartered Accountant or a SEBI registered Merchant Banker or a practicing Cost Accountant, in case of an unlisted Indian Company.
The pricing of CCDs should be decided / determined upfront at the time of issue of CCDs. The price for the convertible instruments can also be a determined based on the conversion formula which has to be determined / fixed upfront, however the price at the time of conversion should not be less than the fair value worked out, at the time of issuance of these instruments, in accordance with the extant FEMA regulations.
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