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Brief note of different types of Debentures

A company for its extension and development may require to raise funds without increasing its share capital. The company may invite the public by open declaration to lend money for a fixed period at a declared rate to be paid on such money. Debenture is an instrument in writing given by a company acknowledging the liability for the total amount received as a result of issue of debentures and agreeing thereby to pay the money raised after the expiry of the stipulated period at a certain rate of interest per annum. The Companies Act Defines debentures as “debenture includes debenture stock, bonds, or any other securities of a company, whether constituting a change on the assets of the company or not.”

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Types of Debentures

Debentures may be classified from different point of view:

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(1) From security point of view

Debentures may be Naked or Mortgage debentures from this point of view. Naked or Simple Debentures are those debentures which do not carry any security in respect of repayment of interest or the principal. The general solvency of the company is the only security for the holders of simple debentures. Mortgaged Debentures are the debentures which are secured by a charge on the asset or properties of the company. The debenture holders have the right to recover their principal amount as well as unpaid interest out of the assets mortgaged by the company.

In case of mortgage debentures, a company may prefer to appoint trustees who will hold the property given by way of security in trust for the benefits of debentures holders. A trust deed for debenture holder is desirable keeping in view their interest. It is not possible to give each debenture holder the title deeds of the mortgaged debentures issue and hands over the title deeds of the property mortgaged to the trust created for debenture holders.

(2) From Permanence point of view

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From this point of view the debentures may be Redeemable or Irredeemable debentures. Redeemable debentures provide for the payment of principal amount on the expiry of certain period. Redeemable debentures can be reissued even after they have been redeemed until they have been cancelled. Irredeemable Debentures are retained as a part of the permanent capital structure during the life time of the company. Such debt becomes due for payment only when the company goes into liquidation or when the payment of interest is not made regularly. The company has the option of canceling its liability to the debenture holders at any time by giving due notice to them.

(3) From priority point of view

From this point of view the debentures may be First and Second debentures. First Debentures are those debentures which are paid first before any payment is made to another type of debentures. Second Debentures are those debentures which are paid after making the payment of first debentures.

(4) From recording point of view

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Debentures may be Bearer or Registered debentures from this point of view. Bearer Debentures are transferable per bearer without endorsement and they are just like bearer cheques or government currency notes. They are treated as negotiable instrument and transferable by mere delivery. It is not necessary that transfer of such debentures should be registered with the company. The interest is paid to the holder irrespective of identity. Registered debentures are made out in the name of a particular person who is registered by the company as a holder and are transferable in the same way as shares. The payment of interest and repayment of capital is made to those whose name are registered with the company and duly entered in the register of debenture holders.

(5) From conversion point of view

From this point of view debentures may be convertible or non-convertible. Convertible debentures given an option to debenture holders to convert them into equity or preference shares at a stated rate of exchange after a certain period. Non-convertible debentures are not convertible into equity or preference shares afterwards. Convertible debentures are very popular these days with the companies as it provides them a major source of permanent working capital. It also provides safety, liquidity, capital appreciation and assured return to the investors.

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