NBFC & Companies Act 2013 w.r.t. issue of Debentures

With the new testament of corporate law, Companies Act, 2013 to be effective from April 01, 2014, NBFC are facing lack of oxygen supply for their survival as to ensure that debenture issuances did not trespass into the domain of public deposits and were beginning to understand that optionally convertible debentures market will die out slowly that the rules have thrown language open to interpretation.

Section 71 of the Companies Act, 2013 along with the rules implies that the debenture issuances have to be secured by specific moveable and immoveable properties. NBFCs may face a rocky time in finding these specific moveable and immoveable properties for issue of secured debenture. 

Section 71 of the Companies Act, 2013 states that –

1.    A company may issue debentures with an option to convert such debentures into shares, either wholly or partly at the time of redemption:

Provided that the issue of debentures with an option to convert such debentures into shares, wholly or partly, shall be approved by a special resolution passed at general meeting

2.    No company shall issue any debentures carrying any voting rights.

3.    Secured debentures may be issued by a company subject to such terms and conditions as may be prescribed (emphasis ours).

4.    Where debentures are issued by a company under this section, the company shall create a debenture redemption reserve account out of the profits of the company available for payment of dividend and the amount credited to such account shall not be utilised by the company except for the redemption of debentures.

    The term ‘specific’ property provided in the rules does not relate to creation of floating charge but implies that there should be a specific and identifiable asset ear-marked for the purpose of creating security.

The term charge on specific (moveable/ immoveable) property cannot be interpreted to mean floating charge as in case of floating charge the asset is not specifically identified. The charge crystallizes at the time of enforcement as opposed to charge on specific property which remains ring-fenced as security and renders priority in claims.

 In general business activities, NBFCs do not have immoveable properties on their balance sheet unlike manufacturing entities which would have land/ plant & machinery etc to offer as charge. NBFCs are financial institutions into the business of lending and their asset sides would be dominated by receivables as moveable property. However, clearly the problem here is that the receivables are amortising in nature and one cannot ear-mark/ ring fence them, call them ‘specific’ to create charge on them for the purpose of issuance of secured debentures.

In the domain of issuance of debentures by NBFCs, optionally convertible debentures will now be public deposits and there are issues of finding the collateral for issuance of secured debentures. The only options left with NBFCs are issuance of compulsorily convertible debentures with no tenure limit on the conversion or contingently convertible debentures or a third instrument that the market may innovate for as they say, necessity is the mother of inventions.