Procedure of converting debentures into shares

The term Conversion of Debentures into Shares denotes a process under which a Debenture Holder decides to become a Shareholder of the company by converting his/ her Debentures into Shares. Further, after becoming a Shareholder in the company, the said person will get the Right to Vote.

In this blog, we will discuss the concept of Conversion of Debentures into Shares and the Procedure for the same.

Concept of Debentures

The term “Debenture” denotes a Long Term Security having a Fixed Interest Rate, issued by a Limited Company against the Assets. In other words, Debentures denotes a Certificate Loan issued by a company at a Fixed Rate of Interest.

Further, Section 2(30) of the Companies Act 2013 defines the term “Debenture” as a Debenture Stock, bond, or any other instrument issued by the company for evidencing a debt.

Moreover, Section 71 of the Companies Act 2013 and Rule 18 of the Companies (Share Capital and Debenture) Rules 2020 acts as the Regulatory Framework for the Issue of Debentures.

FOR YOUR KNOWLEDGE:

A convertible debenture is defined as one of the types of loan which is issued by a company that can be converted into a stock. In Compulsorily convertible debenture the cost of the debenture is converted into an equity share within a fixed period of time. It is also known as CCD. CCD is not a combination of pure debt or pure equity. During the issuance of the company, the CCD decides at which rate the ratio of conversion will be there from debentures to equity share capital.

Concept of Equity Shares

The Equity Shares are the primary source of finance for the Company. The Equity Shares give investors the right to vote, profit sharing, and claim on the assets.

They are also called the Ordinary Shares in the Company. No preference is given to these shares regarding the payment of Dividend and while repayment of Capital. The Equity Shareholders are real owners of the Company. Section 43 (a) of Companies Act, 2013 talks about Equity Shares and states:

• With voting rights; or
• With the right to Dividend, as prescribed by the rules of the Act.

Conditions of conversion of Debentures into equity shares

As per the Rule, 18 of Companies Act, 2013, for debentures following conditions need to be met before issuing Secured Debentures. Also, it should be noted that Rule 18 is applied only on secured debentures.

• The secured debentures will be only be issued by the company if the redemption date is less than or equal to 10 years. Only companies dealing in infrastructure projects, non-Banking Financial Companies, Infrastructure Debt Fund and companies permitted by central Government or Ministry or RBI can issue secured debentures for more than 10 years and less than 30 years.
• The debentures are secured by charge creation that has the payment value of debenture and interest in it.
• The creation of charge will be in name of debenture trustee
• The role of the trustee of the debenture and required qualification should be mentioned clearly.
• The Debenture Trust Deed should be per Form Sh-12 or as near to it as possible
• The company aspiring to create DRR will invest or deposit a sum which is approximately 15% of the debenture amount that is to be matured on 31st March of next year, before April 30th.
• The rule does not apply on any amount received against commercial paper issuance by the company or any other instrument of related variables that are per the notification, guidelines, or regulations issued by RBI.
• This rule is not applicable to the Foreign Currency Convertible bond issued as per the directions or regulations of RBI or foreign currency convertible Bonds and Ordinary Shares Scheme, 1993.

Advantages of Compulsorily Convertible Debentures

There are many advantages of Compulsorily Convertible Debentures like;

• Security Debt- investors are encouraged to put money in CCD as it comes with the promise of conversion to equity shares at the specified time. Also, the conversion of debentures to equity shares is seen in co-relation with the performance of the company by many investors. It Implies that the company only converts the CCD to shares if it has achieved the undertaken growth. If the investors do not observe the achievement of milestone then they can either exercise the put option subject or increase the stake as agreed between parties.
• Discount and Pricing- thanks to the CCD issuance the need for straight away fixing the portfolio evaluation has been eliminated. As the investor’s investment is at a nascent stage of Portfolio Company, they are offered a discount to the valuation of the next round of investment on the issued CCD at the issuance time, by the company.
• Rate of Interest- the rate of interest paid by the company is lower than the rate of interest paid on the Non-convertible Debentures because issued CCD’s were offered at a discount price. Also with CCD comes tax benefit as at the time of Portfolio Company’s income tax computation, the interest paid to the CCD holder is deducted from income.
• Preferential Payment- Preferential right to payment over shareholders goes to CCD holder because of them being the form of debt and not equity as long as they are not converted into equity shares.
• Cap Table- if compared to the investment made by the Portfolio Company’s existing shareholders and promoters in the traditional equity shares, investment through CCD is much more lasting, as promoters and shareholders face immediate dilution on receiving the due investment whereas in the case of CCD dilution in the cap table is deferred until their conversion to equity shares.
• Debenture Reserve- as per the Companies Act, 2013, for secure payment to be made for Non-Convertible Debenture redemption, Debenture Redemption Reserve, appointing a trustee for Debenture, Debenture Trust Deed, etc. is put in place. However, no such conditions are needed for CCD issuance by the portfolio Company.
• The Foreign Direct Investment-FDI has observed a shift in the investment behavior of the investors for the past decade from equity investment to investment through the convertible instrument, for which CCDs can be given a credit for.

Procedure of converting debentures into shares

• Articles of Association of the Company should allow for Conversion option.
• Hold Board Meeting and pass the Board Resolution for Conversion of CCD into Equity Shares along with approving Notice of Genernal Meeting for the approval of Shareholders of the Company.
• Hold General meeting of the Shareholders of the Company and pass the Special Resolution for Conversion of CCD into Equity Shares. According to Section 62 of the Companies Act, 2013 it is mandatory to prepare an explanatory statement for the special resolution. The statement should contain all the necessary information of Conversion.
• Within 30 days of passing a Special Resolution need to file Form- MGT-14 with the Registrar of Companies.
• A letter of an option of the same is sent to the compulsorily convertible debenture holders. It is the duty of the secretary to verify same consent sent by the debenture holders for the conversion.
• After this company needs to  receive the valuation report for conversion.
• The allotment of a share should be completed within 12 months from the date of the passing of the special resolution. The price of the share is determined based on the valuation report.
• As per Form SH-1, it is mandatory to prepare and issue share certificate.
• The share certificate is issued to holders and the names are entered in the Register of Members.
• Within 30 days of allotment of Form PAS-3, a return allotment of securities should be filed with the Registrar. The fee should be given according to the Companies (Registration Offices and Fees) Rules, 2014 along with the list of complete holders.
• The list of paper required in for the return of allotment of PAS-3 is a list of allottees, a copy of the board of resolution, a copy of the special resolution and valuation report

Conclusion

The provisions of the Companies Act, 2013 authorizes for the process of Conversion of Debentures into Shares. Further, the main reason as to why a company chooses this type of conversion is the economic benefit to the shareholders.

The Procedure for the Conversion of Debentures into Shares is a Tiring, Intricate and Time-consuming task. We at Legal Window have an experienced and qualified team of professionals to assist you with the Procedure of Conversion. Our experts will not only plan ideally but will make certain the successful completion of your work.