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Debentures and Types of Debentures

A document which creates a debt or acknowledges it is termed as a debenture. The debentures form the medium and long term instruments used by large enterprises for borrowing money from the market. Other terms for debenture are note, loan stock or bond. The money raised by issuing debentures forms a part of the capital owned by an enterprise. The debenture can be said to resemble a certificate of loan which is evidence to the fact that the company has to pay a certain amount with the interest.

Debentures can be transferred by the debenture holder on his wish. The debenture holders can have separate meeting, votes etc, on small number of issues (for example on changing the rights attached to the debentures), but are not given the right to vote in the general meetings of shareholder’s. The interest which is paid to the debenture holders is shown in the financial statement of the company as the charge against profit.

Key attributes of debentures:

It is a movable property.

It may or may not create a charge on the assets of an enterprise.

The debenture is issued in the form of certificate of indebtness by the enterprise.

A debenture clearly specifies the date of redemption, interest on the specified dates as well the principal’s repayment.

The debentures can be classified on the basis of:

1 Convertibility, and

2. Security

Classification of debentures on the basis of convertibility

Fully convertible debentures or FCD- these are the convertible bonds or bonds which can be converted to equity shares after a specific predetermined time. By adding the convertibility quotient, the companies make the bonds more attractive to the buyers. These debentures can thus be converted easily by the holders. The convertible debentures have lower interest rates when compared to non convertible debentures.

Non convertible debentures or NCD- these from the regular debentures which cannot be converted to equity shares of the company which is liable. They have higher interest rates as compared to convertible debentures.

Partly convertible debentures or PCD-a part of these debentures or instruments can be converted into the equity shares, if the issuer notices for the same. The ratio of conversion is to be decided by the issuer and is normally decided when it the debenture is subscribed.

Optionally convertible debenture or OCD- this debenture provides the investor with an option to convert them to shares, at a price which is decide by the issuer and is agreed upon when the debenture is issued.

Classification of debentures on the basis of security

The secured debentures- these instruments are secured by a charge levied on the fixed assets of the company which is issuing them. The assets of the company can be sold if it fails to pay the principal or loan amount.

Unsecured debentures- no security is provided in these debentures and the investor has no option but to remain with other unsecured creditors when the company defaults on paying the principal and the loan amount.

Security of debentures in different jurisdictions-

Asia-the loan document is called mortgage when the repayment is secured by a charge over land, a debenture when the repayment is secured by a charge which is against the other assets of the company. In cases which involve no security, the document is termed as unsecured deposit note.

United States of America- in USA, only the unsecured corporate bond is termed as the debenture. In case security is provided for the bond, it is called as a mortgage bond.

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