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

The Companies Act, 2013 is turning out to be opening a pandora box for non-banking finance companies (NBFCs). So long the NBFCs were struggling to ensure that the 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 draft rules have thrown language open to interpretation.
 

The reading of the Section 71 of the Companies Act, 2013 read with the draft rules indicates that the debenture issuances have to be secured by specific moveable and immoveable properties. NBFCs may have a hard time in finding these specific moveable and immoveable properties for secured debenture issuances. To throw some light on the issue, it is pertinent to read the text of the section and the extract of relevant draft rules as reproduced below.
 

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 draft rules 4.16 applicable for section 71 (3) states that –
 

Debentures
 

4.16. (1) For the purposes of sub-section (3) of section 71, no company shall issue secured debentures unless it complies with the following conditions:
 

(a) An issue of secured debentures may be made, provided the date of its redemption shall not exceed 10 years from the date of issue. 
Provided that a company engaged in the setting up of  infrastructure projects may issue secured debentures for a period exceeding ten years but not exceeding thirty years;

(b)  such an issue of debentures shall be secured by the creation of a charge, on the properties or assets of the company, having a value which is sufficient for the due repayment of the amount of debentures and interest thereon;

(c)  the company shall appoint a debenture trustee before the issue of prospectus or letter of offer for subscription of its debentures and not later than 60 days after the allotment of the debentures, execute a debenture trust deed to protect the interest of the debenture holders ; and

(d)  security for the debentures by way of a charge or mortgage shall be created in favour of the debenture trustee on-
 

(i) any specific movable property of the company (not being in the nature of pledge), and/or
 

(ii) any specific immovable property wherever situate, or any interest therein.
 

The whammy
 

As mentioned, the reading of the section and the draft rules indicate that there has to be specific moveable/ immoveable property for security creation. The term ‘specific’ property 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 crystallises at the time of enforcement as opposed to charge on specific property which remains ring-fenced as security and renders priority in claims.
 

For anyone understanding the business and functioning of NBFCs it will be a no brainer to realise that 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.
 

What’s left on platter?
 

While the rules have not been enforced, if we were to consider that the final rules would contain the language same as draft rules, the conclusion that can be drawn is pretty clear. 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.
 

(Nidhi Bothra is executive vice president at Vinod Kothari & Company)