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«v CAPITAL FORMATION: SHARES AND DEBENTURES o Introduction o Capital Formation, Market Trend o Banks and Money Supply Capital Investment Profitability ...»

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The Central Government initiated steps to secure expert opinion on these problems in order to find out ways of creating a secondary market for debentures in the country so that the debentures may emerge as a fruitful second source of funds for companies. As a sequel to this policy, the Reserve Bank of India set up a committee under the Chairmanship of Mr. N.N. Pai, Chairman of the Industrial Development Bank of India.

In the light of the recommendations of the N.N. Pai Committee,

the Controller of Capital Issues issued on April 17, 1982 (Third Guidelines) revised Guidelines. The Press Release stated as follows:

"Government has issued revised guidelines for issue of debentures to the public by public limited listed companies. The revised guidelines make a distinction between convertible and non-convertible debentures in respect of ceiling on the interest rate. While the existing 13.5 per cent interest is maintained for the issue of convertible debentures, Government have increased the ceiling on interest rate to 15 per cent per annum in the case of non-convertible debentures. The incentive of 1 per cent has been withdrawn for all debentures. In order to make the nonconvertible debentures attractive, a premium up to 5 per cent of the face value of debentures may also be allowed by companies at the time of redemption of these debentures?".

Thus, the guidelines, of 1982 revising the earlier guidelines of October 27, 1980, contained certain positively attractive features. For instance it contained clear-cut distinction between convertible and nonconvertible debentures from the standpoints of ceiling on the interest rate and the bait of premium at the time of redeeming non-convertible debentures. Certain concessions hitherto enjoyed by convertible debentures were withdrawn and thus the non-convertible debentures were treated more favourably. Since then certain clarifications and modifications in those guidelines have been made by the Controller of Capital Issues. For the convenience of investors and companies the Government decided to up-date the guidelines issued in 1982.

16. Press Release No. S 11(13)-ccr (II) 81 dated April 17, 1982 published by Controller of Capital Issues, Government of India.

CAPITAL FORMATION: SHARES AND DEBENTURES

The revised Guidelines of 1984 were issued by the Ministry of Finance'? in supersession of 1982 Guidelines. They apply to the issue of secured convertible as well as non-convertible debentures by public limited companies and public sector companies. Some of the salient

features are summarised as follows:

(i)' The debentures can be issued for one or more objects e.g.

setting up of new projects, expansion of diversification of existing projects, normal capital expenditure for modernisation, merger or amalgamation of companies, restructuring of capital, acquisition of capital and to augment long term resources of the company.

(ii) The amount of issue of debentures in the case of working capital requirements shall not exceed 20 per cent of the gross current assets, loans and advances. In the case of over subscription of the issue of debentures the companies may be permitted by the Controller to retain subscription for nonconvertible debentures upto a maximum of 50 per cent over the original issue.

(iii) The debt-equity ratio shall not normally exceed 2:1. Any relaxation in this norm will be considered favourably for capital-intensive projects such as fertilizers, petro-chemicals, cement, paper, shipping, etc.

(iv) In the case of convertible debentures the rate of interest shall not exceed 13.5 per cent per annum. In the case of nonconvertible debentures the rate of interest shell not exceed 15 per cent per annum.

(v) Debentures shall not normally be redeemable before the expiry of the period of 7 years except in certain specified cases.

(vi) A premium upto 5 per cent of the face value can be allowed at the time of redemption in the case of non-convertible debentures only.

(vii) The face value of the debentures will ordinarily be Rs. 100 each.

(viii) The debentures shall normally be listed on the stock exchanges except in certain specified situations.

17. Issued by the Ministry of Finance, Department of Economic Affairs, Office of the Controller of Capital Issues vide No. S. 1t(9)-CCI(W 84, dated 15.9.1984.

See also Ministry of Finance Annual Report 1984-85, p, 24.

220 GOVERNMENT REGULATION OF CORPORATE SECTOR

(ix) Only secured debentures will be permitted for issue to the public.

(x) The issue of debetures shall be underwritten. A relaxation may be permitted by the Controller of Capital Issues.

(xi) Certain requirements are relating to listing of shares of companies proposing debenture issues. The shares of the company proposing to issue debentures must be listed in one or more stock exchanges and the market quotation of its shares must have been at or above par value during 6 months prior to the date of application for the issue of debentures. Simultaneous listing of shares and debentures of companies will also be permitted.

(xii) Linked issue of shares and debentures may be permitted only in cases where the interest rate offered in respect of nonconvertible debentures is not more than the maximum rate prescribed for the convertible debentures. Simultaneous issue of equity and convertible/non-convertible debentures may be permitted provided the investors are free to subscribe to either shares or debentures or both at their option.





(xiii) Regarding extra incentives it is pointed out that the schemes which aim at providing an interest rate exceeding 13.5 per cent, but which have built-in features of the convertible debentures issue, will not be permitted. Similarly provisions of nonfinancial incentives which result in restricting the access to a company's products by the general public or which have other undesirable features, will not be permitted.

The real attraction of the 1984 guidelines to prospective investors can be found in the interest rate and the premium at the time of redemption on non-convertible debentures. The guidelines provide that in the case of convertible debentures the rate of interest shall not exceed 13.5 per cent per annum and in the case of non-convertible debentures the rate of interest shall not exceed 15 per cent per annum. Apparently the policy aims at making non-convertible debentures more attractive by allowing a higher rate of interest. In addition to this a premium upto 5 per cent of the face value of non-convertible debentures can be allowed at the time of their redemption. This provision dearly supports the promotion of non-convertible debentures. It is further provided that the debentures shall not be redeemable before the expiry of a period of seven years. As a result of this stipulation, which is mandatory, the shortest maturity period for redemption of debentures can be seven years. The seven years period must apply to all secured debentures of

CAPITAL FORMATION : SHARES AND DEBENTURES

public listed companies whether placed privately or otherwise. In view of the government's policy of encouraging investment habit and thereby channelising savings into the desired directions, the guidelines provide that the face value of the debentures will ordinarily be of Rs. 100 each.

All these guidelines concur with one basic condition that the debentures shall be listed on one of the recognised stock exchanges. This is in order to enhance the degree of confidence of the investing public in such securities as well as for better marketability resulting in liquidity. It is also an essential condition that the company intending to issue debentures must be listed in one or more recognised stock exchanges. It has further been provided that the market quotation of equity shares of company must have been at or above par value during the six months prior to the date of application for issue of debentures.

As regards underwriting of debentures, Clause 11 of the 1984 Guidelines provides in a mandatory tone that the issue of debentures shall be underwritten provided if the Controller of Capital Issues is otherwise satisfied that the issue need not be underwritten.

A predominent concern of the government for public interest is vividly manifest in all the guidelines which put forth their predilection for secured debentures. The government after witnessing several instances of investor's woe emanated from investment in unsecured fixed deposits, adopted the policy of encouraging issue of only secured debentures to the public. Thus the government regulation has instilled considerable confidence in the mind of the investing public and safeguarded their interest in corporate sector.

The 1984 guidelines on debenture issues are certain to reduce still further the private corporate sector's reliance on institutional loans, since unlike the April 1982 guidelines which restricted debenture issues to expansion, diversification and long-term working capital needs, they allow debenture issues to be made for several other purposes. The nonconvertible debentures have emerged as a major instrument of primary capital mobilisation by the corporate sector.

It may, therefore, be stated that while raising capital in the private sector there is a growing trend towards preference for the issue of debentures by the public limited companies". An important factor responsible for the popularity of the convertible and non-convertible debentures, as compared with other modes of raising capital, is the financial benefit enjoyed by both the issuing company and the investing public, A See KC. Ramachandran, "Promoting Debentures at the cost of Equity", 18.

Finanelal Express, Sept. 29. 1984, p, 5.

222 GOVERNMENT REGULATION OF CORPORATE SECTOR

comparative analysis of the various modes of raising capital, as stated in Table Nos. 5.2, 5.8 and 5.9, will further support the merits of the convertible debentures.

Conversion of Preference Shares into Debentures : The prominance and popularity of debentures attracted preference shareholders to consider the conversion of their capital investment into debentures. The beneficial financial returns and tax benefits are the twin factors responsible for the popularity of debentures. Low financial return on prcferance shares is considered disappointing by the shareholders. There are a number of companies which have not been able to declare and pay even this low-dividend for years together. They have also not been able to redeem the shares on maturity dates. In order to deal with such hardship of the irredeemable preference shareholders, inspite of existing provisions of the Companies Act, even the Sachar Committee suggested for suitable amendments in the Companies Act to provide compulsory redemption of these shares.

An analysis of the financial and legal implications of the conversion of preference shares into debentures will be fruitful to understand the meritorious position of one over another. The shareholders feel that such conversion will not only benefit them financially but will also entitle them to the payment of interest regularly, which would not be dependent on distributable profits, but would also give them a better right in their capacity as a creditor of the company. It is also pointed out that the company will also get sufficient relief as the interest paid by the company on debentures would be a deductible expense for tax purposes.

According to the provisions of sub-section (1) of Section 80 such conversion is not permitted. It provides that the preference shares shall be redeemed only out of profits of the company which would be otherwise available for dividend, or out of the fresh issue of shares made for the purpose of redemption. The conversion may thus be tentamount to redemption of preference shares, which cannot be done except out of the profits or out of the proceeds of the fresh issue of shares. On the other hand in view of Section 106 though the conversion may be legally valid, it may require long time to implement it. Under Section 106 the rights, attached to the shares of any class of a company, can be varied with the consent in writing of tbe shareholders of not less than 3/4th of the issued shares of that class or with the sanction of a special resolution passed at a separate meeting of the holders of the issued shares of that class. However, this could be effective only if a provision in respect of such variation is contained in the Memorandum or Articles of Association of the company. It may therefore be possible under Section 391 to

CAPITAL FORMATION: SHARES AND DEBENTURES

convert preference shares into debentures under a scheme of compromise and arrangement. Under Section 391 the court has wide powers and it may pass various orders. Apart from this, it will also be necessary for the company to obtain prior permission of the Controller of Capital Issues and the Company Law BOard. The scheme of any compromise and arrangement may also be challenged by dissenting shareholders or dissenting creditors by filing a petition for winding up before the High Court. Thus, the whole legal process for conversion will creat many difficulties and will also be very much time consuming. The conversion of arrears of dividend may not be legally permitted.

In the light of the legal complications and financial implications as well as the recommendation of the Sachar Committee the matter, relating to conversion of preference shares into debentures, requires further government regulation by amending the Companies Act.

Convertible and non-eonvertible Debentures: The convertible debentures have attracted investors and corporate financial management to finance the working capital requirements as they are beneficial to both of them.

The convertible debentures are preferred by the investors as there is no gestation period for return. The investors have also an option to convert a part of their investment in bonds into equities at a pre-determined price after a specified period and such conversion price is generally lower than the market price of shares. Interest on convertible debentures is also attractive at 13.5 per cent with an extra 1 per cent for the year where equity dividend exceeds a certain limit. The investors require an ideal combination of high yield, low risk and potential capital appreciation and safety of the amount invested. All these benefits are available by investing in debentures.



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