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1 Are the secured debentures really secured? on Thu 11 Oct 2012 - 18:04


CSoC King
CSoC King


There are several types of debentures, but basically there are two kinds of debentures viz. Secured and Un-secured debentures.

A company is permitted to issue secured debentures in accordance with the provisions of the Companies Act, 1956 (the Act). A listed company also has to follow SEBI regulations. The very term ‘secured debenture’ tends to raise visions of an instrument in which the amount invested would not be lost as the same is secured. In other words, investors tend to believe that investment in secured debentures is safe as the company creates a charge on its assets, thereby assuring the investors that their moneys are safe. Is that the reality? Are the secured debentures really secured?

First of all, every investor needs to realise that there is nothing like safe investment. Every investment entails a degree of risk, which would vary, depending upon the nature, terms and conditions of the instrument, background of the promoters, etc. Even assuming that secured debentures are issued by one of the best companies in the country, still there is no guarantee that the debentures would be redeemed on the due date.

While the regulators are aware of the pitfalls of the so-called ’secured debentures’ and have been taking steps to strengthen the law. The Act was amended in 2000 and more stringent provisions have been made for companies intending to issue debentures. Even the trustees are sought to be made more accountable so as to ensure that they protect the interests of investors.
So far as listed companies are concerned, they have to adhere to SEBI guidelines as well. A listed company cannot make a public or rights issue of debt instruments unless credit rating from a credit rating agency has been obtained and is disclosed in the offer document. A trust deed has to be executed by the issuer company in favour of the debenture trustees within six months of the closure of the issue.

Similarly, the merchant banker is required to file with SEBI, along with the draft offer document, a certificate from the company’s banker that the assets on which security is to be created are free from any encumbrances.

Alternatively, a No-objection Certificate has to be obtained from the financial institutions or banks for a second or pari passu charge in cases where assets are encumbered.

Even trustees have been given certain duties under the Act. A debenture trustee has to ensure compliance with the following, that:

(a) The lead financial institution monitors the correct utilisation of funds raised through debentures.

(b) The lead bank for the company has to monitor the debentures raised for working capital funds.
In addition, the trustee is required to obtain a certificate from the company’s auditors:

(i) In respect of utilisation of funds during the implementation period of projects.

(ii) In the case of debentures for working capital, certificate has to be obtained at the end of each accounting year.
In fact, the law also requires the debenture trustees to supervise the implementation of the conditions regarding creation of security for the debentures and the debenture redemption reserve.

However, in spite of the various measures provided by the Department of Company Affairs (DCA) and SEBI, the interests of investors in secured debentures is hardly protected. The case in point is the debenture issue made by Essar Oil (the company) in 1995. The company issued debentures with a coupon rate of 14.5% ; a very attractive rate and as a result nearly three lakh investors put their hard-earned money into these debentures. The scheme looked very good as, apart from offering good return on investment, the debentures were secured and were being issued by a reputed company. Moreover, they were to be redeemed in April 2003.

Unfortunately for the three lakh investors in Essar Oil, reality turned out to be grim as the subsequent events have proved. After paying interest for some years, the company regularly defaulted in meeting its obligation towards the debenture-holders. In fact, since 1999, the company virtually stopped paying interest on the secured debentures issued by it. But more trouble was in store for the hapless investors. Recently, in April 2003, when the debentures were due for redemption, instead of repaying the debenture amount, the company came up with a scheme of arrangement. The substance of the scheme being that the debenture holders would have to take a severe hit. This has happened notwithstanding all the laws and regulations available to protect the interests of investors in debentures.

The investors, particularly small investors, should note that the case of Essar Oil is neither the first nor a unique case. During the last five decades, there have been several companies who have failed to honour their commitment towards debenture holders. Many have defaulted in redeeming the debentures, while several others were unable to pay even the periodic interest payable on the debentures.

Hence, the moral of the story is that, an investor should not be misled by the fact that when a debenture is secured against the assets of the company means it is a safe and secure investment. Even the so called reputed managements can badly let down the investors, as has happened in several cases. Remember, with the markets booming, many companies are planning to once again tap the market. Whether it is equity shares or secured debt instruments, unless you are extremely cautious, once again you will be running the risk of loosing your hard earned money.

(The author is a practising Company Secretary)

Have a happy learning.


CSoC Master
CSoC Master
Good question and very nice answer..


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