On June 3rd 2021, Britannia Industries allotted unsecured, non-convertible redeemable, fully paid-up debentures as bonus debentures to its equity shareholders to raise 698.51 Crores as per the scheme of arrangement. These debentures can be redeemed after 3 years and are proposed to be listed on the Bombay Stock Exchange and the National Stock Exchange. The issue of these bonus debentures offers advantages to both the shareholders and the company.
These are Issued out of the accumulated profits of the company, bonus debentures are issued free of cost to the shareholders of the company, in proportion to the shares held by them. These are issued as a reward to the shareholders. However, unlike other rewards like bonus shares and dividends which are governed by Section 63 and 123-127 of the Companies Act, 2013 respectively, there is no express regulatory provision governing the issue of bonus debentures.
This article aims to analyse the regulatory regime which allows for the issue of bonus debentures and the rationale behind the same. It also aims to analyse the reason why companies in India have usually refrained from issuing them, and what regulatory gaps need to be looked into to bring about a change.
REGULATORY FRAMEWORK BEHIND ISSUE OF BONUS DEBENTURES
Unlike more commonly-heard rewards given to the shareholders including bonus shares, dividends etc., the term ‘Bonus Debenture’ is not defined in the Companies Act, 2013 or the previous 1956 framework. However, Section 2(22)(b) of the Income Tax Act, 1961 considers the distribution of debentures from the accumulated profits of the company within the purview of dividends. This provides certain legal recognition to the concept of bonus debentures.
Owing to the lack of any specific provision dealing with the issue of bonus debentures, it is done by the companies in accordance with a scheme of the arrangement, under Section 230 of the Companies Act, 2013. This section explains the scheme of arrangement as an arrangement or compromise proposed between the Company and its members and/or creditors. In several cases like the Re Indian Petrochemicals, the courts in the country have held that the term ‘arrangement’ as used in the Act is a very broad term. The 1956 Act, through the parallel provision (Section 394), mandated such a scheme of arrangement for any scheme of reconstruction. In its spirit, this would include the issue of bonus debentures, since such an issue brings about a change in the debt (liability) to asset ratio of the company as accumulated profits are transferred to the debit account.
In accordance with Section 230 of the Act, the scheme is to be approved by the Board of Directors of the Company, with a board resolution to that effect. This Section also states that in case such a scheme of arrangement is proposed, the National Company Law Tribunal (NCLT) shall call for a meeting between the creditors and the members of the company for voting upon the scheme, and lists out necessary disclosure requirements. It states that in case such a meeting is called for, a notice must be sent out to all the members, creditors and debenture-holders of the company, along with the Securities and Exchange Board of India (SEBI) and other regulators, if required.
If the scheme of arrangement is agreed to by the members and the creditors in the meeting, it then must be sanctioned by the NCLT, which will give an order to this effect. Additionally, in case the company wishing to issue bonus debentures is a listed company, it is also required to obtain approvals from the stock exchanges in accordance with Regulation 37 of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015. Once, the approvals are obtained, the company can go ahead and issue the bonus debentures after filing the scheme with the Registrar of Companies.
In case the debentures are to be listed, compliance with provisions of the Debt Listing Agreement is to be ensured. Further, bonus debentures may be secured or unsecured (i.e., backed by assets or not, respectively). Listed debentures are always secured and accordingly must comply with provisions regarding the creation of debenture redemption reserve and debenture trustees as provided in Section 71 of Companies Act 2013, and rule 18 of the Companies (Shares and Debentures) Rules, 2014.
RATIONALE BEHIND THE ISSUE OF BONUS DEBENTURES
Bonus Debentures are issued by a company by capitalising its excess cash reserve, i.e., profits available for distribution to its shareholders. It bears advantages for both the issuing company and the eligible shareholders.
The primary advantage for the company is that unlike the issue of dividends, the issue of bonus debentures does not lead to an immediate outflow of cash. Thus, the company can reward its shareholders and plan appropriately for the deferred cash outflow, which would accrue upon the maturity of the debentures. The issue of bonus debentures also prevents equity dilution which occurs upon the issue of bonus shares, thus preventing the dilution of the shareholding and earnings per share. Since, bonus debentures lead to an increase in the debt capital of the company, instead of the equity capital, the return on equity also improves. This may send out a positive signal since it implies that the company can fulfil its debt obligations through cash flows and generate greater returns for the shareholders. This also leads to an increase in return on equity due to financial leverage as despite the decrease in after-tax profits, the division is amongst a smaller equity base which would have increased if bonus shares had been issued instead. Further, because bonus debentures are treated as dividends for tax purposes, they are no longer taxed in the hands of the company. Moreover, since the interest paid to shareholders on the debentures is tax-deductible, the company can save on its tax expenses.
For shareholders (now also the debenture-holders), the bonus debentures act as an additional reward which provides them with yearly interest till the maturity of the cost-free debentures, when they receive the value of the debentures. Also, in case the debentures issued are secured, the claims of debenture-holders get priority over other unsecured creditors. Moreover, when listed, they also give enough liquidity to the debenture-holders to sell them in the market, as and when they wish. However, interest and the value of debentures is taxable in the hands of the shareholders.
ANALYSIS AND CONCLUSION
Britannia Industries in its petition to NCLT stated that in the past several years, it has maintained profitable growth and built up substantial accumulated profits. The company believes that even after accounting for all its current and future capital and cash needs, it still has an excess of reserves. Using this excess, it wishes to reward its members in these difficult and unprecedented times brought by COVID-19. Recognising the need to retain liquidity given the challenging business environment, the company decided to declare bonus debentures for its members.
This sends a positive message to the shareholders of the company as it shows concern for them while retaining cash for immediate use in the hard times and offering the advantages as discussed in the preceding section. Recognising the positive aspect of the same, Britannia Industries has issued such debentures in the past as well. However, Britannia Industries is one of the very few companies in the country which have ever issued bonus debentures as a reward to their shareholders. The other companies are Hindustan Unilever, Blue Dart Express, Dr Reddy’s Lab, Coromandel International Ltd and National Thermal Power Corporation.
This is possible because of the long process required for issuing bonus debentures including getting the scheme of arrangement approved from shareholders, creditors, stock exchanges, NCLT and the regulatory authorities. There is also no clarity as to whether the bonus debentures can be issued out of reserves other than the general reserves of the company such as the Securities Premium Reserve or Capital Redemption Reserve (like in the case of issue of bonus shares). Moreover, while these debentures can be traded in the market, it may be difficult to do so because of a lack of trading volumes. Such unclarity regarding the issue of the bonus debentures and lack of streamlined regulatory framework creates confusion and leads to a lengthy process. In the liquidity crunch created by the pandemic, this instrument can bring benefits to both the shareholders and the company. Hence, the legal procedure to issue such debentures must be looked into, and any doubts regarding the same must be invited and clarified.
Author(s) Name: Srishti Kaushal
She is a 2nd-year law student at the Rajiv Gandhi National University of Law, Patiala.