This article is written by Nandini Jain of 3rd Year of BBALLB of Delhi Metropolitan Education, GGSIPU, an intern under Legal Vidhya
ABSTRACT
In the stock market, stocks and bonds are familiar words when it comes to investing. In business, debt and equity are two important methods for them to raise capital for business expansion and development. Whenever a company chooses stocks to raise capital, the company’s shares are issued to the public and anyone who buys the shares has the opportunity to become part of the company.
The second is debt: a company receives a loan from the public and also agrees to pay interest regularly. There, the bond is issued to the public and the person who buys it is called the creditor. Here, shares are defined as the social capital of an organization. It gives shareholders the right to hold a specific amount of the company’s share capital. Similarly, bonds are an excellent financial instrument that represents a company’s debt to the outside/public and offers a fixed interest rate. Nowadays, most people invest in stocks or bonds with the aim of earning better returns; Therefore, it is essential to understand investment securities as well.
KEYWORDS
Stocks, companies, market risks, bonds, interest rates, payments, stock market, funds, creditors, securities, clear evidence, resolutions, redeemable bonds again, convertible bonds, maturity date.
INTRODUCTION
Financing, an important element in the management of a company’s affairs, can be secured, among other things, by issuing shares and bonds. In fact, stocks and bonds are financial instruments that help organize a company’s capital. Under the Companies Act 2013, they are collectively known as “securities”. Stocks represent shares in a business with business risks and returns, while bonds represent a lender’s interest in a business with limited risks and returns. Sometimes, after issuing capital, a company may amend or reduce its share capital depending on the requirements of the situation.
The company must comply with mandatory regulations in case of modification or reduction of share capital. Stocks and bonds are presented on the balance sheet as liabilities of the issuing company and assets of investors and lenders, respectively.
SHARES
Definition of shares and shares:
Section 2(84) defines shares as part of the share capital of a company and includes shares[1]. The share capital of a company is divided into small units with a certain nominal value. Each of these units is called an action. The definition of “act” indicates that the term “act” includes “action”.
If a company agrees to pool the fully paid-up shares of different members according to their needs and consolidate these shares into one fund, then that fund is called “stock”. In simple terms, we can say that “stock” is a collection or set of fully issued actions.
Types of share capital
Generally, a limited company has two types of share capital:
• Share capital
• Preference share capital.
According to Article 43, the share capital of a joint stock limited company must be of two types, namely: —
(a) share capital —
i. Have voting rights
ii. with differential rights as to dividends, voting rights or otherwise according to such rules as may be prescribed
(b) preference share capital Note: Nothing in this Act affects the rights of preference shareholders to participate in the proceeds of liquidation before the commencement of this Act.
SHARES WITH DISTINCT RIGHTS RULE 4 OF THE COMPANIES (Share Capital and Debentures)
Rules, 2014 contains provisions to be complied with when issuing shares with distinct rights as follows:
Conditions for issuing shares with distinctive rights: According to the provisions of Article 4 (1), public limited companies can issue shares with distinctive rights with respect to dividends, voting rights or not, if it meets the following conditions, namely:
a. The company’s regulations allow the issuance of shares with distinct rights;
b. The issuance of shares is authorized by an ordinary resolution passed by the general meeting of shareholders.
SHARE CERTIFICATES (SECTION 46)
Share certificates are required when issuing shares in physical form. Section 46 contains provisions governing stock certificates. They are stated as follows:
(1) Share certificates are prima facie evidence of ownership: Subject to section 46 (1), certificates, issued under the common seal, if any, of company or signed by the two directors or by the director and the company secretary, whenever the company appoints a company secretary, stating the number of shares held by any person shall constitute evidence obvious about that person’s ownership of that share.
(2) Issuance of duplicate certificates: Section 46 (2) provides that duplicate share certificates may be issued, if such certificate —
a. It is proven to have been lost or destroyed.
b. Damaged, mutilated or torn items are returned to the company.
(3) Method of issuance of certificate/certificate copy: According to section 46 (3), regardless of any content stipulated in the company’s articles of incorporation, method of issuance of stock certificate or a copy thereof, the form of such certificate, the particulars recorded in the register of members and other matters shall be taken as prescribed.
(4) Shares held on deposit: Pursuant to section 46 (4), where shares are held on deposit, the records of the depositary are prima facie evidence of the beneficial owner’s interest.
(5) Penalty for issuing copies of stock certificates for fraudulent purposes: Pursuant to Section 46 (5), if the company has the purpose of fraudulently issuing copies of stock certificates, the penalty shall be penalties are as follows:
• The company will be subject to a fine of not less than five times the nominal value of the shares involved in the issuance of duplicate certificates, but may be up to ten times the face value of the shares or ten crore rupees, whichever is the same.
• Any delinquent company director shall be liable in accordance with the procedures set out in article 447.Material rights to a particular share capital are established from the outset by a certificate The stock must be:
• distinctively numbered;
• issued under common seal of the company or signed by two directors or by a director and the Company Secretary, wherever the company has appointed a Company Secretary.
VOTING RIGHTS AND CHANGES OF SHAREHOLDER’S RIGHTS (ARTICLES 47 AND 48)
(i) Voting rights of members holding share capital: Article 47 (1) stipulates that, pursuant to the provisions of Article 43 , Article 50 (2) and Article 188 (1)-
a. Any member of a limited liability company holding shares therein shall have the right to vote on any resolution presented to the company; and
b. His right to vote in elections is proportional to his share in the paid-up share capital of the company.
(ii) Voting rights of members holding preferred share capital: According to Article 47 (2), each member of a limited liability company holds one share of preferred share capital, for this capital amount, assets:
• the right to vote only on resolutions submitted to the company that directly affect the rights attached to the company’s preference shares, and
• the right to vote on any resolution who tend to dissolve the company, repay or reduce capital or, preferably, share capital.
and his right to vote in elections is proportional to his contributed preferred stock capital in the company.
(iii) Voting rights ratio: According to the first provision of Article 47(2), the ratio of voting rights of shareholders to voting rights of preferred shareholders will be equal to the ratio of paid-in capital. Capital related to participating shares is contributed capital related to preference shares.
(iv) Consequences of not paying dividends to preference shareholders: According to the second provision of Article 47 (2), in which dividends for a type of preference shares are not paid during the period two years or more, this class of preferential shareholders will have voting rights on all resolutions presented to the company.
Exemption for private company – Section 47 does not apply to a private company, where the memorandum or articles of association of the private company so provide.
However, the exemption is applicable to a private company that has not defaulted in filing financial statements under section 137 or annual returns under section 92 with the Registrar.
Private companies can therefore be more innovative with respect to voting rights if their regulations allow it.
VARIATIONS OF SHAREHOLDER’S RIGHTS [SECTION 48]
In cases where the company’s share capital is divided into different classes of shares, it may sometimes be necessary for the company to amend the rights attached to one or more classes share.
Section 48 addresses this situation and stipulates the following variations of shareholder rights:
(1) Variation of shareholder rights with consent: According to Section 48 (1), when dividing share capital of the company into different classes of shares, the rights attached to shares of any class may be varied with the written consent of the holders of at least 3/4 of the issued shares of that class or by a special resolution passed at a separate meeting of the holders of shares issued of that class—
a. whether any provision for such change is contained in the memorandum or articles of incorporation; or
b. In the absence of such provision in the memorandum or articles of association, if such a change is not prohibited by the conditions of issuance of shares of this type.
Provides that if an amendment by one class of shareholders affects the rights of any other class of shareholders, the consent of three-fourths of such shareholders shall also be required and the provisions of this article apply for that modification.
(2) No consent to variation: Subject to section 48 (2), where the holder of at least ten per cent of the issued shares of a class has not consented to the variation or do not vote in favour of the special option for the amendment, they may request the Court to set aside the amendment and where such request is made, the amendment shall take effect only if and until confirmed by the Court.
(3) Application to Court: Reservation to Article 48(2) provides that an application under this Article must be made within 21 days after the date on which consent is given or the date on which the resolution is passed, as the case may be fit, and may be made in the name of the shareholders authorized to submit the request by one or more of them as they may designate in writing for this purpose.
(4) Decision of the Tribunal: Subject to section 48 (3), the decision of the Tribunal in respect of any application under subsection (2) shall be binding on the shareholders.
(5) Filing of copy of order with the Registrar[2]: 48 (4) provides that the company shall, within thirty days of the date of the Court order, file a copy with the Registrar.
(6) Penalties for violations:According to article 48 (5), when committing violations according to the provisions of this article, the penalties will be as follows:
• company: There will be a fine of zero less than twenty-five thousand rupees but can go up to fifty thousand rupees;
• any director of the company commits an offence: He shall be punished with imprisonment up to six months or with a fine not less than twenty-five thousand rupees but not exceeding up to five lakh rupees, or with both.
DEBENTURES
Debentures According to section 2(30) of the Companies Act 2013, “debentures” include debenture shares, debentures or any other instrument of a company evidencing a debt.
Procedure for issuance of debentures under section 71 of the Companies Act, 2013 A company may issue debentures with an option to convert such debentures into shares, wholly or partly for redemption: Provided that The condition is that the issuance of bonds with the option to convert all or part of those bonds into shares.
TYPES OF DEBENTURES
Registered vs. bearer
Where debts are issued in the form of bonds, they may be registered in the name of the issuer. In this case, the transfer or sale of these securities must be done through a clearing system that notifies the issuer of changes in ownership so that the issuer can pay interest to right bondholder.
On the other hand, bearer bonds are not registered with the issuer. The owner (holder) of a bond earns interest simply by holding the bond.
Redeemable and non-redeemable
Redeemable bonds state the terms and exact date by which the bond issuer must repay the debt in full.
Nonredeemable (nonredeemable) bonds do not require the issuer to be repaid in full by a certain date. For this reason, irredeemable bonds are also known as perpetual bonds.
Convertible vs. non-convertible
Convertible bonds are bonds that can be converted into capital shares of the issuing company after a specific period of time. Convertible bonds are hybrid financial products that offer the benefits of both debt and equity. Companies use bonds as loans with fixed interest rates and fixed interest payments.
Non-convertible bonds are traditional bonds that cannot be converted into the equity of the issuing company. To compensate for the lack of convertibility, investors enjoy higher interest rates than convertible bonds.
CHARACTERISTICS OF DEBENTURES
When issuing bonds, a trust deed must first be drawn up. The first trust is an agreement between the issuer and the trustee that manages the interests of investors.
Interest Rate
Interest rate is determined, which is the interest rate that the company will pay to bond holders or investors. This coupon rate can be fixed or variable. The variable rate can be linked to a benchmark such as the 10-year Treasury yield and will change as the benchmark changes.
Credit Rating
The company’s credit rating and ultimately the bond’s credit rating affect the interest rate the investor will receive. They provide investors with insight into the risks of investing in debt. Credit rating agencies, such as Standard and Poor’s, often assign letter grades that represent underlying creditworthiness.
Maturity Date
For nonconvertible debentures, mentioned above, the date of maturity [3]is also an important feature. This date determines when the company must repay the bondholders. The Company has options regarding the form of refund to be made. Typically, this is a return of capital, with the issuer paying a sum when the debt matures. Alternatively, the payment may utilize a repayment reserve, in which the company pays a specific amount each year until fully repaid by the due date.
ADVANTAGES AND DISADVANTAGES OF DEBENTURES
Bonds are the most common form of long-term debt securities issued by companies. A company will issue them to raise capital for its growth and operations, and investors can benefit from regular interest payments, which is a relatively safer investment than company shares. Bonds are unsecured bonds issued by companies to raise loan capital. Because they are not backed by any form of collateral, they are inherently riskier than an identical secured security.
Due to increased risk, bonds will have relatively higher interest rates to compensate bondholders. This also means that bond investors need to pay close attention to the credit reputation of the bond issuer. Relative lack of safety does not necessarily mean that a bond is riskier than any other bond. Strictly speaking, US Treasury bonds and US Treasury bills are both bonds. They are not warrantied but are considered risk-free.
ADVANTAGES
• Bonds pay investors a regular interest rate or coupon rate.
• Convertible bonds can be converted into equity shares after a certain period of time, making them more attractive to investors.
• In the event of a company’s bankruptcy, the bonds are paid before common shareholders.
DISADVANTAGES
• Fixed-rate bonds are subject to interest rate risk in an environment of increasing market interest rates.
• Solvency is important when considering default risk relative to the financial viability of the underlying issuer.
• Bonds can pose inflation risk if the coupon payments do not keep pace with the rate of inflation.
DEBENTURES RISKS FOR INVESTORS
Bondholders may face inflation risk. Here, the risk is that the interest rate paid on the debt [4]may not keep pace with inflation. Inflation measures price increases relative to the economy. For example, let’s say inflation causes prices to increase by 3%. If the bond’s interest rate is 2%, the holder may experience a net loss in real terms.
Bonds also have interest rate risk. In this risky scenario, investors hold fixed-rate debt during periods of rising market interest rates. These investors may find that their debt yields are lower than other investments that pay higher current market rates. If this happens, bondholders will receive lower returns in comparison.
DEBENTURE EXAMPLE
An example of a government bond is a U.S. Treasury Bond (T bond). Treasury bonds help finance projects and finance day-to-day government operations. The U.S. Treasury Department issues these bonds in auctions held throughout the year. Some Treasury securities trade in the secondary market. On the secondary market, through financial institutions or brokers, investors can buy and sell previously issued bonds. Treasury bonds are virtually risk-free because they are backed by the full faith and credit of the U.S. government. However, they also face the risk of inflation and rising interest rates.
CONCLUSION
With the provisions relating to issuance of securities in the Act, the regulators have made efforts to streamline the operations of unlisted companies compared to listed. Most of the chapter’s provisions remain intact with a strong enforcement tool, i.e. stricter criminal provisions. Bonds, stocks, and bonds are all different investment avenues. Determine investment goals, analyze risk profile, conduct in-depth market research and choose the appropriate investment path. A company must pay interest on its bonds before it can pay dividends to shareholders. So, bondholders hold the advantage in this scenario. If a company goes bankrupt, it will almost certainly have to pay bondholders first, then shareholders.
REFERENCES
- https://cleartax.in/s/difference-between-shares-debentures-bond
- https://www.indmoney.com/articles/personal-finance/share-and-debenture-difference
- https://ca2013.com/rule-18-companies-share-capital-and-debentures-rules-2014/
- https://taxguru.in/company-law/legal-concept-provision-debentures.html
[1] True Tamplin, Shares and debentures: Definition, features, & types Finance Strategists (2023), https://www.financestrategists.com/accounting/shares-and-debentures/ (last visited Nov 15, 2023).
[2] Share capital Sushita Chakraborty UG (R1) (1) – west Bengal, https://wbsche.wb.gov.in/assets/pdf/commerce/GCC&BA_SUPR_Share-capital-1_Sushita-Chakraborty_UG(R1).pdf (last visited Nov 15, 2023).
[3] Unit 4: Share Capital & Debenture – Umeschandra College, https://umeschandracollege.ac.in/pdf/study-material/company-law/Share%20Capital%20&%20Debenture.pdf (last visited Nov 15, 2023).
[4] Uzair Ahmad Khan, IPleaders blog – different types of debentures and their use iPleaders (2019), https://blog.ipleaders.in/different-types-of-debentures-use/ (last visited Nov 15, 2023).
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