What is a Debenture Redemption Reserve
A debenture redemption reserve (DRR) is a provision stating that any Indian corporation that issues debentures must create a debenture redemption service in an effort to protect investors from the possibility of a company defaulting. This provision was tacked onto the Indian Companies Act of 1956, in an amendment introduced in the year 2000.
BREAKING DOWN Debenture Redemption Reserve
A debenture is a debt security that lets investors borrow money at a fixed interest rate. This instrument is considered unsecured, because it is not backed by an asset, lien, or any other form of collateral. Therefore, to protect debenture holders from the risk of default by the issuing company, Section 117C of the Indian Companies Act of 1956 implemented the debenture redemption reserve mandate. This capital reserve, which is to be funded by profits issuers generate every year until the debentures are redeemed, must represent at least 25% of the debenture's face value.
- A debenture redemption reserve is requirement imposed on Indian corporation that issue debentures, where they must create a debenture redemption service, to protect investors from the possibility of a company defaulting.
- This rule offers investors a measure of protection, because debentures are not backed by an asset, a lien, or any other form of collateral.
- The reserve must represent at least 25% of the face value of debentures issued.
For example, let's assume a company issues $10 million in debentures on January 10, 2017, with a maturity date of December 31, 2021. In this case, a $2.5 million (25% x $10 million) debenture redemption reserve must be created, before the debenture's date of maturity. Company's that fail to create such reserves within 12 months of issuing the debentures, will be required to pay 2% interest, in penalties, to debenture holders. But companies don't have to immediately fund the reserve account with one big chunk deposit. Rather, they have the option of crediting the account by an adequate amount every year, to satisfy the 25% requirement.
Before April 30 of each year, companies are also required to reserve or deposit at least 15% of the amount of its debentures that are due to mature on March 31 of the following year. These funds, which may either be deposited in a scheduled bank or invested in corporate or government bonds, are to be used to settle interest or principal payments on debentures maturing during the year, and cannot be used for any other purpose.
The debenture redemption service only applies to debentures that were issued after the 2000 amendment to Indian Companies Act of 1956. And companies falling under the following four categories are altogether exempt from DRR requirements:
- All India Financial Institutions (AIFIs) regulated by Reserve Bank of India (RBI)
- Other financial institutions regulated by RBI
- Banking companies for both public and privately-placed debentures
- Housing finance companies registered with the National Housing Bank
With partially convertible debentures, debenture redemption reserves must only be created for the non-convertible portion--the only redeemable portion.
[Important: The minimum reserve requirement changed in 2014, from 50% to the current 25%.]