What is a Debenture Redemption Reserve
A debenture redemption reserve is a provision that states that any Indian corporation that issues debentures must create a debenture redemption service to protect investors against the possibility of default by the company. The provision was added to the Indian Companies Act of 1956 during an amendment in the year 2000.
BREAKING DOWN Debenture Redemption Reserve
A debenture is an unsecured debt instrument issued by corporations to borrow money at a fixed interest rate. To protect debenture holders against the risk of the default of the issuing company, Section 117C of the Indian Companies Act of 1956 requires every debenture issuer to create a capital reserve, known as the debenture redemption reserve, which will be funded by the issuer’s profit and loss account. Under the provision, debenture redemption reserves will be funded by company profits every year until the debentures are redeemed. The reserve is to be created out of the issuer’s divisible profits of at least 25% of the face value of debentures issued, before the start of redemption.
For example, assume a company issues debentures for a total amount of $10 million on January 10, 2017 with a maturity date of December 31, 2021. The debenture redemption reserve must be created with at least 25% x $10 million = $2.5 million before the date the debentures are set to mature. If a company does not create a reserve within 12 months of issuing the debentures, they will be required to pay 2% interest in penalty to the debenture holders. The company does not have to fund the reserve account immediately through one big deposit, as it has the option of crediting the account by an adequate amount every year to attain its minimum 25% requirement before redemption of the debentures.
In addition to the rules stipulated in the Companies’ Act of 2013, companies are also required to reserve or deposit, on or before April 30 each year, at least 15% of the amount of its debentures maturing on March 31 of the following year. These funds can be deposited in a scheduled bank or invested in corporate or government bonds. The funds are to be used in settling interest or principal payments on debentures maturing during the year, and cannot be used for any other purpose. Furthermore, the amount deposited or invested is not at any time to fall below 15% of the amount of debentures maturing during the fiscal year ending March 31.
Only debentures that were issued after the amendment in 2000 are subject to the debenture redemption service. Furthermore, not all companies are required to create a debenture redemption reserve. Entities that are exempt from initiating the debenture capital reserves include:
- All India Financial Institutions (AIFIs) regulated by Reserve Bank of India (RBI)
- Other Financial Institutions regulated by Reserve Bank of India
- Banking Companies for both public as well as privately placed debentures; and
- Housing Finance Companies registered with the National Housing Bank
In the case of partially convertible debentures, debenture redemption reserves are to be created for the non-convertible portion, as only that portion is redeemable.