Meaning of Redemption:
Redemption of debenture is the discharge of debenture liability. It can be done either by repaying the money to debenture holders or converting the debenture into shares. The conditions of redemption are clearly stated at the time of issue of debenture in the prospectus. Debentures can be redeemed at par, premium or discount as per the terms of issue. The period of maturity, redemption amount, yield on redemption etc. will be mentioned in the prospectus. In case the non convertible debentures proposed to be rolled over (repayment extended for an additional period), a compulsory option should be given to the debenture holders who wish to withdraw from the debenture programme, as per the guidelines issued by SEBI.
Sources of Funds for Redemption of Debentures
Redemption of debentures is an important commitment to be fulfilled by a joint stock company. Failure to redeem debentures will disqualify the directors of the company. Moreover, such a default will invite strict penalties and loss of reputation. As the redemption of debentures drains a large amount of resources, companies will make advance preparations to meet this need.
i. Redemption of Debentures - from the proceeds of fresh issue of share capital and debentures
ii. Redemption of Debentures - out of accumulated profits
Methods of Redemption of Debentures
i) Redemption In lump-sum, at the end of stipulated period:
Under this method the entire debentures are redeemed at the stipulated date stated in the prospectus for the issue of debentures. The drawback of this method is that the company has to arrange a large amount at the time of redemption. Usually companies prepare well advance for the redemption of debentures.
ii) By Draw of Lots:
Under this method the company does not redeem all the debentures at the same time. Instead it will call back only a portion of its debentures in the market for redemption each year. The company select the debentures of a predetermined value, by drawing lot and they are redeemed that year. This method of redemption reduces the burden of redemption. Planning is relatively easy and the impact of redemption on the finance of the company is limited.
iii) By Purchasing in the Open Market
Debentures can be redeemed by purchasing them from the open market. If a company finds its debentures are available in the open market at cheap rate it will purchase those debentures and cancel them.
iv) By Conversion into New Debentures or Shares.
Conversion of debentures into shares is another method of redemption. When debentures are converted to shares, the company does not pay money to debenture holders. Instead the company issues share certificates in place of debentures. It may look good for the company because there is no need of cash payment. But the company is selling its shares. Selling shares is actually selling part of the ownership. Debenture holders become shareholders. Creditors become owners. It is better to pay off creditors rather than selling them part of the company. But sometimes company agree to give some shares to make the issue of debentures more attractive to buyers.
Debenture Redemption Reserve: The newly introduced Section 117C in the Companies Act, 1956 by Companies (Amendment) Act, 2000 has made a bold step in protecting the interests of debenture holders by making it mandatory for the company to create security and debenture redemption reserve. Accordingly, it shall now be mandatory for the companies to create a debenture redemption reserve for the redemption of debentures. The company shall have to credit adequate amount from out of its profits every year till such debentures are redeemed.
The debenture reserve shall be used by the company only for the redemption of debentures. Such redemption shall be in accordance with the terms and conditions of the issue of debentures. The company shall pay interest due on outstanding debentures as per the terms and conditions of the issue only.
If a company fails to redeem the debenture on due dates or on maturity, any or more than one or all the debenture holders can make an application to the Tribunal and then Tribunal on hearing all the parties concerned may direct by way of an order to redeem the debentures forthwith by payment of principal and interest due on such debentures.
If default is made in complying with the order of the Tribunal, every officer of the company who is in default shall be punishable with imprisonment which may extend to 3 years and shall also be liable to a fine of not less than Rs. 500 for every day during which such default continues.