[The following post is contributed by Priya Garg, who is a student at the West Bengal National University of Juridical Sciences (WB-NUJS).
An earlier post on this Blog discussing the features and implications of bonus debentures is available here.]
Bonus debentures are those debentures which a company issues to its shareholders by using its reserves’ balance. Their issue does not require cash inflow from the shareholders, making these debentures free of cost for the shareholders. There is no specific provision under the Indian Companies Act, 2013 dealing with the issue of bonus debentures due to which companies issuing bonus debentures rely upon a scheme of arrangement under Sections 391-394 of the Companies Act, 1956 to establish the validity of such issue. This gives rise to several questions relating to the issue of bonus debentures which remain unanswered. Some of these issues and concerns related to the issue of bonus debentures have been identified here, and the possible answers to some of the issues have also been elaborated upon.
First, due to the lack of a provision dealing specifically with the issue of bonus debentures, on account of an immensely broad scope of Section 391 of the Companies Act, 1956 regarding the arrangements that can be arrived at among the shareholders and the creditors, as well as because of the wide discretionary powers that the Court possesses while arriving at its decision to sanction the resolution passed at the meeting convened upon its order under Section 391, there has been ambiguity with respect to the legal position on different aspects pertaining to the issue of bonus debentures. However, concerns over several such ambiguities have not been raised in Indian scenario. This is because hitherto the bonus debentures issued in India have been the simplest cases of debentures issue as the debentures so issued have been non-convertible debentures and they have been issued out of general reserves and to all the shareholders. Hence, the position of law with respect to the more complicated cases some of which have been stated here remain unclear:
a. Whether bonus debentures can be issued out of capital redemption reserve (CRR) or securities premium reserve (SPR) besides their issue from the undistributed profits/general reserves/free reserves?
Though it is a settled that bonus debentures can be issued out of the company’s general reserves, Indian courts did not get the opportunity to determine if such debentures, like in case of bonus shares, can also be issued out of Capital Redemption Reserve or Securities Premium Reserve. Under Section 69(1) of the Companies Act, 2013, Capital Redemption Reserve is credited whenever the company reduces its share capital by making payment out of its distributable profits. This is to ensure that the creditors’ interest stay protected despite the reduction of company’s share capital. This explains the reasons behind statutorily restricting the use of Capital Redemption Reserve to the issue of bonus shares, etc. and also for providing that unless explicitly stated otherwise, the balance of the Capital Redemption Reserve can be reduced only in the manner in which share capital can be reduced. Similarly, under Section 52(1) of Indian Companies Act, 2013, Securities Premium Reserve balance can be decreased only in the manner in which share capital can be reduced.
Under, Section 100 of Indian Companies Act, 1956, reduction of share capital has three pre-conditions: first, company’s articles of association should provide for such reduction, second, a special resolution is passed by the shareholders approving the reduction; and third, the Court sanctions the resolution so passed. The Court while sanctioning the resolution is required to ensure that no creditor (creditors being the affected party) opposes the reduction. The same procedure has to be followed for debiting the balance of Capital Redemption Reserve and Securities Premium Reserve. Therefore, ideally, bonus debentures could be issued by debiting the Capital Redemption Reserve and Securities Premium Reserve, provided that for the meeting which the Court orders to convene under Section 391, all the creditors and not merely the shareholders are invited, and in such meeting no creditor opposes the motion and later, the Court’s sanctions of such resolution. Alternatively, the Court can sanction the special resolution passed by the shareholders supporting the reduction of Capital Redemption Reserve/Securities Premium Reserve to issue bonus shares under Section 391, provided no creditor expresses disapproval to the proposal. Similarly, these two reserves can be utilized to issue bonus debentures in cases where the company does not have any creditors.
Therefore, though this position has not been pronounced by law yet, nevertheless, by application of legal principles, it can be stated that debentures can be issued out of the Capital Redemption Reserve and Securities Premium Account. Further, business prudence demands that the law is interpreted with the possibility of using Capital Redemption Reserve and Securities Premium Reserve in this manner because that would enable bonus debentures to become a real alternative to issue of bonus shares as a source of finance.
b. In the areas of ambiguity, can the Court apply the principles related to the issue of bonus shares?
There are several questions related to bonus debentures such as:
(a) Whether or not the company which has once announced the decision recommending a bonus issue can subsequently withdraw the same?, or
(b) What happens when an individual shareholder refuses to accept the bonus debentures issued to him?, or
(c) Whether or not the issuing company is required to make a reservation of bonus debentures in favour of the holders of outstanding [compulsorily] convertible debt instruments, in proportion to the convertible part thereof, etc.
The answers to these questions have not been clearly provided by the law yet. Since, bonus debentures and bonus shares share some similarities; there remains ambiguity whether or not the Courts can apply the general principles applicable to the issue of bonus shares while deciding under Section 391 of the Companies Act, 1956 whether or not to sanction the issue bonus shares, or even while adjudicating upon any matter related the bonus debentures.
Further, another issue is that unlike in case of bonus shares, there is no express pre-condition to the issue of bonus debentures that the latter cannot be issued in lieu of the payment of dividends. On one hand, it may be argued that there is no need for having such provision for the issue of bonus debentures. This is because, unlike in case of bonus shares, with respect to the bonus debentures there is an in-built check for the company against issuing bonus debentures in lieu of dividends due to the prospects of having its obligations to pay Dividend Distribution Tax, regular and compulsory payment of interest and redemption amount upon maturity. However, this argument is flawed. This is because had this been the case, there would have been no need for imposing such restriction upon the issue of bonus shares because in a way such an in-built test also exists w.r.t the bonus shares in the form of the apprehension of lowering of Earning per Share upon the expansion of equity base. Therefore, it is important to impose pre-condition upon the issue of bonus debentures that such debentures cannot be issued in lieu of the payment of dividends. This would protect the interest of those shareholders whose interest lies in being paid by way of dividends instead of waiting for the long term benefits. Furthermore, such a pre-condition regarding the issue of bonus debentures is needed to complement the function of Section 63(3) under the Companies Act, 2013 or to ensure that the reason behind enacting Section 63(3) does not get defeated. Under Section 63(3), a company cannot issue bonus shares in lieu of its payment of dividends. This has been done to protect the investors’ interest by ensuring that the company does not abstain from paying dividends even in instances of profitability by pacifying the shareholders by issuing the bonus shares instead. In absence of a similar restraining pre-condition to the issue of bonus debentures, the company may end up issuing bonus debentures in lieu of payment of dividends because it is aware that it cannot issue bonus shares by evading the payment of dividends. This would partially defeat the objective that Section 63(3) of the Indian Companies Act, 2013 seeks to fulfill. Therefore, in order to assist Section 63(3) in fulfillment of its purpose, it is crucial that an explicit pre-condition is enacted to the issue of bonus debentures that such debentures cannot be issued in lieu of the payment of dividends.
Further, there are concerns such as the comparatively poorer marketability of bonus debentures in financial markets than the bonus debentures, etc.
In conclusion, it is important to address the issues and concerns that are presently in existence and which in certain cases explain the reasons behind the infrequent use of bonus debentures. Two major changes which need to be brought are to simplify the procedure related to the issue of debentures and to incorporate direct provisions under the Companies Act dealing specifically with the issue of bonus debentures so that the ambiguities of law in the matter can be solved substantially, if not fully.
- Priya Garg
 In the present post, the provisions of Companies Act, 2013 have been analyzed. However, with respect to the provisions of Companies Act, 1956 whose corresponding provisions under Companies Act, 2013 have not been enforced yet, the former have been cited.