The Hindu Business Line : Debenture redemption reserve

Section 117C of the Companies Act, 1956, was introduced in 2000 as a measure to protect the interest of debenture-holders. It requires every company which has issued debentures to create a Debenture Redemption Reserve (DRR).

As per this section, a company shall credit adequate amounts to DRR from its profits every year until such debentures are redeemed. The amounts credited to the DRR shall not be utilised by the company except for the redemption of debentures.

Recognising the insertion of Section 117C, the Securities and Exchange Board of India (SEBI), which had earlier prescribed separate requirement for creation of DRR by listed companies, has amended its earlier guidelines. Now, the SEBI guidelines also require listed companies to create DRR as per Section 117C. Thus, both listed and unlisted companies are subject to the same requirements of Section 117C for creation of DRR.

What follows is an FAQ on DRR:

As per Section 117C, a company should credit adequate amounts to DRR. What does this imply?

To clarify the applicability of Section 117C, the Department of Company Affairs ( now Ministry of Corporate Affairs) issued General Circular No. 9/2002 dated April 18, 2002. The Circular outlines the following limits for adequacy of DRR in case of certain classes of companies:

a) All India financial institutions regulated by RBI and banking companies — public issue, nil; private placement, nil.

b) NBFCs and other financial institutions — public issue, 50 per cent; private placement, nil.

c) Manufacturing and infrastructure companies — public issue, 50 per cent; private placement, 25 per cent.

For other companies, there is no specific guidance in the Circular.

Is the above limit fixed or can a company create higher DRR as well?

The DCA Circular does not make it very clear. However, the limits prescribed in the Circular for creation of DRR should be considered as minimum and in case a company desires to create higher DRR, it can do so.

Are companies not specified in the circular required to create DRR?

Service companies or trading companies, for which no specific percentages have been laid down in the DCA Circular, are also required to create DRR.

Such companies would have to decide the ‘adequate amount’ for creation of DRR after considering factors such as amount of debentures outstanding, tenure of debentures and adequacy of profits, including future projections, etc.

However, on a conservative side, it is advisable for such companies to at least create DRR to the extent prescribed for manufacturing companies.

Section 117C requires DRR to be created out of profits for the year. Is DRR required if a company does not have any profits during the year?

As per the DCA General Circular, there is no obligation on the part of a company to create DRR, if there is no profit for the particular year.

What if a company has profits but the same are not sufficient to create ‘adequate amount’ of DRR?

If the profits are not adequate, the company should transfer the entire amount of profit to DRR. If such profits are applied for payment of dividends, it could be interpreted as giving preference to equity holders as against debenture holders. This could be construed as a violation of law and a debt covenant.

Do companies require to create DRR for all types of debentures, including convertible debenture?

The DCA Circular clarifies that Section 117C will apply only to the non-convertible portion of debentures issued, whether they are fully or partly convertible.

What about short-term debentures?

On a reading of Section 117C, SEBI guidelines and the DCA Circular, there is no exemption from creation of DRR with respect to short-term debentures. However, since creation of DRR is done annually, whereas short-term debentures may have been paid before the annual accounts are approved or shortly thereafter, keeping the spirit of the law in mind, it may not be necessary to create a DRR.

Once debentures are extinguished, what happens to the DRR?

The DRR may be transferred to P&L surplus balance or the General Reserve Account.

Bottomline, therefore?

Since creation of DRR is a legal matter, and at times complex, companies need to act based on an appropriate legal opinion. The purpose of DRR is to ensure that debenture-holders are protected and that profits generated by a company, are first allocated for payment to debenture holders rather than equity holders.

Whilst there could be debate on the details, this fundamental principle should not be compromised.

(The author is a senior professional in a member firm of Ernst & Young Global. The views are personal.)

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