ARE 'OPTIONALLY FULLY CONVERTIBLE DEBENTURES' DEBT UNDER SARFAESI ACT, 2002

 

Optionally Fully Convertible Debentures (OFCDs) are kinds of debt instruments; they are a hybrid instrument, as the investor has the option to convert this debt into equity (shares) of the issuing company after a specified period and at a predetermined price. 

DO OFCDs CONSTITUTE DEBT AS PER SARFAESI Act, 2002.

In SARFAESI the Meaning of ‘Debt’ as per section 2(1)(ha) of SARFAESI Act, is ‘debt’ shall have the meaning assigned to it in section 2(g) of RDB Act, 1993 and includes: (i) unpaid portion of purchase price of any tangible asset given on hire or financial lease or conditional sale or any other manner (ii) any right, title or interest on any intangible asset or licence or assignment of such intangible asset, which secures the obligation to pay any unpaid portion of the purchase price of such intangible asset or an obligation incurred or credit otherwise extended to enable any borrower to acquire the intangible asset or obtain licence of such asset. and the Meaning of Debt Securities as per section 4 [(ia) “debt securities” means debt securities listed in accordance with the regulations made by the Board under the Securities and Exchange Board of India Act,1992 (15 of 1992);]

OFCDs are securities; whether they constitute ‘debt’ enforceable under SARFAESI or not would depend on the structure they are issued. If the OFCDS are issued as secured debentures with a binding agreement with a valid security interest, the trustee can invoke SARFAESI against the secured assets in the event of default.  Unless the OFCD issuance is accompanied by creation of a security interest (e.g., via DTD creating mortgage/hypothecation/charge registered as required) securing repayment obligations, SARFAESI cannot be invoked merely because an issuer defaults on OFCD terms. Where security is created, the debenture trustee or secured creditor may invoke SARFAESI subject to default/NPA and statutory compliance. 

The Supreme Court in Sahara India Real Estate Corp.Ltd.& Ors vs Securities & Exch.Board Of India & Anr CIVIL APPEAL NO. 9833 OF 2011 has held that an OFCD being a hybrid security falls under the definition of “securities” as defined u/s 2 (h) of Securities Contract (Regulation) Act, 1956 and u/s 2(45AA) of Companies Act, 1956 as it inherits the characteristics of debentures initially and also that of the shares at a later stage (if the option to convert the securities into shares are being exercised by the security holder). 

However, before initiating SARFAESI on debenture defaults, one has to confirm that thhe DTD/security documents create a qualifying “security interest,”  and are registered with CERSAI as mandated under section 22 of the SARFAESI Act, 2002. (for priority under Section 26E of the Act.)
It is important to note that the SARFAESI framework mandates filing of security interests with the Central Registry of Securitisation Asset Reconstruction and Security Interest (CERSAI) under Section 21 of the SARFAESI Act, 2002 
Thus, unless the security interest has been registered with the Central Registry.  (CERSAI records can confirm whether the charge has been properly registered. In the event of non-compliance, the validity of the creditor’s enforcement action under SARFAESI can be challenged on this ground.

AN OFCD IS A FINANCIAL DEBT.

The Hon'ble NCLAT in Santosh Kumar v. ASK Trusteeship Services (P) Ltd., (2024) 243 Comp Cas 40) has opined that debenture subscription agreement that optionally convertible debentures are financial debt within the meaning of section 5(8)(c) of the IBC (para 10). The case is currently pending appeal before the Supreme Court of India. 

By perusing the judgment in Santosh Kumar (supra) it is evident that optionally convertible debentures constitute ‘financial debt’ within the meaning of Section 5(8)(c) of the IBC. The IBC is applicable to both secured and unsecured debts, whereas the SARFAESI Act applies only to secured debts backed by assets.


LEGAL CLARIFICATION.

The Supreme Court in Sahara India Real Estate Corp.Ltd.& Ors vs Securities & Exch.Board Of India & Anr CIVIL APPEAL NO. 9833 OF 2011 has held that an OFCD being a hybrid security falls under the definition of “securities” as defined u/s 2 (h) of Securities Contract (Regulation) Act, 1956 and u/s 2(45AA) of Companies Act, 1956 as it inherits the characteristics of debentures initially and also that of the shares at a later stage (if the option to convert the securities into shares are being exercised by the security holder). 

It is pertinent to note the section 2 (h)(ic) of Securities Contract (Regulation) Act, 1956 also include:(ic)security receipt as defined in clause (zg) of section 2 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002;] As per section 2(zg) of SARFAESI“security receipt” means a receipt or other security, issued by a  [asset reconstruction company] to any [qualified buyer] pursuant to a scheme, evidencing the purchase or acquisition by the holder thereof, of an undivided right, title or interest in the financial asset involved in securitisation; 

In M/S.Deccan Chronicle Holdings Ltd vs Il& Fs Trust Co. Ltd. Rep. WP 14252/2014, The Telangana High Court while adjudicating certain immoveable properties of the company that were mortgaged in favour of the respondent in terms of the debenture trust deed. The Court opined that since “secured debt” whereby "secured interest" were created in the Debenture Trustee, its recovery actions initiated were strictly in accordance with the provisions of the SARFAESI Act and do not suffer from any illegality. It opined that

"debenture trust deed, that the immoveable properties of the petitioner-company were mortgaged in favour of the 1st respondent which, in terms of the debenture trust deed, holds securities (mortgaged properties) on behalf of the debenture holders i.e., LIC, OBC and CB which are financial institutions and banks. A charge (security interest) was created, over the immovable and moveable properties of the petitioner-company, in favour of the 1st respondent for the due repayment of the principal and interest due on redemption of the debentures, of the petitioner-company, subscribed earlier by LIC, OBC and CB. Section 2(f) of the SARFAESI Act defines “borrower” to mean any person who has been granted financial assistance by any bank or financial institution, or who has created any mortgage or pledge or security for the financial assistance granted by any bank or financial institution. Section 2(k) defines “financial assistance” to mean, among others, any debentures subscribed by any bank or financial institution. As the debentures of the petitioner company have been subscribed by CB, OBC and LIC, which are banks/financial institutions, these three entities must be held to have rendered financial assistance to the petitioner which would, in terms of Section 2(f), be a borrower both on account of its being granted financial assistance by these three entities, and for having created a charge, over its movable and immovable properties, in favour of the first respondent. 

In the present context, the “security agreement”, as defined in Section 2(zb), is the debenture trust deed. Section 2(zc) defines "secured asset" to mean the property on which security interest is created. The moveable and immoveable properties on which the petitioner has created a charge, in favour of the 1st respondent, are the “secured assets”. Section 2(ze) defines “secured debt” to mean a debt, which is secured by any security interest, which, in the present context, refer to the amount payable on the redemption of the non-convertible debentures subscribed by the three entities. Section 2(zf) defines “security interest” to mean right, title, interest of any kind whatsoever upon property created in favour of any secured creditor and includes a mortgage, charge, hypothecation or assignment. In terms of the security agreement (debenture trust deed), security interest (charge on the movable and immovable properties of the petitioner) is created in favour of a secured creditor (debenture trustee)"

Therefore, an OFCD can be considered as a debt in case of non payment and can come under the ambit of SARFAESI. However,  the same may not be enforceable under SARFAESI  if the OFCD that are kept as securities are not registered. 

Greetings, I am a young legal professional and a proud Gorkha who’s eager as a morning bird, loves poetry and drama, listens to the Floyd and the Beatles, admires the court craft and is passionate about the little things that adds immense value.

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