Issue of Convertible Debt Instruments
PART II: ISSUE OF CONVERTIBLE DEBT INSTRUMENTS AND WARRANTS
Regulation 106. Issue of Convertible Debt Instruments and Warrants
Eligibility for FPO of Convertible Debt Instruments
An issuer can make a further public offer (FPO) of convertible debt instruments only if its equity shares are already listed.
Therefore, the issuer must already have listed equity shares before making the FPO of convertible debt instruments.
The issuer must also not have a continuing default in relation to debt instruments issued to the public.
Specifically, it must not have defaulted in:
Payment of interest; or
Repayment of principal amount.
A default becomes disqualifying when it has continued for more than 6 months.
Example:
Company X has listed equity shares.
It has issued debt instruments to the public.
If Company X has failed to pay interest for 7 months, it cannot make an FPO of convertible debt instruments.
If the default has existed for only 4 months, this particular 6-month disqualification is not triggered.
Regulation 107. Additional requirements for issue of convertible debt instruments
107(1).
The issuer must comply with all other applicable requirements under the regulations.
Additionally, for a public issue of convertible debt instruments, the issuer must satisfy the specific conditions prescribed below:
(a).
Credit Rating for Convertible Debt Instruments
The issuer must obtain a credit rating for the convertible debt instruments proposed to be issued.
The rating must be obtained from one or more recognised credit rating agencies.
The credit rating indicates the creditworthiness of the convertible debt instrument and the issuer’s ability to meet its debt obligations.
The requirement can be satisfied by obtaining a rating from:
One credit rating agency; or
More than one credit rating agency.
(b).
Appointment of Debenture Trustee
The issuer must appoint at least one debenture trustee for the convertible debt instruments.
The debenture trustee must be appointed in accordance with:
Companies Act, 2013; and
SEBI (Debenture Trustees) Regulations, 1993.
A debenture trustee acts on behalf of the debenture holders and protects their interests.
The trustee also monitors whether the issuer complies with the terms and conditions relating to the debt instruments.
(c).
Creation of Debenture Redemption Reserve
The issuer must create a Debenture Redemption Reserve (DRR) for the convertible debt instruments.
The DRR must be created in accordance with:
Companies Act, 2013; and
Rules made under the Companies Act, 2013.
DRR is a reserve created to provide protection to debenture holders by setting aside funds for repayment of debentures.
The issuer must therefore comply with the applicable requirements relating to the amount, timing and manner of creating the DRR.
(d).
Security Requirements for Secured Convertible Debt Instruments
If the issuer proposes to create a charge or security over its assets for secured convertible debt instruments, it must satisfy the following conditions:
(i) Assets must be sufficient:
The secured assets must be sufficient to discharge the principal amount of the convertible debt instruments at all times.
The security must therefore provide adequate asset cover for the principal amount.
(ii) Assets must be free from encumbrance:
The assets offered as security must be free from any encumbrance.
This means they should not already be subject to another charge or restriction, unless the permitted second/pari passu charge conditions are satisfied.
(iii) Consent for second or pari passu charge:
If the assets already have a charge in favour of a public financial institution or scheduled commercial bank, their consent must be obtained.
Similarly, if security is proposed on leasehold land, the consent of the lessor must be obtained.
The consent must permit:
A second charge; or
A pari passu charge.
This consent must be submitted to the debenture trustee before the issue opens.
(iv) Asset cover after reducing prior liabilities:
If the convertible debt instruments have a second or subsequent charge, the asset cover must be calculated after deducting liabilities secured by the first or prior charge.
Therefore, the issuer cannot count the entire asset value when determining the security available to the new debenture holders.
107(2).
Redemption of Convertible Debt Instruments
The issuer must redeem the convertible debt instruments according to the terms specified in the Offer Document.
The Offer Document will specify the terms relating to redemption, such as:
Redemption date;
Redemption amount; and
Other applicable redemption conditions.
The issuer must follow these disclosed terms and cannot arbitrarily change the redemption terms.
Example:
An issuer states in its Offer Document that the convertible debt instruments will be redeemed after 5 years at ₹1,000 each if they are not converted.
The issuer must redeem them according to those disclosed terms.
Regulation 108. Roll over of non-convertible portion of partly convertible debt instruments
108(1).
Applies to the non-convertible portion of partly convertible debt instruments issued by a listed issuer.
The value of such portion must exceed ₹10 crore.
Such non-convertible portion may be rolled over.
The rollover must comply with the Companies Act, 2013.
It must also satisfy the additional conditions as follows:
(a).
Approval of Rollover by Convertible Debt Holders
Rollover of the convertible debt instruments requires approval from at least 75% of the holders in value.
“75% in value” means the holders representing at least 75% of the total value of the convertible debt instruments must approve the rollover.
The approval must be given through a resolution.
The resolution must be passed through a postal ballot.
Therefore, a simple majority of holders is not sufficient; approval representing at least 75% in value is required.
Example:
Total value of convertible debt instruments = ₹100 crore.
Holders representing ₹75 crore or more in value must approve the rollover.
If holders representing only ₹70 crore approve, the 75% requirement is not met.
(b).
Auditors’ Certificate Before Rollover Approval
When seeking approval for rollover, the issuer must send an auditors’ certificate to all holders of the convertible debt instruments.
The certificate must be sent along with the notice for passing the rollover resolution.
The auditors’ certificate must contain:
Details regarding the issuer’s cash flow; and
Comments on the issuer’s liquidity position.
This information allows the holders to assess whether the issuer has sufficient cash flow and liquidity before deciding whether to approve the rollover.
The certificate must be provided to all holders, not only to those who are expected to vote in favour.
Example:
Company X proposes to roll over its convertible debt instruments.
Along with the postal-ballot notice seeking approval, it sends every holder an auditors’ certificate.
The certificate explains Company X’s cash flows and gives the auditors’ comments on its liquidity position.
Holders can then use this information when deciding whether to approve the rollover.
(c).
Redemption of Non-Convertible Portion for Dissenting Holders
This condition applies when the issuer proposes to roll over partly convertible debt instruments.
Some holders may not agree to the rollover resolution.
The issuer must undertake to redeem the non-convertible portion of the partly convertible debt instruments held by all such dissenting holders.
Therefore, holders who do not agree to the rollover cannot be forced to continue with the non-convertible portion.
The issuer must redeem that non-convertible portion for those holders.
Example:
A partly convertible debt instrument consists of:
₹600 non-convertible portion; and
₹400 convertible portion.
The rollover is approved by the required majority.
A holder does not agree to the rollover.
The issuer must redeem the holder’s ₹600 non-convertible portion.
(d).
Fresh Credit Rating Before Rollover
The issuer must obtain a credit rating from at least one credit rating agency registered with SEBI.
The credit rating must be obtained within 1 month before the due date of redemption.
The fresh credit rating must be communicated to the holders of the convertible debt instruments.
The holders must receive this rating before the rollover takes place.
This ensures that holders have recent information about the creditworthiness of the issuer before deciding on the rollover.
Example:
Redemption due date = 30 September.
Credit rating must be obtained on or after 30 August.
The rating must be communicated to the holders before the rollover.
108(2).
Fresh Security and Fresh Trust Deed
Normally, when secured convertible debt instruments are rolled over, the issuer may need to create fresh security and execute a fresh trust deed.
However, this is not mandatory if the existing documents already provide that the security will continue until the secured convertible debt instruments are redeemed.
The relevant existing documents can be:
Existing trust deed; or
Existing security documents.
Therefore, if the existing documents clearly ensure that the security remains valid until redemption, there is no automatic requirement to create fresh security or execute a fresh trust deed.
However, the final decision rests with the debenture trustee.
The debenture trustee will decide whether:
Fresh security needs to be created; and/or
A fresh trust deed needs to be executed.
Example:
Existing trust deed states that the security will continue until the secured convertible debt instruments are fully redeemed.
The issuer proposes to roll over the instruments.
In such a case, a fresh security and fresh trust deed are not mandatory merely because of the rollover.
However, the debenture trustee can still require the issuer to create fresh security or execute a fresh trust deed.
Regulation 109. Conversion of optionally convertible debt instruments into equity share capital
109(1).
Positive Consent Required for Conversion of Optionally Convertible Debt Instruments
The issuer cannot convert optionally convertible debt instruments into equity shares merely on its own decision.
The holders of the optionally convertible debt instruments must give their positive consent for the conversion.
“Positive consent” means the holder must actively agree to the conversion.
Mere silence or failure to respond does not amount to consent.
If the issuer sends a notice asking holders whether they agree to conversion and a holder does not reply, that holder is treated as not having consented.
Example:
Company X sends a notice to 100 holders asking for consent to convert their optionally convertible debt instruments into equity shares.
70 holders give positive consent.
30 holders do not respond.
The 30 holders who remain silent cannot be treated as having consented.
109(2).
Option Not to Convert for Large Convertible Debt Instruments
This rule applies when all the following conditions are satisfied:
The convertible debt instruments are listed.
The value of the convertible portion exceeds ₹10 crore.
The issuer has not determined the conversion price at the time of making the issue.
In such a case, the holders must be given an option not to convert the convertible portion into equity shares.
Therefore, the holder is not forced to accept equity shares when the conversion price was not fixed at the time of issue.
The holder can choose to:
Convert the convertible portion into equity shares; or
Not convert it into equity shares.
Exception Where Upper Conversion Limit or Formula Is Disclosed
Normally, if the conversion price is not determined at the time of issue, holders must be given an option not to convert the convertible portion.
However, this option is not required if, at the time of making the issue, the issuer has determined and disclosed:
The upper limit of the conversion price; or
The formula for determining the conversion price.
The issuer must also disclose the justification for fixing that upper limit or conversion formula.
These details must be disclosed to investors at the time of making the issue.
The conversion into equity shares can then take place within the disclosed upper limit.
Example:
Convertible debt instruments are issued without fixing an exact conversion price.
However, the issuer discloses:
Maximum conversion price = ₹200 per equity share; and
The formula used to determine the final conversion price.
The issuer also gives the justification for the ₹200 upper limit.
In this case, holders do not need to be given the option to refuse conversion within that ₹200 upper limit.
109(3).
Redemption When Holder Chooses Not to Convert
This rule applies where holders have been given an option under sub-regulation (2) not to convert their convertible debt instruments into equity shares.
The conversion price must have been determined in a general meeting of the shareholders.
If one or more holders choose not to exercise the conversion option:
The issuer must redeem the corresponding portion of their convertible debt instruments.
Redemption must be completed within 1 month from the last date for exercising the option.
The redemption price cannot be less than the face value of the instruments.
Example:
Face value of convertible debt instrument = ₹1,000.
Shareholders determine the conversion price in the general meeting.
A holder chooses not to convert.
The issuer must redeem that holder’s instrument within 1 month after the option-exercise period closes.
Redemption price must be at least ₹1,000.
109(4).
Exception Where Redemption Terms Are Already Disclosed
109 (3) requires the issuer to redeem the convertible debt instruments of holders who choose not to convert.
However, this requirement does not apply if the redemption is already provided for in the disclosures made in the Offer Document.
In other words, if the Offer Document has already clearly specified the applicable redemption arrangement, the special redemption requirement 109(3) does not apply.
Regulation 110. Issue of convertible debt instruments for financing
Restriction on Financing Promoter Group or Group Companies
An issuer cannot issue convertible debt instruments for:
Financing any person who is part of the promoter group or group companies;
Providing loans to such persons; or
Acquiring shares of such persons.
Therefore, the issue proceeds cannot generally be used to financially benefit a promoter group member or group company through these activities.
However, there is an exception for fully convertible debt instruments.
Fully convertible debt instruments can be issued for these purposes if:
The instruments are fully convertible; and
The conversion period is less than 18 months from the date of issue.
Example:
Company X wants to issue fully convertible debt instruments to finance the acquisition of shares of a promoter group company.
If the instruments are converted into equity within 12 months from their issue, the exception can apply.
If the conversion period is 18 months or more, the exception does not apply.
Regulation 111. Issue of warrants
An issuer shall be eligible to issue warrants in a further public offer subject to the following conditions:
(a).
Maximum Tenure of Warrants
The tenure of warrants issued through a public issue cannot exceed 18 months.
The 18-month period is calculated from the date of allotment of the warrants.
The warrants must therefore be exercised or otherwise dealt with within the permitted tenure.
(b).
Warrants Attached to Specified Securities
A specified security can have one or more warrants attached to it.
This means a single specified security does not have to be accompanied by only one warrant.
The issuer may attach:
One warrant; or
Multiple warrants
to the same specified security.
(c).
Upfront Exercise Price and 25% Payment
The exercise price of the warrants must be determined upfront.
Instead of fixing an exact price, the issuer may specify a formula for determining the exercise price.
The price or formula must be disclosed at the time of issue, so investors know how much they will have to pay when exercising the warrants.
At least 25% of the consideration amount based on the exercise price must be received upfront.
The remaining amount can be paid when the warrant holder exercises the warrant, subject to the applicable terms.
Example:
Exercise price of warrant = ₹100.
1,00,000 warrants are issued.
Total consideration based on exercise price = ₹1 crore.
At least 25% = ₹25 lakh must be received upfront.
Remaining ₹75 lakh can be received when the warrants are exercised.
25% Upfront Payment Where Exercise Price Is Based on a Formula
This is an exception to the normal rule where the warrant exercise price is determined through a formula.
If the exercise price is based on a formula, the exact exercise price may not be known at the time of issue.
In such a case, the issuer must calculate the upfront payment using the cap price of the price band of the linked equity shares or convertible securities.
At least 25% of the consideration amount calculated using this cap price must be received upfront.
“Cap price” means the upper limit of the price band.
Example:
Price band of linked equity shares = ₹90–₹110.
Cap price = ₹110.
Warrant exercise price is determined through a formula.
If the consideration based on the cap price is ₹110 per warrant, at least 25% of ₹110 = ₹27.50 must be received upfront.
(d).
Forfeiture of Warrant Consideration
A warrant holder has the option to exercise the warrant and receive equity shares.
After making the required consideration payment, the warrant holder must exercise the option within 3 months from the date of payment.
If the warrant holder does not exercise the warrant within this 3-month period:
The consideration already paid for those warrants is forfeited.
The issuer is entitled to retain the forfeited amount.
The forfeiture applies only to the warrants that were not exercised within the prescribed period.
Example:
Warrant holder pays ₹25 per warrant as the upfront consideration on 1 January.
The holder must exercise the warrant by 1 April.
If the holder does not exercise it by then, the ₹25 paid for that warrant is forfeited by the issuer.
