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.
So, the issuer must already have listed equity shares before making the FPO of convertible debt instruments.
If the issuer has issued debt instruments to the public:
It must not be in default in payment of interest or repayment of principal for more than six months.
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.
If it has issued no debt instruments to the public, then this condition has nothing to test.
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 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.
Clarification:(Not in the Act): [PLEASE RESEARCH THIS PART AND CHECK ON YOUR OWN AS WELL]
Fully Convertible Debentures (FCDs / CCDs):
No DRR is required.
Because these instruments convert entirely into equity shares upon maturity, no cash payout is needed from the company for redemption; hence, DRR does not apply.
Partly Convertible Debentures (PCDs):
Under Rule 18(7)(c) of the Companies (Share Capital and Debentures) Rules, 2014, DRR is required only for the non-convertible portion of the debenture issue, not the convertible portion.
Non-Convertible Debentures (NCDs): Following major amendments by the Ministry of Corporate Affairs (MCA):
Listed Companies: Exempt from creating DRR for both public issues and privately placed debentures.
Unlisted Companies (other than NBFCs/HFCs/AIFIs): Required to maintain a DRR of 10% of the value of outstanding debentures.
AIFIs, Banking Companies, NBFCs, and HFCs: Completely exempt from creating DRR.
Reg 106 requires the issuer’s equity shares to be already listed, so every issuer making an FPO of convertible debt instruments is a listed company.
Listed companies are exempt from creating a DRR, for both public issues and privately placed debentures.
So in practice no DRR will apply to an FPO of convertible debt instruments, and 107(1)(c) has no practical effect for such an issuer.
The DRR rules (Companies Act and Rule 18(7)) matter only if a listed company’s status changes, or for unlisted issuers outside this Part.
(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 of the Offer Document.
The Offer Document will specify the terms relating to redemption, such as:
Redemption date.
Redemption amount.
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).
A listed issuer may issue partly convertible debt instruments, which consist of a convertible portion and a non-convertible portion.
The convertible portion can be converted into equity shares, whereas the non-convertible portion remains debt and cannot be converted into equity shares.
Where the value of the non-convertible portion exceeds ₹10 crore, the issuer may consider rolling it over.
Rollover means extending the repayment period of the non-convertible portion beyond its original maturity date, subject to the applicable requirements.
The issuer cannot roll over the non-convertible portion merely because its value exceeds ₹10 crore.
The rollover must comply with the relevant provisions of the Companies Act, 2013.
In addition, the issuer must fulfil the specific conditions prescribed under the applicable SEBI regulations before proceeding with the rollover.
The conditions are as follows:
(a).
Approval of Rollover by Convertible Debt Holders
The rollover of the non-convertible portion of the partly convertible debt instruments must be approved by holders of the convertible debt instruments.
Holders representing at least 75% of the total value of the issuer’s convertible debt instruments must approve the rollover.
The approval must be given through a resolution passed by postal ballot.
The 75% is calculated on the value of the instruments held, not the number of holders.
A simple majority of holders is not enough.
Holders who do not vote still count in the total, so the 75% is measured against the full value of the convertible debt instruments, not just the value of those who vote.
This approval must be obtained before the rollover.
The notice for the resolution must be accompanied by the auditors’ certificate required under (b).
Once the required approval is obtained through postal ballot, condition (a) is satisfied.
Conditions (b) to (d), and compliance with the Companies Act, 2013, must still be met.
Example:
The total value of the convertible debt instruments is ₹20 crore.
Holders representing at least ₹15 crore (75%) must approve the rollover of the non-convertible portion through the postal ballot resolution.
If holders representing only ₹14 crore approve, the requirement is not met and the rollover cannot proceed.
(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 the non-convertible portion of its partly 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 Holders who have not agreed
When the issuer proposes to roll over partly convertible debt instruments then the following applies:
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 holders who have not agreed to the resolution.
This includes holders who abstained or did not vote.
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.
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
Where all of 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.
Then the holders must be given an option not to convert the convertible portion into equity shares.
In these cases, the holder is not forced to accept equity shares even though 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
In a case covered above:
The holders must be given an option not to convert.
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.
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 not convert within that ₹200 upper limit.
109(3).
Redemption When Holder Does Not Exercise the Option to Convert
Where holders have been given the option under 109(2), the price at which the instruments can be converted into equity shares is determined in the general meeting of the shareholders.
Each holder can then decide whether or not to exercise the option to convert into equity share capital at that price.
One or more holders may not exercise the option. This includes holders who do not respond, as well as those who actively decline.
A holder who does not exercise the option cannot be forced to accept equity shares.
Instead, the issuer must redeem that part of the instruments.
The issuer must complete the redemption within one month from the last date by which the option is to be exercised.
The redemption price cannot be less than the face value of that part of the instruments.
A holder who does not convert is therefore protected: the relevant part is redeemed within one month, at not less than face value.
Example:
Face value of the convertible debt instrument = ₹1,000.
The conversion price is determined in the general meeting of shareholders.
A holder does not exercise the option to convert by the last date.
The issuer must redeem that holder’s instrument within 1 month after the last date for exercising the option.
The 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 do not exercise the option 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.
Where this applies, the redemption terms in the Offer Document govern. The one-month period and the face-value floor in 109(3) may therefore not apply.
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 Determination of Exercise Price and 25% Upfront Payment
General Rule
The exercise price of the warrants, or the formula for determining it, must be decided upfront, at the time of issue.
The issuer must determine in advance the amount payable by the warrant holder to exercise the warrants and acquire the underlying securities.
At least 25% of the total consideration amount, calculated on the exercise price, must be received upfront.
The remaining consideration may be paid later, in accordance with the applicable terms, typically when the warrant holder exercises the warrants.
Example:
Company X issues warrants with an exercise price of ₹100 per warrant.
The exercise price is determined upfront at the time of issue.
The warrant holder must pay at least 25% of the exercise price upfront.
Upfront payment: 25% of ₹100 = ₹25 per warrant.
Remaining consideration: ₹100 − ₹25 = ₹75 per warrant.
The warrant holder can pay the remaining ₹75 in accordance with the applicable terms when exercising the warrant to acquire the underlying equity shares.
Upfront Payment Where Warrant Exercise Price Is Formula-Based
Where the exercise price of warrants is determined using a formula:
The upfront payment must be calculated based on the cap price of the price band determined for the linked equity shares or convertible securities.
The cap price means the highest price within the price band fixed for the linked equity shares or convertible securities.
The issuer must receive at least 25% of the consideration amount calculated using the cap price as upfront payment.
The upfront payment is therefore not calculated using the lower price or an estimated price. It must be based on the cap price specified for the linked securities.
Example:
Company X issues warrants linked to equity shares with a price band of ₹150 to ₹200 per share.
The exercise price of the warrants is determined using a formula.
The cap price is ₹200 per share, being the highest price in the price band.
The issuer must receive at least 25% of the consideration calculated using the cap price as upfront payment.
Minimum upfront payment: 25% of ₹200 = ₹50 per warrant.
The remaining amount of ₹150 per warrant may be paid later, in accordance with the applicable terms and conditions.
(d). Forfeiture of Warrant Consideration
The warrant holder has 3 months from the date of payment of consideration to exercise the option to take equity shares.
If the option is not exercised within this period, the consideration paid for those warrants is forfeited by the issuer.
The warrant holder has 3 months from the date of payment to exercise the option, failing which the consideration paid is forfeited.
So , 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.
