CORPORATE LAW I ASSIGNMENT 2016-17

Dr. SHAKUNTALA MISRA NATIONAL REHABILITATION UNIVERSITY, LUCKNOW

AN ASSIGNMENT

ON

DEBT FINANCE FOR COMPANIES

UNDER THE SUPERVISION OF

SHAIL SHAKYA

SUBMITTED TO SUBMITTED BY

SHAIL SHAKYA DEVANAND PANDEY

ASSISTANT PROFESSOR B.COM.LLB (Hons.)
FACULTY OF LAW 5th SEMESTER (2016-17)
D.S.M.N.R.U D.S.M.N.R.U

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ACKNOWLEDGEMENT

I would like to thank my Assistant Professor Mr. Shail Shakya for providing me this great
opportunity to learn from the topic “A Study of Patent System in India in the Light of the
Patent Cooperation Treaty”.

I would also like to thank my friends and well-wishers for their kind support and help during
the making of this assignment.

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TABLE OF CONTENTS

1) INTRODUCTION………………………………………………………………………….4-5
1.1 Historical Background………………………………………………………..…4-5

2) DEBT FINANCING………………………………………………………………………….6
2.1 Advantages……………………………………………………………………...…6
2.2 Equity v Debt………………………………………………………………………6

3) INSTRUMENTS OF DEBT FINANCE………………………………………………...7-8

3.1 Loans………………………………………………………………………………7
3.2 Debentures………………………………………………………………………7-8
3.3 Participatory Notes………………………………………………………………...8
3.4 Guarantee…………………………………………………………………………..8

4) EXTERNAL COMMERCIAL BORROWING……………………………………………9

5) CONCLUSION…………………………………………………………………………...…10

6) BIBLIOGRAPHY…………………………………………………………………………..11

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1. INTRODUCTION

Debt Finance is the process of borrowing for a company in other words it may be define as
the process by which a firm raises its capital expenditure or working capital by selling bonds,
bills, debentures or other debt instruments. A company cannot borrow unless it is so
authorized by its memorandum. In case of trading company, it is not, however, necessary that
the objects clause of its memorandum should expressly authorize it to borrow1.

Generally, Short Term Borrowing is cheaper than long term borrowings. This is because
many lenders equate time with the amount of risk. The longer they lend for, the more risk is
involved as more things can go wrong. Hence they charge a higher interest rate on longer-
term lending than on short-term lending. However, Short-term borrowing has a major
disadvantage renewal risk. Short-term loans have to be regularly renewed and the company
carries the risk that the lenders may refuse to extend further credit. This risk is at its highest
on overdraft borrowing where the bank can call in the overdraft ‘on demand’. With long-term
borrowing, as long as the borrower does not breach the debt covenants involved, the finance
is assured for the duration of loan.2

The condition for debt finance is that it must be repaid with some interest. It may be
classified as that asset of the company which is having charge on it. One of the most
important factors is the duration of the Debt Finance whether it is for short term or long term.
It is important to note that if a company borrows in foreign currency then it has to repay the
borrowings in the same currency with the required interest and the risk involved of currency
fluctuation is to bear by the company itself.

HISTORICAL BACKGROUND

In the History also various process like Mortgage etc were there which is similar to debt
Financing. Particularly the exact time of the starting of a process like debt Financing is not
yet known exactly.

1
Avatar Singh, Company Law,470 (Eastern Book Company, Lucknow, 15th Edn., 2013)
2
http://www.accaglobal.com/content/dam/acca/global/PDF-students/2012s/sept09_jayv2.pdf (Last Visited on
15/11/2016 at 6:44 PM)

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There are various laws which deal with the process of debt financing for a company for
example Reserve Bank of India Act, 1934, The Companies Act, 2013 etc. These laws have
come into force so that the interest of the investors is looked after with utmost care and for
the better relation of the Company and Investors.

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2. DEBT FINANCING

As the process of Debt Financing means borrowing for rising of Capital of a firm with the
promise to repay with interest. This process has its own advantages which are listed below:

2.1 ADVANTAGES

 Retain control. When a company or firm agrees to debt financing from a lending
institution, the lender has nothing to deal about how the company or firm will manage
that borrowing for the company. The company may make all the decisions. The
business relationship ends once the company has repaid the loan in full.
 Tax advantage. The Borrowings Company or firm pay in interest is tax deductible,
effectively reducing the company’s net obligation.
 Easier planning. The company management knows well in advance exactly how
much principal and interest the company will pay back each month. This makes it
easier to budget and make financial plans.

2.2 EQUITY V. DEBT

Definite advantages exist in using debt instruments instead of equity to finance a corporation.
One such advantage is that the holder of a debt instrument may be entitled to an ordinary loss
deduction if the obligation becomes completely or partially worthless. In addition, the issuer
is allowed an ordinary tax deduction for payments of interest on its debt instruments but not
for the payments of dividends with respect to its stock. Furthermore, the issuer will need
more in earnings to pay dividends instead of interest3.

3
http://ir.lawnet.fordham.edu/cgi/viewcontent.cgi?article=1520&context=ulj (Last visited on 15/11/2016 at
11:32 PM)

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3. INSTRUMENT OF DEBT FINANCE

There are various instruments which are used in the process of Debt Financing. The
Instruments are:

1) Loans 2) Debentures 3) Participatory Notes 4) Guarantee

3.1 LOANS

It is one of the very important instruments which are used for the process of Debt Financing.
It is mainly of two types that is loans for short term and loans for long terms. When it comes
to company every transaction is done according to the various provisions of law and Reserve
Bank of India Act keeps an eye on all the transaction because it is an obligation on the banks
to check all the transactions in order to prevent fraud and malpractices.

A term loan is a contract under which a borrower agrees to make a series of interest and
principal payments, on specified dates, to a lender. Investment bankers generally are not
involved; term loans are negotiated directly between the borrowing business and the lender4.

3.2 DEBENTURES
A debenture is an unsecured bond which a company issue for short term period in order to
raise its capital or working capital. In debentures a company is under an obligation to pay the
same amount of transaction with added interest on it in a specified period of time.

A debenture is an unsecured bond, and as such, it has no lien against specific property as
security for the obligation. These bonds are not secured by real property but are backed
instead by the revenue-producing power of the corporation. Debenture holders are, therefore,
general creditors whose claims, in the event of bankruptcy, are protected by property not
otherwise pledged. In practice, the use of debentures depends on the nature of the firm’s
assets and general credit strength. If a firm’s credit position is exceptionally strong, it can
issue debentures because it simply does not need to pledge specific assets as security.
Debentures are also issued by firms with only a small amount of assets suitable as collateral.

4
https://www.ache.org/PUBS/HAP_Companion/GapenskiFHF2/FHFCH14E2_clean.pdf (Last Visited on
16/11/2016 at 12:32am)

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Finally, firms that have used up their capacity to borrow in the lower-cost mortgage market
may be forced to use higher-cost debentures5.

3.3 PARTICIPATORY NOTES

It is considered to be one of the most important instruments for the process of debt financing.
A company can borrow from outsiders if the company is not listed on the stock exchange of
that particular country. The transactions which will be done will be regulated by the various
provisions of the Foreign Exchange Management Act and other laws. But there is an
obligation that the company has to return the borrowings in the same currency in which the
transaction was made.

3.4 GUARANTEE
It is also a form of an instrument which is used in the process of Debt Financing. It is very
much similar to Participatory notes.

5
Ibid

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4. EXTERNAL COMMERCIAL BORROWINGS

External commercial borrowing is the process of borrowing from outside, Loans does not
create a charge on the union of India whereas External Commercial Borrowings creates a
charge on the Union of India. If a company is not authorized it cannot hold currency of
foreign.

There are various bodies which regulate the process of External commercial borrowing such
as Reserve Bank of India with Securities and Exchange Board of India together regulates this
process. The Foreign Exchange Management and Transfer or Issue of Securities to a Person
Resident outside India Regulation, 2000.

There are various accounts:

a) Non Resident Ordinary Account: It is same as our saving account but this account
cannot be utilized for the purposes other than those mention in Foreign Exchange
Management
b) Non-Resident External Account: It only opened for educational purposes in foreign
for a person going outside India.
c) Foreign Currency Non-Resident Banking Account: Ths account is for traders and
merchants. This is the Indian account and only Indian Account in which money in
foreign currency can be stored. It may be also useful for a foreigner who frequently
visits India.

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5. CONCLUSION

Debt Finance has its own advantages and disadvantages. It is useful only for short period, for
a long term period Debt finance for companies is a game of high risk. There are various
things which needs to given more attention some of them are discussed below:

a) As External Commercial Borrowings Creates a Charge on Union of India, if the

borrowings are not repaid at the appropriate time and as per the regulations mentioned
SEBI and RBI, then it will create a charge on Union of India which is a matter of
shame. Therefore, this point should be given more attention and the implementation
of laws on this point should be more effective.
b) Debt Finance for Companies should only be used for shorter period of time.

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BIBLIOGRAPHY

PRIMARY SOURCES

STATUTES

1. THE COMPANIES ACT, 2013(18 OF 2013)

2. RESERVE BANK OF INDIA ACT, 1934(2 OF 1934)

3. THE SECURITIES AND EXCHANGE BOARD OF INDIA ACT, 1992(15 OF 1992)

4. THE SECURITIES CONTRACTS (REGULATION) ACT, 1956(42 OF 1956)

5. THE FOREIGN EXCHANGE MANAGEMENT ACT, 1999(42 OF 1999)

SECONDARY SOURCES

JOURNALS

1. STEVE JAY, SELECTING SOURCES OF FINANCE FOR BUSINESS, (8TH SEPTEMBER,

2003)

BOOKS

1. Dr. KAPOOR G.K. & DHAMIJA SANJAY, A COMPREHENSIVE TEXT BOOK ON

COMPANIES ACT, 2013, (TAXMANN’S 19TH Ed.)

WEBSITES

1. www.inc.com

2. www.indiankannon.com

3. www.judis.nic.in

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