Revamped debenture regime – SEBI's latest amendments

Introduction
Pre-issue actions
Post-issue actions
Post-listing actions

Introduction

In recent months, the Indian capital markets regulator – the Securities and Exchange Board of India (SEBI) – has issued several amendments and clarificatory circulars in respect of debenture issuance in India in order to:

• enhance the transparency of disclosures by issuers;
• strengthen the role of debenture trustees (DTs); and
• protect the interests of investors.

These changes reflect a paradigm shift with respect to the role envisaged for DTs, which are now required to independently verify security and undertake ongoing enhanced due diligence and monitoring of asset cover compliance. Issuers too are now subject to a much stricter regime.

The amended regulations include:

• the SEBI (Listing Obligations and Disclosure Requirements) Regulations 2015 (LODR Regulations);
• the SEBI (Issue and Listing of Debt Securities) Regulations 2008 (ILDS Regulations); and
• the SEBI (Debenture Trustees) Regulations 1993 (Debenture Trustee Regulations).

To lend support to these amendments, SEBI has also issued several additional clarificatory circulars.(1) This article focuses on the changes brought about by these regulatory amendments and circulars.

Pre-issue actions

Independent due diligence by DTs prior to execution of DTA
As of 1 April 2021 (ie, for new issues proposed to be listed on or after 1 April 2021), DTs must conduct independent due diligence (themselves or through professional advisers or experts), including on the assets to be secured, to ensure that such assets are free from encumbrances or that the necessary consents from existing charge holders are in place. The debenture trust agreement (DTA) must specify the terms of the due diligence, including as follows:

• DTs must verify that the assets are unencumbered or that all necessary existing lender and other approvals have been obtained. Where conditional consent is received, DTs must verify that the conditions are as per the existing transaction documents and notify charge holders via email of the proposed creation of the charge.
• DTs must verify filings with the Ministry of Corporate Affairs, stock exchanges, TransUnion CIBIL Limited or information utilities. If issuers offer personal guarantees, corporate guarantees or any other guarantee or form of security, DTs must verify the relevant filings.
• DTs must obtain the necessary net-worth certifications from the statutory auditor (of a corporate guarantor) or chartered accountant (of a personal guarantor).
• DTs must independently assess whether the assets are adequate for security. DTs (either themselves or through an appointed chartered accountancy firm, registered valuer or legal counsel) must prepare one or more reports (eg, a valuation report, a Registrar of Companies search report, a title search reprort, an appraisal report, an asset cover certificate or any other report or certificate, as applicable) as part of the independent assessment.
• DTs must issue due diligence certificates in the specified format, confirming the creation of the security and that the relevant disclosures (including any covenants proposed to be included in the debenture trust deed (DTD) or side letters) align with and have been disclosed in the offer document or information memorandum.

DTs must maintain records of diligence for at least five years from redemption.

Issuers must provide necessary information to DTs to enable due diligence
As of 1 April 2021, when issuers enter into a DTA, they must provide the DTs with all relevant information for the purpose of the diligence, including:

• details of the assets on which a charge is proposed (including title deeds or reports, agreements or memoranda of understanding and evidence of registration with, for example, the sub-registrar, the Registrar of Companies or the Central Registry of Securitisation Asset Reconstruction and Security Interest (CERSAI), as applicable); and
• if the relevant assets are unencumbered, an undertaking to that effect.

For encumbered assets, the following information must also be provided:

• details of existing charges, including with respect to the charge holders, the value or amount of the charge and evidence of registration with the sub-registrar, the CERSAI or the information utilities, as applicable;
• consent certificates or no-objection certificates (NOCs) from existing charge holders for the creation of further charges; and
• consent certificates or NOCs from existing unsecured lenders, where a negative lien exists in favour of existing unsecured lenders.

For a personal guarantee or any other document or letter with a similar intent, the following information must also be provided:

• details of the personal guarantor's relationship to the issuer;
• the net-worth statement (which must be dated within six months of the date of the DTA and certified by a chartered accountant of the guarantor);
• a list of the guarantor's assets, including undertakings, consent certificates and NOCs;
• the conditions of invocation of the guarantee, including details of put options or any other terms and conditions which may affect the security created; and
• executed copies of prior agreements to guarantee any other person.

For a corporate guarantee or any other document or letter with a similar intent, the following information must also be provided:

• audited financial statements of the guarantor (which must be dated within six months of the date of the DTA), which must include details of contingent liabilities;
• an undertaking by the guarantor that the guarantee will be disclosed as a contingent liability in the 'notes to accounts' of the guarantor's financial statement;
• executed copies of prior agreements to guarantee any other person, if any;
• a list of the guarantor's assets, along with any undertakings, consent certificates and NOCs;
• the conditions of invocation (including put options or other terms which may affect the security created); and
• the impact on the security in case of the guarantor's restructuring.

In cases where securities (eg, equity shares) are being offered as security, the following information must also be provided:

• a holding statement from the depository participant, along with an undertaking that these securities will be pledged in favour of DTs in the depository system; and
• details of any other security being offered and any other document or information required by the DT with regard to the creation or perfection of security.

The above information may have to be expressly legislated in the DTA.

Issuers must create REF
SEBI has introduced an obligation for issuers to create a recovery expense fund (REF) to enable DTs to take prompt action to enforce security in case of a default in listed debt securities.

Any issuer proposing to list debt securities must deposit an amount equal to 0.01% of the issue size (subject to a maximum of Rs2.5 million per issuer) towards the REF with the designated stock exchange, as identified and disclosed in its offer document and information memorandum. Post-creation, details of the REF must be disclosed in the offer document and information memorandum and to DTs.

The REF must be created at the time of making the application for listing by way of a deposit of cash or cash equivalents, including bank guarantees. The issuer must ensure that any bank guarantee remains valid for six months following the maturity date of the listed debt security. The issuer must keep the bank guarantee in force and renew it at least seven working days before its expiry, failing which the designated stock exchange must invoke the bank guarantee. DTs must ensure that the REF conditions are met and implemented.

The balance in the REF will be refunded to the issuer on redemption or payment of all outstandings under the debentures for which an NOC will be issued by DTs to the designated stock exchange. DTs must satisfy themselves that there are no other ensuing defaults on any other listed debt securities of the issuer before issuing the NOC.

In the event of a default, the DTs or lead DT(2) must obtain the debenture holder's consent to enforce the security and notify the designated stock exchange thereof. The designated stock exchange must release the amount remaining in the REF to the DTs or the lead DT within five working days of receiving such intimation.

REFs are capped at RS2.5 million per issuer. It remains to be seen how this capped amount will be implemented across the several stock exchanges which may be used by one issuer. Further, details on the value of the refund where the REF has reached the Rs2.5 million cap in light of multiple debenture issuances may also need to be considered to ensure that sufficient REF funds (which can cover the outstanding debenture issuances) remain with the stock exchanges at all times.

While the SEBI circular on the REF came into force with effect from 1 January 2021 for all applications to list debt securities made on or after 1 January 2021, existing issuers whose debt securities were already listed on stock exchanges as at 1 January 2021 must also meet the REF requirements. Such issuers have been granted an additional 90 days to create an REF.

Disclosures in offer documents and information memoranda
For issuances which take place after 8 October 2020, the following requirements apply:

• The issuer must undertake in the information memorandum that the assets on which the charge is created are free from any encumbrances or, in cases where the assets are encumbered, that the existing creditors have consented to the creation of a second or pari passu charge on the issuer's assets.
• The following disclosures must be made in the summary term sheet in the offer document and information memorandum:
  • a security description providing details as to the type of security, the date of creation or likely creation of the security, the minimum security cover, revaluation and the replacement of security;
  • the interest to be paid to the debenture holder over and above the coupon rate, as specified in the DTD and disclosed in the offer document and information memorandum;
  • all covenants regarding the issue items. This section should specifically clarify that no side letters are being executed or disclose details of any side letters;
  • the creation of the REF, including details thereof (eg, its purpose);
  • the manner of voting and the conditions of signing an inter-creditor agreement;
  • the conditions for a breach of covenants (as specified in the DTD); and
  • risk factors pertaining to the issue.

For issuances listed on or after 1 April 2021, the issuer must also make the following disclosures in the offer document and information memorandum:

• perfection is compulsory – debt securities will be considered secured only if the charged asset is registered with the sub-registrar and the Registrar of Companies, CERSAI or the depository (among others), as applicable, or is independently verifiable by DTs;
• the terms and conditions of the DTA, including fees charged by DTs and details of the security to be created and the due diligence process carried out by DTs; and
• the due diligence certificate, as per the specified format.

Post-issue actions

Execution of DTD and creation of charge prior to listing application
While under the Companies (Share Capital and Debentures) Rules issuers had three months to execute the DTD, as of 1 April 2021, issuers must ensure that the DTD is executed and security is created as specified in the offer document and information memorandum prior to the listing application. The new timelines prescribed for listing applications are set out below. Clarification may be required from SEBI to reconcile these diverging timelines.

Listing approval only on receipt of diligence certificate
Stock exchanges are permitted to list the debt securities only on receipt of the duly completed due diligence certificate from DTs, which must reflect that security has been duly created and that the DTD has been executed. To this extent, the amendment also imposes heightened due diligence obligations on stock exchanges.

Form of DTD
For issuances made after 8 October 2020, DTs may accept only DTDs that contain the matters specified in Section 71 of the Companies Act 2013 and Form SH.12. Such a DTD must consist of two parts:

• Part A must contain the statutory and standard information pertaining to the debt issue (while clarity is awaited from SEBI, it is understood from market participants that the items specified in the SH12 will likely be included in Part A).
• Part B must contain details specific to the particular debt issue.

This change has been introduced in both the SEBI (ILDS) Regulations and the SEBI (Debenture Trustee) Regulations. While the former clarifies that this form is required only for public issuances, the latter does not distinguish between a public issue or a private placement. Therefore, it appears that this form requirement also applies to debentures issued by private placement.

Timeframe for listing on private placement basis
As of 1 December 2020, privately placed debentures must be listed within the following timeframe, post-allotment.

The T+4 timeline deviates from Regulation 19 of the SEBI (ILDS) Regulations, which provides a 15-day timeline for listing applications in case of a private placement. It remains to be seen whether a further clarification will be issued to reconcile this divergence.

Penalties for listing delay
In case of a delay in listing beyond these timelines (ie, T+4), the issuer must:

• pay the debenture holders penal interest of 1% per annum over the coupon rate from the date of allotment to the date of listing;
• be permitted to utilise issue proceeds of its subsequent two privately placed issues only after receiving final listing approval from stock exchanges.

Under the earlier SEBI circular (now superseded),(3) penal interest was payable on the expiry of 30 days from the deemed date of allotment until the actual listing. The above circular imposes penal interest from the date of allotment until the actual listing.

ISIN and freeze on trading until listing approval
As of 1 December 2020, depositories are directed to activate the International Securities Identification Number (ISIN) for debt securities issued on a private placement basis only after the listing approval has been accorded by the stock exchange. To facilitate reissuances of new debt securities in an existing ISIN, depositories can allot such new debt securities under a new temporary ISIN which will be kept frozen. On receipt of a listing approval, the debt securities credited in the new temporary ISIN will be debited. The same will also be credited in the pre-existing ISIN of the existing debt securities, before they become available for trading.

Registration of charge
As of 1 January 2021, charges created for an issue must be registered with the sub-registrar, the Registrar of Companies, CERSAI or the depository (among others), as applicable, within 30 days of their creation. Where the charge is not registered anywhere or is not independently verifiable, this will be considered a breach of the covenants or terms of the issue by the issuer. Debt securities will be considered secured only if the charged assets are registered or independently verifiable by the DT.

Periodic monitoring
DTs must incorporate the terms and conditions of periodic monitoring in the DTD to ensure that the listed entity is liable to provide relevant documents and information to enable the DT to submit the following reports and certifications to stock exchanges within the below timeframes.

The requirement to provide these reports and certificates took effect from Q4 2020 for listed debt securities. For existing debt securities, listed entities and DTs must enter into supplemental or amended DTDs which incorporate these changes within 120 days of 12 November 2020.

Post-listing actions

As of 8 October 2020, the following additional post-listing obligations have been imposed on issuers and DTs.

Issuers' additional post-issue obligations
In addition to the above, issuers must:

• maintain 100% asset cover or asset cover as per the terms of their offer documents, information memorandum and DTD (at a minimum, such cover must be sufficient to discharge the principal amount of the debentures at all times);
• provide DTs with a half-yearly certificate from a statutory auditor regarding maintenance of 100% asset cover or asset cover as per the terms of the offer documents, information memorandum and DTD, including compliance with all covenants, along with the half-yearly financial results;
• intimate the DT on all covenants of the issue, including side letters and accelerated payment clauses; and
• disclose the initiation of a forensic audit (ie, the fact that a forensic audit has been initiated, along with the name of the entity initiating the audit and the reasons for doing so, if available) and provide the final forensic audit report (unless initiated by regulatory or enforcement agencies) on receipt of such by the listed entity, along with managements' comments, if any.

DTs' additional obligations
Further diligence if the security is over receivables or book debts
It is the duty of DTs to monitor whether security and security cover is maintained. Where the listed debentures are secured by receivables or book debts, DTs must:

• conduct due diligence and monitor asset cover on a quarterly basis, in the manner as may be prescribed; and
• obtain, on a half-yearly basis, a certificate from the issuer's statutory auditor certifying the value of the receivables or book debts, including compliance with the covenants of the offer documents and information memorandum.

​Asset cover ratio for unsecured debentures
Prior to the introduction of the amendments, DTs were not specifically mandated to monitor asset cover compliance for unsecured debentures themselves and instead relied on an asset cover compliance certification issued by the practising company secretary or a practising chartered accountant for the issuer company. In its consultation paper, SEBI observed that there was no established practice regarding such asset cover certificates. While a few DTs required the issue to provide them with a detailed list of assets on which a charge was created, along with an asset cover certificate, reliance was often placed merely on a statement that the required 100% asset cover was maintained by the company.

DTs are now required to carry out due diligence and monitor the asset cover on a quarterly basis. They are further required to issue asset cover certificates for unsecured creditors based on the following formula: asset cover(4) = available assets/total borrowings (unsecured).(5)

The earlier exemption on maintenance of the asset cover in case of unsecured debt securities issued by regulated financial sector entities eligible for meeting capital requirements as specified by respective regulators is no longer available.

Disclosures on website by DTs
DTs are required to make the following disclosures on their website.

In the event of a default, the following requirements apply:

• DTs must call a meeting of all debenture holders in the event of any breach of the covenants specified in the offer document, information memorandum or DTD.
• An 'event of default' is to be recognised at the ISIN level, as all terms and conditions of the issuance of security will be the same when issued under a single ISIN even if the security was under multiple information memoranda.

In case of a default by issuers, DTs must obtain the investors' consent to enforce the security and/or enter into an inter-creditor agreement under the RBI framework,(6) which may involve a restructuring, including the roll over of debt securities, as follows:

• DTs must send notice to investors within three days of the event of default. Such notice must contain:
  • provisions for negative consent for proceeding with the enforcement of security;
  • positive consent for signing the inter-creditor agreement;
  • the period within which consent must be provided (ie, consent must be given within 15 days of the date of notice); and
  • the date of the meeting to be convened.

While all of the above will apply for issues by private placement, in case of public issues, the notice will not contain a negative consent provision and the requirement to convene a meeting for enforcement of security will not apply.

• The meeting must be held within 30 days of the event of default. However, the meeting may be dispensed with if the default is remedied between the date of notice and the date of the meeting.
• DTs must take action to enforce the security or enter into the inter-creditor agreement, as decided in the meeting of investors, subject to the following:
  • Where the majority of investors do not consent to enforce the security, DTs must not do so.
  • Where the majority of investors consent to enter into the inter-creditor agreement, DTs must do so.
  • Where consent to enforce the security and sign the inter-creditor agreement is withheld, DTs must take any further action as directed in the decision taken in the meeting of the investors.
  • DTs may form a representative committee of investors to participate in the inter-creditor agreement, enforce the security or take further action as decided in the meeting.
  • 'Consent of the majority of investors' means the approval of no less than 75% of the investors by value of the outstanding debt and 60% of the investors by number at the ISIN level. Parties may need to consider existing DTDs that already contain provisions for a lower voting threshold of debenture holders.
  • DTs may sign an inter-creditor agreement and consider the resolution plan on behalf of the investors. However, DTs are free to exit the inter-creditor agreement with the same rights as if they had never signed the agreement and the resolution plan will not be binding on DTs if:
    • the resolution plan imposes conditions on DTs that conflict with the Companies Act 2013 and the rules made thereunder, the Securities Contracts (Regulations) Act 1956 or the Securities and Exchange Board of India Act 1992 (the implications of this provision will need to be carefully analysed on a case-by-case basis);
    • the resolution plan is not finalised within 180 days of the end of the review period. DTs may consent to an extension beyond 180 days subject to the investors' approval, provided that the total timeframe does not exceed 365 days from the date of commencement of the review period; or
    • any of the terms of the approved resolution plan are contravened by any of the signatories to the inter-creditor agreement.

DTs must ensure that these conditions for exit are suitably incorporated into the inter-creditor agreement prior to its signing.

Comment

From the above, it is evident that SEBI is seeking to make the debenture market more investor friendly while at the same time ensuring investor protection through transparency. However, for issuers and DTs, teething issues in respect of this transition are inevitable.

For further information on this topic please contact Anand Shah, Hufriz Wadia or Neeraj Nainani at AZB & Partners by telephone (+91 22 4072 9999) or email (anand.shah@azbpartners.com, hufriz.wadia@azbpartners.com or neeraj.nainani@azbpartners.com). The AZB & Partners website can be accessed at www.azbpartners.com.

Endnotes

(1) This note covers the following clarificatory circulars:

• Standardisation of Timeline for Listing of Securities Issued on a Private Placement Basis (SEBI/HO/DDHS/CIR/P/2020/198, dated 5 October 2020, effective 1 December 2020);

• Standardisation of Procedure to be Followed by Debenture Trustee(s) in Case of 'Default' by Issuers of Listed Debt Securities (SEBI/HO/MIRSD/CRADT/CIR/P/2020/203, dated 13 October 2020, effective 13 October 2020) (Circular on Standard Procedure in Case of Default);

• Contribution by Issuers of Listed or Proposed-to-be-Listed Debt Securities Towards Creation of "Recovery Expense Fund"(SEBI/HO/MIRSD/CRADT/CIR/P/2020/207, dated 22 October 2020, effective 1 January 2021) (Circular for Creation of REF);

• Creation of Security in Issuance of Listed Debt Securities and 'Due Diligence' by Debenture Trustee(s) (SEBI/HO/MIRSD/CRADT/CIR/P/2020/218, dated 3 November 2020, as amended by Creation of Security in Issuance of Listed Debt Securities and 'Due Diligence' by Debenture Trustee(s) – Extension of Timeline for Implementation (SEBI Circular SEBI/HO/MIRSD/CRADT/CIR/P/2020/254, dated 31 December 2020, effective from 1 April 2021) (Creation of Security and Due Diligence Circular); and

• Monitoring and Disclosures by Debenture Trustee(s) (SEBI/HO/MIRSD/CRADT/CIR/P/2020/230, dated 12 November 2020, effective Q4 2020 for listed debt securities).

(2) A 'lead DT' is a DT which has been chosen to be the lead DT by other DTs or a DT which is the DT of more than 50% of the outstanding value of debt securities.

(3) SEBI Circular on Enhanced Disclosure in Case of Listed Debt Securities (SEBI/ HO/ MIRSD/ DOS3/CIR/P/2019/68, dated 27 May 2019).

(4) 'Available assets' are the net assets of the listed entity available for unsecured lenders (property plant and equipment (excluding intangible assets and prepaid expenses) + investments + cash and bank balances + other current and non-current assets excluding deferred tax assets (-) total assets available for secured lenders and creditors on a pari passu and exclusive charge basis under the above heads (-) unsecured current and non-current liabilities (-) interest accrued and payable on unsecured borrowings).

(5) Total borrowings (unsecured) are term loans, non-convertible debt securities, cash credit and overdraft limits, other borrowings and AS adjustments for effective interest rates on unsecured borrowings.

(6) Under the RBI 7 June 2019 circular.