The Silent Law on UCCDs

Unsecured Compulsorily Convertible Debentures (“UCCDs”) are a popular tool in corporate financing, particularly in inter-company funding structures. But a persistent and often complex question arises: “Can the maturity period of UCCDs bebeyond 10 years?”. While this may initially appear to be a straight forward issue of compliance, the legal position is far from settled. It requires navigating through the interplay of multiple statutes and rules under the Companies Act, 2013 (“2013 Act”), along with understanding the regulatory intention behind them.

Law Governing Debentures

The 2013 Act, along with the accompanying Companies (Share Capital and Debenture) Rules, 2014 (“Share Capital and Debenture Rules”), and Companies (Acceptance of Deposits) Rules, 2014 (“Deposit Rules”), provide the broad legal framework for the issuance and treatment of debentures, including UCCDs.

Historically, under the Companies Act, 1956 (“1956 Act”), Section 120 of the 1956 Act allowed for perpetual debentures, including those redeemable only upon the occurrence of a remote contingency. This provision gave companies the flexibility to issue long-term or even indefinite debt instruments. Section 120 of the 1956 Act has not been retained under the 2013 Act. Instead, Section 71 of the 2013 Act which governs debentures, is notably silent on the maturity period for ‘unsecured debentures. ’Meanwhile, the Share Capital and Debenture Rules steps in to impose a 10-year cap but only for secured debentures^[1], thereby leaving a grey area when it comes to unsecured debentures like the UCCDs.

This silence has resulted in competing interpretations, one that views the absence of a limit as intentional flexibility for companies, and the other that sees it as are gulatory vacuum that should be filled through express guidelines.

Deposit Rules and its Impact

Although the primary provisions governing debentures do not place maturity restriction on unsecured debentures, the impact of Deposit Rules cannot be ignored. In relation to the scope of a deposit, the Deposit Rules give an impression that in case conversion period of a UCCD exceeds 10 years, the relevant amount raised could be classified as a deposit ^[2]– a classification that opens the can of additional and critical compliance burdens under the 2013 Act.

Notably, the Deposit Rules also provide for a situation where any money received by one company from another company is not treated as a deposit. The provision seems broad, and maybe intended to cover ‘any amount,’ and therefore arguably includes UCCDs, regardless of their conversion period. This provision also mirrors Rule2(b)(iv) of the relevant deposit rules formulated under the 1956 Act. As such, this exception under the Deposit Rules seems to reinforce the long-standing intent to exclude inter-corporate financial transactions from the scope of deposits.

While there seems to be enough clarity regarding amounts given from one company to another, in the context of UCCDs, it still leaves an important question unanswered: “If UCCDs issued from one company to another are not considered deposits under the rules, does the 10-year maturity restriction really apply?”

While there is no direct court ruling on the 10-year UCCD maturity issue, the Bombay High Court (“Court”) provided some relevant guidance in the context of inter-company transactions. The Court examined the rationale behind the deposit exclusions for inter-company transactions and noted that companies are fundamentally different from individual investors. Unlike retail depositors, companies: (i) have the capacity to assess financial risks;(ii) operate with professional decision-making structures; and (iii) are expected to act on informed commercial judgment. The Court concluded that the exclusion of inter-corporate borrowings from the definition of deposits (under the Deposit Rules) is intentional and justified, given that companies are capable of protecting their own interests in financial transactions. ^[3]

While this case supports a liberal reading of inter-company financial flexibility, it does not conclusively settle the issue of extending UCCDs with a maturity of beyond 10years. It does, however, highlight the judicial recognition for the distinct aspectsconcerning corporate participants in financial arrangements.

The Legal Uncertainty and the Way Forward

Even though some interpretations support it, the question of whether can UCCDs legally have a maturity period longer than 10 years is still unclear, (i) as the 2013 Act and associated rules are silent on maturity of unsecured debentures, (ii) the Deposit Rules create an interpretational overlap, depending on how one reads the exemptions to a deposit and (iii) the courts haven not directly ruled on this dichotomy, but their approach suggests some flexibility in inter-company transactions.

This shows that there is a clear gap in the Deposit Rules and Share Capital and Debentures Rules and in the absence of any official clarification or suitable amendments, corporates and legal advisors are operating in a space of ambiguity, especially when dealing with long-term debt instruments like UCCDs. As such, it is important for the Ministry of Corporate Affairs to provide clear guidance and resolve this issue.

References

[1] Rule 18 of the Share Capital and Debenture Rules

[2] Rule 2(1)(c)(ix) of the Companies (Acceptance of Deposits) Rules, 2014

[3] Ashish Mahendrakar & Others v. State of Maharashtra & Others, (2020) 1 MH LJ (CRI) 639