THE COMPLETE GUIDE TO COMPULSORILY CONVERTIBLE DEBENTURES

What are CCDs

Compulsorily Convertible Debentures (“CCDs”) are hybrid instruments that are neither pure equity nor pure debt. CCDs are a type of debenture bond which must be converted into equity stocks of the issuing company by a specified date. For companies, when they turn debentures into equity, they repay a debt without using actual cash. Instead, they give back the borrowed money and cover the interest by giving the CCD holder shares in the company. CCD holders have no rights to vote as shareholders until their CCDs are converted into shares.

How are CCDs governed

Section 71 of the Companies Act, 2013 (“Act”) along with Rule 18 of the Companies (Share Capital and Debentures) Rule, 2014 deal with debentures. The Act allows the issuance of debentures with an option to be converted to equity on a future date subject to certain compliances. A company may issue CCDs through private placement by complying with provisions of Section 42 of the Act.

The issue of debentures is followed by the application of Section 73 of the Act, i.e., prohibition on acceptance of deposit from public. The Act read with the Companies (Acceptance of Deposits) Rules, 2014 (“Deposit Rules”) prohibit private companies to accept any kind of deposit from the public. However, Rule 2(1)(c)(ix) of the Deposit Rulescarves an exception that ‘bonds or debentures compulsorily convertible into shares of the company within ten years’ are not to be treated as Deposits. Therefore, any company issuing CCDs shall convert those CCDs into equity shares within 10 years from the date of issue of the CCDs or the CCDs will be treated as a deposit which are specifically prohibited for private companies under the Act and the Deposit Rules.

Breakdown of a CCD Instrument

A. What do the investors get?

An agreed number of CCDs are issued by a company to the investors at an agreed value, the total of which makes the principal amount of the CCD. The company may or may not pay interest on the principal amount until the date of redemption, as agreed between the parties. This date of redemption must not be more than 10 years from the date of issue. At the time of redemption, the company will issue shares to the investor against the principal amount and the interest amount.

B. When are CCDs converted to equity?

Although, CCDs are deemed to convert at the time of redemption as agreed between the parties in the CCD agreement, the conversion may happen earlier under certain circumstances such as an Initial Public Offering issued by the company, change of control, merger/ reconstruction, dissolution, buy out by a third party, mandatory call option, tag along rights, ROFR, drag along or any other circumstance. The parties will have to specifically agree to one or more circumstances or exit options where the CCDs can be converted to equity or the investor gets an exit before the agreed date of redemption between the parties.

Can CCDs be issued to non-residents

Investments from abroad can be generally accepted under the External Commercial Borrowing (ECB) regime or the Foreign Direct Investment (FDI) regime. ECB regime allows funding that is not in the equity form. CCDs, which are however debentures, are not a pure debt instrument and thus cannot be accepted under the ECB regime.On the other hand, the FDI regime allows investment only in equity shares, compulsorily convertible preference shares and CCDs. The FDI Scheme imposes certain pricing guidelines for issue of CCDs. Firstly, as per the RBI guidelines, the formula for converting debentures into equity must be decided when these debentures are issued. It is important to highlight that the conversion price, at the time it happens, should not be lower than the fair market value. Secondly, any agreement related to issuing CCDs should avoid having optionality clauses (like put options). If such clauses are present, they must comply with RBI guidelines, specifically ensuring a minimum lock-in period of one year and allowing investors to exit at the prevailing market price. This is to prevent any guaranteed exit price or assured returns in exchange for their investment.

How to issue CCDs

The following procedure should be followed to issue CCDs in a compliant manner: