Debenture Redemption Reserve - Modes, Applicability and Utilisation

Every business needs funds to function effectively. Companies need funds for growth and development. Generally, corporations raise funds through either stocks or debts. Debentures are a type of debt instrument that corporations use to raise funds from different sources. They engage in the process called redemption of debentures if they need to settle liabilities.

This blog focuses on Debenture Redemption Reserve. Read on to know crucial details.

What Is Debenture Redemption Reserve (DRR)?

Every company that issues debentures needs to have the provision of a Debenture Redemption Reserve (DRR). It is a fund that is reserved by companies for making payments on debentures.

It provides financial protection to investors and minimises risk if there’s a default in payment.

How Does a Debenture Redemption Reserve Work?

According to Section 117C of the Companies Act of 1956, every company that issues debentures needs to set aside a percentage of the amount raised through debentures. They need to create a special fund for this amount.

This case study will illustrate the working of Debenture Redemption Reserve:

Suppose an unlisted company has issued ₹ 12 Crore worth of debentures in February 2020. The maturity date for the amount is December 2025. Now the company needs to create a Debenture Redemption Reserve of ₹ 1,20,00,000.
One must note that a part of the company’s profit must be transferred to DRR. The company must use those profits that are fit to be distributed as dividends.
One should note that companies need to establish these funds within a year of issuing debentures. As per rules, companies would have to pay a penalty of 2% interest to debenture holders if they cannot create this reserve of money within the stipulated time.
It is not compulsory for companies to immediately establish a Debenture Redemption Reserve with a huge amount of money. Companies can credit the stipulated amount to the designated account annually to fulfil the 10% requirement.
Companies need to transfer 15% of the debenture amount due to mature on 31st March of the following year before 30th April of every year.
One can invest the funds in the reserve account in corporate or Government bonds, or Government approved bonds. They can use these funds to make the interest/principal payments on debentures that are maturing in that particular year.
One must note that companies need to use these funds to fulfil their liability toward debenture holders. They cannot use these funds for any other reason.

Mode of Redemption

Debentures can be classified into two types based on their redeemability:

1. Redeemable Debentures

These are debentures with a specific date of repayment. One can redeem them at the end of the period. They can do so either by lump sum or instalments at any time before the business closes. Redeemable debentures help the country attract more investors.

2. Irredeemable Debentures

These are debentures that cannot be redeemed before a company closes. In this case, the borrower doesn’t have a fixed date for repayment of the principal. Redemption of such debentures will happen only when the company is willing to repay the amount borrowed. In case of bankruptcy, the company focuses on repaying lenders first.

What Are the Various Methods of Redemption of Debentures?

Given below are the details of the methods of debenture redemptions:

Lump-sum Payment upon Maturity

After the maturity period, a company can redeem the debentures through a one-time lump sum payment per applicable terms and conditions.

Payment in Instalments After Maturity

Here, one repays the borrowed funds via instalment payments at the specified date as per applicable terms and conditions of the debenture.

Redemption Through Purchase From Open Market

Here, a company purchases debentures from the open market. In order to alter the debenture’s date of maturity, the company can cancel it. A company can avail of the debenture at a discounted rate from the open market. This contributes to decreasing the redemption payment and business revenue.

What Is the Applicability of Debenture Redemption Reserve?

Every company needs to maintain a DRR. However, there are a few exceptions.

The details of institutions that are exempted from maintaining a Debenture Redemption Reserve are as follows:

Listed Companies

A company that is listed in any of the two stock exchanges, i.e. either Bombay Stock Exchange (BSE) or National Stock Exchange (NSE)

Non-Banking Financial Companies (NBFCs)

A company, registered as per the regulation of Section 45-IA of the Reserve Bank of India Act, 1934 doesn’t need to maintain a DRR

All India Financial Institutions (AIFI)

These are companies that are regulated under supervision of the Reserve Bank of India. Some examples of these companies include the National Bank for Agriculture and Rural Development (NABARD), Export-Import Bank of India (Exim Bank), National Housing Bank (NHB), Small Industries Development Bank of India (SIDBI)

Scheduled Banks

Every bank mentioned under second schedule of RBI Act of 1934, falls under this particular category

Housing Finance Companies (HFCs)

These companies are exempted from maintaining DRR

Public Financial Institutions (PFIs)

If Government of India holds more than 51% paid-up capital in a particular company, then that PFI is exempted from maintaining a Debenture Redemption Reserve. Some examples of PFIs include Life Insurance Corporation of India (LIC) and Industrial Development Bank of India (IDBI).

Utilisation of Debenture Redemption Reserve

As per regulations, a company can make use of DRR funds by investing them in approved and specified securities.

Given below is the list of the approved securities:

Government Treasury Bills (t – bills) and commercial papers
Deposits with scheduled banks
Long-term bonds of Government

The company needs to ensure that they invest the funds before 30th April. Please note that the ledger balance of the DRR must match the ledger balance of the investment. In simpler words, the amount of investment needs to be the same as the DRR amount.

This blog enumerates the important details related to Debenture Redemption Reserve. It illustrates the working and modes of redemption. Additionally, it shows the three different methods of redemption of debentures- payment via instalment, lump-sum payment and redemption through purchase from the open market. Furthermore, the blog also provides the details of institutions that do not require to maintain a DRR.

Frequently Asked Questions

✓ Is DRR a free reserve?

A free reserve is a reserve whose funds are available for distribution as dividends. A Debenture Redemption Reserve is not a free reserve.

✓ What are the advantages of redeemable debentures?

When it comes to redeemable debentures, both the investors and issuing agency enjoy the benefits of fixed income, easy financing options and security.

✓ What type of account is a DRR?

A Debenture Redemption Reserve happens to be a company’s liability account.