2 Debenture Trustees' Comprehensive Due Diligence Obligations for Securing Investors' Interests

Key Takeaways:

- Debenture Trustees must exercise independent due diligence to verify the adequacy and enforceability of security for debt securities.

- Detailed guidelines are provided for assessing the validity of security, obtaining necessary consents, and evaluating asset valuation reports.

- Continuous monitoring of security cover, covenants, and issuer compliance is mandated through periodic reporting and certification requirements.

- Debenture Trustees are responsible for timely disclosure of any breaches, defaults, or adverse developments to investors and regulatory authorities.

Detailed Narrative:

The Securities and Exchange Board of India (SEBI) has issued comprehensive guidelines for Debenture Trustees, emphasizing their crucial role in safeguarding the interests of investors in debt securities. The Master Circular for Debenture Trustees 2023 outlines rigorous due diligence obligations to ensure the creation of adequate and enforceable security for debt securities.

At the outset, the circular mandates that Debenture Trustees exercise independent due diligence to verify that the assets offered as security are free from encumbrances or that necessary consents have been obtained from existing charge holders. This due diligence process involves scrutinizing title deeds, agreements, and registration documents to ascertain the validity and enforceability of the proposed security.

The circular provides detailed guidance on the documents and information that issuers must provide to Debenture Trustees at the time of entering into the debenture trustee agreement. This includes details of assets, existing charges, consents from charge holders, guarantor information, and any other relevant documents or undertakings. Debenture Trustees are required to obtain valuation reports, title search reports, and appraisal reports from independent professionals to assess the adequacy of the security.

Furthermore, the circular outlines specific due diligence requirements for different types of security, such as immovable property, movable assets, receivables, securities, guarantees, and other contractual comforts. Debenture Trustees must meticulously evaluate the validity, enforceability, and value of each type of security offered.

Upon completion of the due diligence process, Debenture Trustees are required to issue a due diligence certificate to the issuer, confirming the adequacy of the security and the disclosure of relevant information in the offer document or placement memorandum. This certificate must be submitted to the stock exchange along with the listing application.

The circular also emphasizes the importance of continuous monitoring by Debenture Trustees. They are obligated to periodically assess compliance with covenants, monitor security cover, and validate the status of interest and principal payments. Debenture Trustees must disclose any breaches, defaults, or adverse developments to investors, stock exchanges, and regulatory authorities in a timely manner.

To facilitate effective monitoring, the circular introduces a 'Security and Covenant Monitoring System' hosted by depositories. This system enables recording and tracking of security creation, covenant compliance, credit ratings, and payment status, fostering transparency and accountability.

In addition to due diligence and monitoring responsibilities, the circular outlines guidelines for handling conflicts of interest, outsourcing activities, and redressing investor grievances. Debenture Trustees are expected to maintain high standards of integrity, fairness, and transparency in their operations.

The Master Circular for Debenture Trustees 2023 underscores SEBI's commitment to strengthening the regulatory framework for debt securities and enhancing investor protection. By imposing rigorous due diligence and monitoring obligations on Debenture Trustees, the circular aims to ensure the creation of adequate and enforceable security, promote transparency, and safeguard the interests of investors in debt securities.

FAQs:

Q1: What is the primary objective of the due diligence requirements outlined in the circular?

A1: The primary objective is to ensure that Debenture Trustees thoroughly scrutinize the adequacy and enforceability of the security offered for debt securities, thereby protecting the interests of investors.

Q2: What types of due diligence are Debenture Trustees required to perform?A2: Debenture Trustees must conduct independent due diligence to verify the validity of security, obtain necessary consents, assess asset valuation reports, and continuously monitor security cover, covenant compliance, and issuer compliance.

Q3: What is the significance of the due diligence certificate issued by Debenture Trustees?

A3: The due diligence certificate confirms that the Debenture Trustee has carried out the required due diligence and that the security and disclosures are adequate. This certificate is a prerequisite for listing debt securities on stock exchanges.

Q4: How does the circular address continuous monitoring by Debenture Trustees?

A4: The circular mandates periodic monitoring of security cover, covenants, and payment status. It also introduces a 'Security and Covenant Monitoring System' hosted by depositories to facilitate transparent tracking and reporting.

Q5: What are the responsibilities of Debenture Trustees in case of breaches or defaults?

A5: Debenture Trustees are required to promptly disclose any breaches, defaults, or adverse developments to investors, stock exchanges, and regulatory authorities. They must also initiate appropriate actions as per the terms of the issue and the decisions of the holders of debt securities.

Key Precedents:

The Master Circular for Debenture Trustees 2023 consolidates and supersedes several previous circulars and regulations issued by SEBI. Some of the key precedents referenced in the circular include:

1. SEBI/HO/MIRSD/CRADT/CIR/P/2020/218 dated November 03, 2020:

This circular provided guidelines for the creation of security in the issuance of listed debt securities and the due diligence requirements for Debenture Trustees.

2. SEBI/HO/DDHS/DDHS_Div1/P/CIR/2022/106 dated August 04, 2022:

This circular enhanced the guidelines for Debenture Trustees and listed issuer companies regarding security creation and initial due diligence.

3. SEBI/HO/DDHS/DDHS-RACPOD1/P/CIR/2022/176 dated December 19, 2022:

This circular clarified the guidelines issued in the August 04, 2022 circular on security creation and initial due diligence.

4. SEBI/HO/MIRSD/MIRSD_CRADT/CIR/P/2022/67 dated May 19, 2022:

This circular revised the format of the security cover certificate, monitoring requirements, and timelines for Debenture Trustees.

5. SEBI/HO/MIRSD/CRADT/CIR/P/2020/230 dated November 12, 2020:

This circular outlined the monitoring and disclosure obligations of Debenture Trustees.

6. Securities and Exchange Board of India (Debenture Trustees) Regulations, 1993 (DT Regulations):

The DT Regulations provide the broad framework for Debenture Trustees, including their due diligence and monitoring responsibilities.

The Master Circular for Debenture Trustees 2023 builds upon these precedents and consolidates the various guidelines and regulations into a comprehensive document, ensuring a robust and consistent regulatory framework for Debenture Trustees in the debt securities market.

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Here's the SEBI's Debenture Trustees' circular's verbatim Chapter II

Chapter II: Due Diligence by Debenture Trustees

1. Appointment of Debenture Trustee

A Debenture Trustee shall ensure compliance with the provisions of the regulations 13 and 13A of DT Regulations with regard to being appointed as a Debenture Trustee in relation to an issue.

2. Due Diligence in respect of Secured Debt Securities{11}

The Debenture Trustee shall ensure the following with regard to due diligence at the time of creation of security:

2.1. Documents/ Consents required at the time of entering into debenture trustee agreement

In order to enable the Debenture Trustee to exercise due diligence with respect to creation of security, the Issuer at the time of entering into debenture trustee agreement shall provide the following information/ documents to the Debenture Trustee:

a) Details of assets, movable property and immovable property on which charge is proposed to be created including title deeds (original/ certified true copy by issuers/ certified true copy by existing charge holders, as available) or title reports issued by a legal counsel/ advocates, copies of the relevant agreements/ Memorandum of Understanding, copy of evidence of registration with Sub-registrar, Registrar of Companies, Central Registry of Securitization Asset Reconstruction and Security Interest (CERSAI) etc.

b) For unencumbered assets, an undertaking that the assets on which charge is proposed to be created are free from any encumbrances.

c) For encumbered assets, on which charge is proposed to be created, the following consents along-with their validity as on date of their submission:

i. Details of existing charge over the assets along with details of charge holders, value/ amount, copy of evidence of registration with Subregistrar, Registrar of Companies, CERSAI, Information Utility (IU) registered with Insolvency and Bankruptcy Board of India (IBBI) etc. as applicable;

ii. Consent/ No-objection certificate (NOC) from existing charge holders for further creation of charge on the assets or relevant transaction documents wherein existing charge holders have given conditional consent/ permission to the Issuer to create further charge on the assets, along-with terms of such conditional consent/ permission, if any; and

iii. Consent/ NOC from existing unsecured lenders, in case, negative lien is created by Issuer in favour of unsecured lenders.

d) In case of personal guarantee or any other document/ letter with similar intent is offered as security or a part of security:

i. Details of guarantor viz. relationship with the Issuer; and

ii. Net worth statement (not older than 6 months from the date of debenture trustee agreement) certified by a chartered accountant of the guarantor; and

iii. List of assets of the guarantor including undertakings/ consent/ NOC as per para 2.1(b) and 2.1(c) above; and

iv. Conditions of invocation of guarantee including details of put options or any other terms and conditions which may impact the security created; and

v. List of previously entered agreements for providing guarantee to any other person along with an undertaking that there are no agreements other than those provided in the list, if any.

e) In case of corporate guarantee or any other document/ letter with similar intent is offered as security or a part of security:

i. Details of guarantor viz. holding/ subsidiary/ associate company etc.;

ii. Audited financial statements (not older than 6 months from the date of debenture trustee agreement) of guarantor including details of all contingent liabilities;

iii. List of assets of the guarantor along-with undertakings/ consent/ NOC as per para 2.1(b) and 2.1(c) above;

iv. Conditions of invocation of guarantee including details of put options or any other terms and conditions which may impact the security created;

v. Impact on the security in case of restructuring activity of the guarantor;

vi. Undertaking by the guarantor that the guarantee shall be disclosed as

vii. “contingent liability” in the “notes to accounts” forming part of the financial statements of the guarantor;

viii. Copy of Board resolution of the guarantor for the guarantee provided in respect of the debt securities of the Issuer;

ix. List of previously entered agreements for providing guarantee to any other person along with an undertaking that there are no agreements other than those provided in the list, if any.

f) In case of any other contractual comforts/ credit enhancements provided for or on behalf of the issuer, it shall be required to be legal, valid and enforceable at all times, as affirmed by the issuer. In all other respects, it shall be dealt with as specified above with respect to guarantees.

g) In case securities (equity shares, etc.) are being offered as security then a holding statement from the depository participant along with due pledge of such securities in favour of Debenture Trustee in the depository system shall be ensured.

h) Details of any other form of security being offered viz. Debt Service Reserve Account, etc.

i) Any other information, documents or records required by the Debenture Trustee with regard to creation of security and perfection of security.

2.2. Due diligence by a Debenture Trustee for creation of security

2.2.1. Regulation 15(6) of DT Regulations inter-alia requires a Debenture Trustee, to exercise independent due diligence to ensure that security is free from encumbrances, adequate consent has been taken from existing charge holders, if any, etc. Regulation 15(1)(i) of DT Regulations places obligations on the Debenture Trustee to ensure that the assets of the Issuer are sufficient to discharge the interest and principal amount with respect to debt securities of the Issuer at all times.

2.2.2. A Debenture Trustee, by itself or through professionals appointed and compensated/ remunerated by the Debenture Trustee viz., practicing chartered accountant, practicing company secretary, registered valuer, or legal counsel shall independently carry out due diligence. The terms and conditions with respect to exercising due diligence shall also be included in the debenture trustee agreement. The due diligence to be exercised by Debenture Trustee with respect to creation of security shall inter-alia include the following:

(a) Debenture Trustee shall verify that the assets provided by Issuer for creation of security are free from any encumbrances or necessary permissions or consents has been obtained from existing charge holders by carrying out the following checks:

(i) Verify from Registrar of Companies, Sub-registrar, CERSAI, IU or other sources where charge is registered/ disclosed as per terms.

(ii) In case of conditional consent/ permission received as per para 2.1(c)(ii) above:

(A) Verify whether such conditional consent/ permission given to Issuer by existing charge holders is valid as per terms of transaction documents; and

(B) Intimate existing charge holders through necessary and appropriate means (including via e-mail) about the proposal to create further charge on assets by Issuer seeking their comments/ objections, if any, to be communicated to the Debenture Trustee within next five working days.

(b) In case of personal guarantee, corporate guarantee and any other guarantees/ form of security, the Debenture Trustee shall verify the relevant filings made on websites of Ministry of Corporate Affairs, Stock Exchange(s), CIBIL, IU etc. and obtain appraisal report, necessary financial certificates from professionals as referred earlier in this Chapter.

2.2.3. A Debenture Trustee, by itself or by engaging professionals, shall prepare one or more reports viz. valuation report, ROC search report, title search report/ appraisal report, security cover certificate, any other report/ certificate as applicable etc. and shall independently assess that the assets for creation of security are adequate for the proposed issue of debt securities.

2.2.4. A Debenture trustee shall issue ‘due-diligence certificate’ to the Issuer, as per format specified in Annex-IIA of this Master Circular, subject to the following:

(a) Information on consents/ permissions required for creation of further charge on assets is adequately disclosed in Offer Document (‘OD’)/ Placement Memorandum (‘PM’).

(b) All disclosures made in the OD/PM with respect to creation of security are in conformity with the clauses of debenture trustee agreement.

(c) All covenants proposed to be included in debenture trust deed (including any side letter, accelerated payment clause etc.) are disclosed in OD/PM.

2.2.5. A Debenture Trustee shall maintain records and documents pertaining to due diligence exercised for a period of five years from redemption of the debt securities unless required by law, or on account of any enquiries or proceedings to retain such records.

2.3. Due Diligence Certificate in case of Shelf Prospectus/ Placement Memorandum:

2.3.1. In case security details have not been finalized at the time of filing of a draft shelf prospectus/ placement memorandum by an issuer, then the Debenture Trustee shall undertake due diligence as under:

(a) The Debenture Trustee may furnish a due diligence certificate, confirming that it has carried out due diligence for the clauses other than that related to security creation [clauses are specified in the formats prescribed under regulations 40(a) and 44(3) of the SEBI NCS Regulations and Annex-IIA of this Master Circular].

(b) At the time of the issuance of the tranche prospectus/ placement memorandum when the issue structure including terms related to security has been determined and finalized, the Debenture Trustee shall issue a due diligence certificate covering all clauses of formats prescribed under regulations 40(a) and 44(3) of the SEBI NCS Regulations and Annex-IIA of this Master Circular.

2.4. Encumbrance on securities for issuance of listed debt securities:

2.4.1. Creation of encumbrance on the securities for securing the listed debt securities shall be through the depository system only in accordance with the Depositories Act, 1996, the SEBI (Depositories and Participants) Regulations, 2018, Depository bye laws and other applicable regulations and circulars.

2.4.2. Encumbrance for the above shall mean the following:

(a) Pledge, hypothecation, mortgage, lien, negative lien, non-disposal undertaking or non-disposal agreement;

(b) Any restriction on the free and marketable title to the asset, by whatever name called, whether executed directly or indirectly;

(c) Any covenant, transaction, condition or arrangement in the nature of encumbrance, by whatever name called, whether executed directly or

indirectly.

2.5. Disclosures in the OD/PM and filing of OD/ PM by the Issuer

2.5.1. The Issuer, in addition to disclosures made under Schedule I of SEBI NCS Regulations and circulars issued thereunder, shall also disclose the following in the OD/PM:

(a) “Debt securities shall be considered as secured only if the charged asset is registered with Sub-registrar and Registrar of Companies or CERSAI or Depository etc., as applicable, or is independently verifiable by the Debenture Trustee.”; and

(b) Terms and conditions of debenture trustee agreement including fees charged by Debenture Trustee, details of security to be created and process of due diligence carried out by the Debenture Trustee; and (c) Due diligence certificate as per the format specified in Annex-IIA of this Master Circular.

2.5.2. An Issuer proposing to make an issue of debt securities by way of a public issue or offer debt securities by way of a private placement, shall submit to the Stock Exchange, a due diligence certificate from the Debenture Trustee as per the format specified in Annex-IIA and update the same into the Security and Covenant Monitoring System operated by a recognised Depository, which the Debenture Trustee shall validate/ confirm on such system as detailed in Chapter III of this circular.

2.6. Creation and registration of charge of security by the Issuer

2.6.1. Before making the application for listing of debt securities, the Issuer shall create charge as specified in the OD/ PM, in favour of the Debenture Trustee and also execute a debenture trust deed{12} with the Debenture Trustee.

2.6.2. The Stock Exchange shall list the debt securities only upon receipt of a due diligence certificate as per format specified in Annex-IIB of this Master Circular from the Debenture Trustee confirming creation of charge and execution of the debenture trust deed.

2.6.3. The charge created by Issuer shall be registered with Sub-registrar, Registrar of Companies, CERSAI, Depository etc., as applicable, within 30 days of creation of such charge. In case the charge is not registered anywhere or is not independently verifiable, then the same shall be considered a breach of covenants/ terms of the issue by the Issuer.

2.7. Manner of change in security/ creation of additional security/ conversion of unsecured to secured in case of already listed debt securities:

2.7.1. Regulation 59 of SEBI LODR Regulations provides for a change in terms of listed debt securities. A change in the structure of debt listed debt securities, inter-alia, may include:

a) A change in security,

b) Creation of additional security in case of already secured listed debt securities or

c) Creation of security in case of unsecured listed debt securities.

2.7.2. In order to harmonize the process of creation of security pursuant to listing, the following directions are issued:

a) Before initiating due diligence, the Debenture Trustee and the Issuer shall ensure compliance with the paras 2.1 and 2.2 of this Chapter.

b) Pursuant to carrying out of due diligence as per paras 2.1 and 2.2 of this Chapter, the Debenture Trustee shall issue a no-objection certificate (NOC) to the issuer for going ahead with proposed change in the structure/ creation of security.

c) Thereafter, the issuer shall create the proposed security and the charge in favour of Debenture Trustee and the same shall be registered with the sub-registrar, Registrar of Companies, CERSAI, Depository etc., as applicable, within 30 days of creation of such charge. In case the charge is not registered anywhere or is not independently verifiable, then the same shall be considered as a breach of the covenants/ terms of the issue by the Issuer.

d) Pursuant to the creation and registration of charge, the issuer and Debenture Trustee shall enter into a supplemental/ amended debenture trust deed including all the terms and conditions arising out of the due diligence carried out by the Debenture Trustee as well as of the security created by Issuer.

e) The issuer, pursuant to execution of supplemental/ amended debenture trust deed, shall submit the following to the Depositories and Stock Exchanges:

i. NOC by Debenture Trustee for change in security or creation of security.

ii. Executed supplemental/ amended debenture trust deed;

iii. An undertaking from the Debenture Trustee that the security has been created and registered.

iv. Other documents/ consents required to be submitted to Stock Exchanges and Depositories in terms of Regulation 59 of SEBI LODR Regulations, circulars issued thereunder and bye-laws of Stock Exchanges and Depository, as applicable.

f) The Depository shall assign a new ISIN to the listed debt securities pursuant to submission of documents mentioned above only and shall share the information with respect to change in ISIN of listed debt securities, with the recognized Stock Exchanges.

g) It may be noted that none of the cases mentioned in para 2.7.1 would constitute a change in the structure of the listed debt securities, provided there are no other changes to the terms/ nature of issue of the listed debt securities such as maturity date, coupon rate, face value, redemption schedule, nature of the debt securities (secured/ unsecured), etc. Accordingly, the Depository shall not assign a new ISIN in such cases. However, where there is a change in the underlying security, the Debenture Trustee shall ensure compliance with the provisions of Regulation 15(1)(i) of DT Regulations.

2.8. Engagement of Independent professionals by Debenture Trustee:

2.8.1. For the purpose of availing the services of an independent professional for carrying out due diligence and continuous monitoring under the provisions of this Master Circular, the Debenture Trustee shall:

a) Put in place a criterion/ policy for engagement of an independent professional/ availing the services of an independent professional as approved by its board of Directors and shall disclose the same on its website

b) Formulate a policy on mitigating conflict of interest and shall disclose the same on its website; the policy shall, inter-alia, include a requirement that the independent professional should not have had pecuniary relationship with the issuer three years prior to the date of opening of the issue.

c) The Debenture Trustee shall directly compensate/ remunerate the professional who is engaged.

2.8.2. While a Debenture Trustee may avail the services of independent professionals, the responsibility shall rest with the Debenture Trustee.

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Annex-IIA

FORMAT OF DUE DILIGENCE CERTIFICATE TO BE GIVEN BY THE DEBENTURE TRUSTEE AT THE TIME OF FILING THE DRAFT OFFER DOCUMENT/ PLACEMENT MEMORANDUM

To,

Stock Exchange

Dear Sir / Madam,

SUB.: ISSUE OF ____________________ BY _______________LTD.

We, the debenture trustee(s) to the above mentioned forthcoming issue state as follows:

1) We have examined documents pertaining to the said issue and other such relevant documents, reports and certifications.

2) On the basis of such examination and of the discussions with the Issuer, its directors and other officers, other agencies and on independent verification of the various relevant documents, reports and certifications, WE CONFIRM that:

a) The Issuer has made adequate provisions for and/or has taken steps to provide for adequate security for the debt securities to be issued and listed.

b) The Issuer has obtained the permissions / consents necessary for creating security on the said property(ies).

c) The Issuer has made all the relevant disclosures about the security and also its continued obligations towards the holders of debt securities.

d) Issuer has adequately disclosed all consents/ permissions required for creation of further charge on assets in offer document/ placement memorandum and all disclosures made in the offer document/ placement memorandum with respect to creation of security are in confirmation with the clauses of debenture trustee agreement.

e) Issuer has disclosed all covenants proposed to be included in debenture trust deed (including any side letter, accelerated payment clause etc.), offer document/ placement memorandum.

f) Issuer has given an undertaking that charge shall be created in favour of debenture trustee as per terms of issue before filing of listing application.

We have satisfied ourselves about the ability of the Issuer to service the debt securities.

PLACE:

DATE:

DEBENTURE TRUSTEE TO THE ISSUE WITH HIS STAMP

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Annex-IIB

FORMAT OF DUE DILIGENCE CERTIFICATE TO BE GIVEN BY THE DEBENTURE TRUSTEE AT THE TIME OF FILING OF LISTING APPLICATION BY ISSUER

To,

Stock Exchange

Dear Sir / Madam,

SUB.: ISSUE OF ____________________ BY _______________LTD.

We, the debenture trustee(s) to the above mentioned forthcoming issue state as follows:

1) We have examined documents pertaining to the creation of charge over assets of Issuer.

2) On the basis of such examination and of the discussions with the Issuer, its directors and other officers, other agencies and of independent verification of the various relevant documents, WE CONFIRM that:

(a) The Issuer has created charge over its assets in favour of debenture trustee as per terms of offer document/ placement memorandum and debenture trustee agreement.

(b) Issuer has executed the debenture trust deed as per terms of offer document/ placement memorandum and debenture trustee agreement.

(c) The Issuer has given an undertaking that charge shall be registered with Sub-registrar, Registrar of Companies, Central Registry of Securitization Asset Reconstruction and Security Interest (CERSAI), Depository etc., as applicable, within 30 days of creation of charge.

We have satisfied ourselves about the ability of the Issuer to service the debt securities.

PLACE:

DATE:

DEBENTURE TRUSTEE TO THE ISSUE WITH HIS STAMP

Note:-

{11}SEBI/HO/MIRSD/CRADT/CIR/P/2020/218 dated November 03, 2020, SEBI/HO/DDHS/DDHS_Div1/P/CIR/2022/106 dated August 04, 2022 and SEBI/HO/DDHS/DDHS-RACPOD1/P/CIR/2022/176 dated December 19, 2022

{12}Form SH 12 of Companies (Share Capital and Debentures) Rules, 2014