Bearer Debentures – Meaning, features, types and benefits

Last Updated at: Dec 16, 2019

Before we understand what a bearer debenture is, it is important to understand, what actually debentures are and then follow this up with the types, features and benefits. Debentures are a common type of long-term loans raised by a company. Debentures and are issued in the form of a document containing the terms and conditions of the loan, redemption of the loan, payment of interest, and other features. Most debentures pay a fixed rate of interest to its holders. Generally, debentures are secured, however, there are unsecured types of debentures as well.

Here, we focus on understanding Bearer bonds and how are they different from other bonds. Bearer bonds have now mostly been prohibited in most countries as they became an easy instrument to launder money and evade taxes. Most of these were issued in the United States for Civil War reconstruction and are now relieved of payment. 

Let us now look at the various types of debentures.

Types of debentures

Convertible and non-convertible debentures

Debentures are classified as per their convertibility. Debentures that can be converted, after a specific period of time into preference shares are termed as convertible debentures. Hence, the holders of these become both the creditors and shareholders of a company.

On the other hand, as the name suggests, the debentures that cannot be converted into shares are called non-convertible debentures.

Preferred and ordinary debentures

At the time of winding up of the company, the debentures that are paid off first are the preferred debentures. 

On the other hand, the debentures that are paid off after paying off the preferred debentures are known as ordinary debentures.

Registered debentures and bearer debentures

Usually, debentures are transferable by mere delivery. However, in case of registered debentures, the transfer is not by delivery and all details like the name of the debenture holder along with the type of debenture, number and value of the debenture is recorded in the register of the debenture holder.

Bearer debentures, on the other hand, can be transferred by mere delivery and hence, are payable to the bearer of the instrument. No records are maintained in the register of debenture holders and registration of transfer is not necessary. That is why they are also known as unregistered debentures.

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Secured debentures and unsecured debentures

Secured debentures get their name due to the fact that these debentures have a charge attached to them in the form of an asset of a company. To further explain, in case the company doesn’t have any funds to pay the secured debenture holders, then, the company will sell the said asset to pay such a loan. The charge may either be a fixed charge, i.e., against a specific asset/s or a floating charge, i.e., against all the assets of the company.

Unsecured debentures or naked debentures, do not have any fixed or floating charge attached to them in the form of assets of the company.

Redeemable debentures and irredeemable debentures

Redeemable debentures are payable at the time of the specified time period as per the terms and conditions. These debentures can be redeemed at par, premium or at a discount.

On the contrary, irredeemable debentures cannot be redeemed during the lifetime of the company. Also known as perpetual debentures, these are repayable at the time of liquidation or after an unspecified time interval.

Bearer debentures

Now that we have a fair idea about the features of debentures, let us throw some light on bearer debentures.

Features and benefits of bearer debentures

  • Bearer debentures are unregistered debentures that can be transferred by mere delivery. No records are maintained in the company’s debenture-holders’ register for the ownership of these securities.
  • Such debentures are issued physically, i.e., on paper.
  • In order to receive interest payments, the bondholder needs to submit the coupons for interest payment which are physically attached to the security to the bank or the issuing company.
  • These debentures can be redeemed within thirty days from the date of maturity which is printed on the bond.
  • Selling bearer debentures is relatively easy as no third party or intermediary is needed since these can be simply transferred by just handing over the certificate to the other person.

Risks involved in purchasing bearer debentures

Even though there are many benefits attached to the purchase of bearer debentures, the risks involved cannot be ignored.

  • Since the sale of these securities is not recorded by the issuing company, replacement in case of a lost or a stolen debenture is not possible. Any person who finds it will be considered the owner as these debentures can change ownership by mere delivery.
  • Likewise, since no information is printed on this type of bond, the person in possession of the bond can claim the final payment.
  • In case of any rise in the interest rates, the issuing company is under no obligation and can call back the bearer debentures anytime.
  • There is always a risk of losing the interest payment coupons if these are detached and sent through the mail. So, the bond needs to be delivered to a bank in person to redeem it at the time of maturity.
  • In case of death of the bearer debenture holder before the date of maturity, it becomes nearly impossible to claim the principal and interest payments.
  •  Apart from the risks involved mentioned above, there is another very important factor that has prompted many economies to stop the issue of these bonds. The bearer bonds can be easily used for money laundering or tax evasion as owners of bearer bonds are able not to report any profits that come from holding this type of bond.