Compulsorily Convertible Debentures (CCDs) In M&A Due Diligence In India

In Indian M&A transactions, Compulsorily Convertible Debentures (“CCD”) often sit quietly in the capital structure until they don’t convert. While they may initially appear as debt, their eventual conversion into equity means they can significantly reshape ownership, control, and valuation.

This dual nature makes CCDs one of the most critical instruments to diligence. In private equity and venture capital transactions, CCDs are widely used for their flexibility in structuring valuation and aligning with foreign investment regulations. However, poorly structured CCDs can create hidden dilution, regulatory exposure, and unexpected shifts in control upon conversion.

For acquirers, a robust review of CCDs is not just a compliance exercise, it is essential to understanding the true economic and governance position of the target.

1.   Is It Truly a CCD?

The first step in diligence is to confirm whether the instrument is genuinely “compulsorily convertible.” This requires a careful review of transaction documents, among them subscription agreements, term sheets, and debenture trust deeds. A true CCD must mandatorily convert into equity within a defined timeframe or upon a specified event in accordance with its terms of issuance. Red flags that may call into question the classification of the instrument as a CCD include:

1. Embedded redemption or buyback rights
2. Optional conversion features
3. Cash settlement clauses

If any of these are present, the instrument may not qualify as a CCD. This has significant implications under foreign exchange regulations and accounting treatment, potentially resulting in re-characterisation as debt, with attendant regulatory, tax, and accounting consequences.

2.  Validity of Issuance: Corporate and Legal Compliance

Invalid issuance of CCDs can unravel an M&A transaction at a late stage. A buyer must therefore test not just whether approvals exist, but whether the correct legal process under the Companies Act, 2013 (“ the Act”)was followed end-to-end.

i.   Authority under Charter Documents

Firstly, the Articles of Association (“AoA") should expressly permit the company to issue debentures and convertible instruments, and to attach conversion rights, security and special investor protections with it. If the AoA is silent or restrictive, check whether it was amended prior to issuance through a special resolution.

ii.   Board Approvals: First Level of Authorisation

The Board of Directors must approve the CCD issuance before any offer is made. Such board resolution should clearly cover:

• Approval for the CCD issuance and total consideration;
• Key commercial terms (tenor, coupon, conversion formula, security, covenants);
• Approval of draft offer letter (PAS-4 in case of private placement);
• Opening of a separate bank account for receipt of subscription money;
• Authorisation to issue the offer, execute the agreements and make the

The board meeting for the approvals must be duly convened with proper notice, quorum and recorded minutes in accordance with Section 173 of the Act and Secretarial Standards-1 .

iii.   Shareholder Approvals: Critical for Validity

Under the Act, CCDs are treated as “Securities”, and their issuance typically requires shareholder approval.

(a) Private placement route (most common for CCDs)

• If CCDs are issued on a private placement basis under Section 42 read with Section 71, following shall be complied with:
• A special resolution of shareholders shall be passed;
• An offer letter in Form PAS-4 must be issued to identified investors;
• Offer shall have been made to a maximum of 200 persons in a financial year (excluding QIBs and employees under ESOP);
• Subscription money must be received through banking channels (no cash);
• Funds must be kept in a separate bank account until

(b)    Allotment and filings

• After receipt of funds:
• Allotment must be completed within 60 days,
• Return of allotment in Form PAS-3 must be filed within 15 days,
• Any delay in complying with above-stated requirements, can trigger refund obligations with

iv.   Debenture-Specific Compliance (Section 71)

Verify:

• For secured CCDs, the company has created a valid charge and registered it by filling Form CHG-9 within 30 days, failing which it may be void against creditors and liquidators.
• Execution of a debenture trust deed and appointment of a debenture trustee is carried out (mandatory if issued to more than 500 persons, though commonly implemented even in privately negotiated transactions)
• Debenture Redemption Reserve (“DRR”) is not required for CCDs as there is no repayment obligation in cash and the instrument mandatorily converts into equity.

v.   Pre-emptive Rights and Contractual Consents

Failure here may not invalidate the issuance legally but can trigger breach of contract claims or investor disputes.

From an acquirer’s perspective, such gaps may translate into indemnity exposure, consent requirements, or post-closing renegotiation risk.

vi.   Borrowing Limits under Section 180

Even though CCDs convert into equity, they may be treated as debt until conversion. Accordingly, verify compliance with Section 180(1)(c):

Whether aggregate borrowings (including CCDs) exceeded limits and requisite shareholder approval was obtained. Non-compliance may result in technical breaches impacting enforceability of borrowing arrangements.

3.  Contractual Rights and Consents

Beyond statutory compliance, CCD issuances are often governed by contractual arrangements such as shareholders’ agreements or investor rights agreements. These documents may require prior consent from existing investors, promoters, or lenders. While failure to obtain such consents may not invalidate the issuance itself, it can trigger contractual breaches, disputes, or enforcement actions. For acquirers, these translate into potential contingent liabilities and execution risks.

4.  CCDs as “Quasi-Debt”: Borrowing Limits and Covenants

Although CCDs convert into equity, they may be treated as debt until conversion for certain purposes. This hybrid character is particularly relevant when assessing borrowing limits and financial covenants. Such provisions can materially constrain the acquirer’s flexibility post-closing and must be carefully evaluated.

5.  Conversion Mechanics: The Core of CCD Analysis

Particular caution is required for structures that are “quasi-optional” in practice where economic disincentives or fallback rights effectively allow investors to defer or avoid conversion.

6.  Pricing and Anti-Dilution: Hidden Value Shifts

From an M&A perspective, it is critical to model multiple scenarios, including down-rounds. Anti-dilution protections can significantly enhance investor ownership in downside scenarios, potentially resulting in disproportionate dilution for promoters or incoming investors.

Instead, acquirers must prepare a fully diluted cap table. This analysis should be aligned with transaction modelling to assess both ownership and governance outcomes.

8.  Regulatory Compliance: FEMA, SEBI and AIF Considerations

Regulatory compliance is a key diligence area, particularly where CCDs involve foreign investment, listed entities, or pooled investment vehicles.

i.   Foreign Investment (FEMA)

CCDs are treated as foreign direct investment under the Foreign Exchange Management Act, 1999. Key checks include:

• Timely filing of Form FC-GPR and FLA Return
• Compliance with sectoral caps and entry routes
• Adherence to pricing guidelines based on fair valuation
• Alignment of conversion terms with regulatory requirements
• Non-compliance can result in penalties or require

ii.   Listed Companies (SEBI Framework)

For listed entities, CCD issuance must comply with regulations prescribed by SEBI This includes:

• Pricing norms for preferential allotments
• Shareholder approval requirements
• Disclosure obligations to stock exchanges
• Lock-in provisions and dilution impact

iii.   AIF Investors

Where CCDs are held by Alternative Investment Funds, alignment with SEBI (Alternative Investment Funds) Regulations, 2012 and a key risk area is mismatch between CCD conversion timelines and fund tenure, which can create exit challenges or force restructuring.

9.  Documentation and Filing Gaps: Spotting Inconsistencies

Statutory records serve as the primary source of truth. However, inconsistencies between internal registers, MCA filings, and financial statements are common and often signal deeper legal or compliance issues. A diligence approach based on triangulation across records rather than reliance on a single document is critical.

Key Records to Review

Registers (Debenture Holders & Members)

Ensure accurate recording of allotments, transfers, and conversions Cross-verify with transaction documents and approvals

Red flag: Incomplete, inconsistent, or retrospectively updated entries impacting ownership certainty.

MCA Filings (PAS-3)

Filed for both CCD allotment and equity conversion

Accurate disclosure of allottees, consideration, and securities

Red flags: Filing prior to receipt of funds, backdated allotments, non-filing for conversion events and mismatch with financials or cap table.

Corporate Approvals:

Proper approval of issuance and conversion terms Alignment between approval dates and allotment Red flag: Post-facto approvals or procedural gaps.

Funds Flow and Financial Records: Traceability of subscription money and alignment with filings and financial statements

Red flag: Allotments without receipt of funds or unexplained variances.

Conversion Trail: Clear linkage between CCD issuance and equity allotment

Risk: Breaks in audit trail affecting ownership and enforceability.

Timeline Compliance: Delays in filings and allotments

Check: Exposure to additional fees, penalties, or compounding. Documentation gaps are not merely procedural they can:

• Undermine validity of issuance or conversion
• Trigger ownership disputes
• Create regulatory exposure
• Delay closing or require pre-closing remediation
• Early identification and resolution are critical to deal certainty and post-closing stability

10.  Events of Default: Downside Risk Analysis

CCD documentation often includes detailed default provisions. Remedies may include:

• Enforcement of security
• Forced conversion at discounted valuations

• Enhanced governance rights

These provisions can materially shift control and economics in downside scenarios and must be carefully evaluated from a risk allocation perspective.

Conclusion

A poorly structured CCD instrument can result in unexpected dilution, regulatory non-compliance, or post-closing disputes. Conversely, a well-understood CCD structure enables accurate assessment of ownership, control, and valuation.

For acquirers, CCD diligence is not merely about compliance it is about anticipating how value, control, and risk may evolve over the life of the investment.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.