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India’s corporate bond market has had its fair share of ups and downs in the past. While the recent years have seen this market size nearly triple from Rs 18 lakh crore in FY2014-15 to Rs 53 lakh crore in FY2024-25, there have been some defaults that have been able to rattle investors.
From DHFL, IL&FS, Essar Steel, Reliance Capital, to Gitanjali Gems, high-profile bond defaults like these had managed to shake investor confidence and went on to reshape risk perceptions in the last decade or so.
While India’s market regulator SEBI's regulatory framework has been evolving over the years to increase investor protection, understanding your rights as a bondholder is equally important.
So in this blog, we have done a deep dive into the concept of corporate bond defaults, the immediate actions required when it happens, the role of debenture trustee, debenture holders’ rights (especially as a retail investor), and the key risks you must factor in when investing in corporate bonds.
A corporate bond default occurs when the bond issuer fails to make timely payment of either the interest (coupon) or the principal amount on the agreed-upon maturity date. India’s market regulator SEBI formally defines bond default when there is “a delay of 1 day, even of 1 Rupee (of principal or interest) from the scheduled repayment date”, as per Annexure 11 of the SEBI Master Circular released in May 2024.
SEBI clearly mentions that in case of delay/default in servicing debt obligations, the issuer needs to provide the information to the CRA (Credit Rating Agency) immediately. Failure to do so within 2 days is considered as suppression of material information, post which the CRA can go on to issue a press release stating the suppression of information, and then disseminate the same on its website and to all stock exchanges where the security is listed. The CRA shall also inform SEBI regarding such suppression of information by the issuer and non-cooperation with CRA.
Also, such suppression of information is considered a violation of the provisions of section 12A of SEBI Act, 1992 and SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003, and the penalty in such a case can be Rs 1 lakh - Rs 1 crore.
Besides this, SEBI also mandates issuers to provide the credit rating agency with an NDS (No Default Statement) every month, wherein the issuer explicitly confirms that it has not delayed on any payment of interest/ principal in the previous month. Such a statement shall be provided to the credit rating agency on the first working day of the next month itself.
The issuer also needs to inform depositories, stock exchanges, and the debenture trustee within 2 working days of the default. Stock exchanges will suspend trading in the defaulted securities within 2 working days of the default intimation. The issuer is also required to provide continuous assessment of the default status—informing the stock exchanges/depositories and debenture trustee on or before the second working day of April every financial year about the updated status of payment, and reporting any developments affecting the default status within 1 working day.
Once a default is declared, it becomes an ‘event of default’ at the ISIN (International Security Identification Number) level, even if the bond was issued under multiple information memorandums.
Defaults can take multiple forms, from missing a single interest payment to a complete refusal to honour debt they are legally bound to pay. Nonetheless, once a default happens, debenture holders can either exercise their right to enforce security (in case of secured bonds) or go for the ICA option. Read on as we have explained both these options in the latter part of this blog..
But first, let us help you understand the role of ‘debenture trustee’, a term you have already seen multiple times in this blog.
A debenture trustee is an independent third party appointed by the issuer company to safeguard the interests of its debenture holders. These trustees play a critical role in ensuring that the terms and conditions of the debenture are followed, and debenture holders’ rights are protected.
SEBI clearly defines the key duties of a debenture trustee as the following:
Call for periodical reports from the issuer of debentures.
Take possession of trust property in accordance with the provisions of the trust deed.
Enforce security in the interest of the debenture holders.
Ensure continuously that the property charged to the debenture is available and adequate at all times to discharge the interest and principal amount payable in respect of the debentures and that such property is free from any other encumbrances except those which are specifically agreed with the debenture trustee.
Exercise due diligence to ensure compliance by the body corporate with the provisions of the Companies Act, the listing agreement of the stock exchange or the trust deed.
Take appropriate measures for protecting the interest of the debenture holders as soon as any breach of the trust deed or law comes to his notice.
Ascertain that the debentures have been converted or redeemed in accordance with the provisions and conditions under which they are offered to the debenture holders.
Inform the Board immediately of any breach of the trust deed or provision of any law.
Appoint a nominee director on the board of the body corporate when required.
As per SEBI, entities including a scheduled bank carrying on commercial activity, a public financial institution, body corporate, or an insurance company can act as a debenture trustee, provided it is registered with SEBI to act as a trustee.
Note that it is mandatory for bond issues with maturity beyond 18 months to appoint a trustee.
The debenture trustee, appointed at the time of bond issuance, becomes crucial when the event of default takes place. The trustee acts as a legal representative of bondholders and must take immediate protective actions in case of default.
Next, within 3 days of a default, the debenture trustee must seek investor consent for two key actions:
enforcement of security (if the bond is secured), or
entering into an Inter-Creditor Agreement (ICA) for debt restructuring
The trustee is also required to convene a meeting of investors within 30 days of the default to discuss courses of action.
The trustee's obligations include communicating promptly with bondholders about the default and action taken, monitoring the company's compliance with debt covenants, and taking necessary legal action on behalf of bondholders.
If you are wondering what covenant breaches are, we’ve explained this concept in this detailed blog of ours: https://blog.thealtinvestor.in/blusmart-to-pharmeasy-what-are-covenant-breaches
It’s noteworthy that covenant breaches can be seen as one of the red flags that signal a possible default in future. For example, if the issuer tends to breach financial covenants, such as maintaining a certain ratio of net borrowings to total equity, it might indicate some problems with their financials. While every covenant breach may not always translate into a default later, investors should watch out for such signs.
Coming back to the trustee’s obligations, it can appoint a nominee director on the company's board to safeguard investor interests in case two consecutive defaults occur in interest payments or the issuer fails to properly create and register the security which it had promised to debenture holders, or there is a default in redemption of debentures.
Now coming back to the enforcement of security – what does this actually mean?
Well, as an investor, voting for enforcing the security means that the Trustee will take legal actions to seize, sell, or realize this collateral, and use the proceeds from the sale to repay you and other investors.
There are both pros and cons of enforcing security:
Enforcement of security can give you a better outcome in case you suspect that the company’s position will worsen in the near future.
Enforcement of security can ensure that all ISIN holders are given equal treatment. Here, it is noteworthy that voting happens at an ISIN level, so each ISIN gets treated as a separate decision-making unit.
Enforcement of security can turn out to be a relatively faster recovery mode if the collateral provided is strong.
Enforcement of security is a lengthy and uncertain process that can take months or even years.
Legal proceedings upon enforcement may divert the issuer’s focus from repayment, since a lot of legalities, compliance, and issues will come up for handling.
It becomes harder to go back to the cooperative repayment plan once the legal action starts. Court visits and insolvency processes have rigid timelines of their own.
Enforcement of security is mostly a costly affair, because if the cost of enforcing security is more than the Recovery Expense Fund (REF), the additional amount needs to be paid by the debenture holders.
So, if the company genuinely has the ability to make repayments after taking a bit more time or minor restructuring, then it might be better to not to go ahead with the enforcement of security. Voters may also choose not to pursue the enforcement of security in a bond default if the associated negative consequences, such as the high cost and complexity of legal action, outweigh the potential financial recovery.
However, if bond holders feel that the issuer may not pay without enforcing security, they may choose to exercise this option.
The voting process is slightly complex. Here’s how it works:
Any major action to be taken by the trustee (such as enforcing security) requires approval of a super-majority of investors. SEBI defines ‘majority of investors’ as not less than 75% of the outstanding debt by value and 60% by number of investors, at the ISIN level.
Simply put, for the trustee to proceed with the enforcement of the security:
At least 75% of the total outstanding principal amount (of that ISIN) held by those voting must be in favor of enforcing the security, and
Those in favor must also constitute at least 60% of the number of debenture holders
An important point to note is that according to SEBI’s master circular (para 3.3.6), the majority has to be at an ISIN level. This means:
Each ISIN gets treated as a separate decision-making unit.
For the trustee to go ahead with the enforcement of security for a particular ISIN, that ISIN individually must cross the super-majority threshold:
75% of the outstanding value
and 60% of the number of holders (both criteria met within that ISIN)
Let’s first understand the concept of negative consent.
Essentially, SEBI says that the default vote is considered FOR enforcement of security. So if a debenture holder does not vote at all, his/her vote is, by default, considered as FOR enforcement of security.
If a debenture holder does not want to enforce security, they must explicitly vote against it, else it is assumed that they want to enforce security.
And this becomes a problem, because unless the super-majority of debenture holders (75% by value as well as 60% by number) don’t vote against it, enforcement of security goes on to take place.
Take the example of what happened in the case of TruCap — During the voting process, many debenture holders had not voted until the said deadline, which by default, was taken as consent to go ahead with enforcement of security. This gave the debenture trustee no choice but to start the process.
Luckily, TruCap managed to repay the entire amount to the investors before the trustee started with legal proceedings. Else, who knows, the process may still have been stuck.
Now, besides enforcement of security, a debenture trustee can also seek investor consent to go for an Inter-Creditor Agreement (ICA).
In the context of debt restructuring and bond defaults in India, ICA is a legally binding contract among multiple creditors of a borrower, who share exposure to the same debt. This agreement sets out agreed terms on how creditors will work together in the event of stress or default on the debt, covering a wide range of issues like enforcement, rights to collateral, voting on restructuring plans, and penalties for non-compliance.
In case of bond defaults, the ICA provides a framework to:
Coordinate collective decision-making among creditors,
Agree on steps for restructuring the debt,
Establish which creditor actions take precedence,
Avoid conflicting or chaotic enforcement actions,
Ensure that a majority creditor decision can bind dissenting minority creditors.
As far as voting is concerned, it is a crucial part of the ICA process in bond defaults and debt restructuring cases. Key points about voting in ICA are as follows:
A majority of investors (75% by value of debt and 60% by number) must agree to approve any restructuring or settlement plan.
Once the required majority votes in favor, the decision will bind all creditors, including dissenting minorities.
Back in 2020, SEBI had issued a circular mentioning the creation of REF (recovery expense fund) in order to enable the Debenture Trustees to take prompt action for enforcement of security in case of ‘default’ in listed debt securities. Any issuer that wishes to list its debt securities would need to deposit an amount equal to 0.01% of the issue size (subject to a maximum of Rs 25 lakhs per issuer) towards this fund, before issuing the bonds. This needs to be deposited with the designated stock exchange, as identified and disclosed in its Offer Document/Information Memorandum. You can read more about this fund by clicking here.
Before we end this blog, a word of caution – While it's true that credit risk remains one of the biggest risks that affect your bond investment, it’s not the only risk you should factor in.
Besides the risk of default, the following are some of the key risks investors should know when investing in corporate bonds:
Liquidity Risk: Bonds are not as liquid as equity. Some corporate bonds may be hard to sell quickly, especially those issued by smaller companies or in illiquid markets.
Inflation Risk: Whenever the rate of inflation increases, it erodes the value of your investment, as the purchasing power of the bonds' coupons/ yield and principal falls when inflation keeps rising. So, if inflation goes on to rise significantly, the real value of your fixed coupon payments can decrease, thus reducing the purchasing power of your bond income.
Reinvestment Risk: This is the probability that an investor will not be able to reinvest cash flows, such as coupon payments, at a rate equal to their current return. Such a risk can arise if your bonds contain a clause that allows the issuer to redeem before the due date/maturity, i.e. do a prepayment. Hence, this can force investors to reinvest at the current market interest rates, which usually tend to be lower than the ones at which they had earlier invested.
Interest Rate Risk: As bond prices are inversely affected by interest rate movements, a rise in interest rates could see a fall in bond prices. On the other hand, if interest rates fall, buyers have to pay a higher price to receive a coupon that is higher than the prevailing market rates. All this impacts even more in case you're planning to sell the bonds before maturity, and the value of your existing bonds falls due to an interest rate rise.
In the end, we all can agree that when a corporate bond defaults, the aftermath can indeed be uncertain, complex, and time-consuming. But that is exactly the time when investors need to stay alert and participate actively in processes like trustee votes, and weigh the pros and cons of whatever decision they take regarding legal enforcement.
After all, you being absent from the entire scenario, especially the voting process, can hand over your investment’s destiny into other investors’ as well as the trustee’s hands.
Nonetheless, while SEBI’s framework and trustee mechanisms offer pathways for recovery, the process is not always quick or straightforward. Ultimately, understanding your rights and maintaining realistic recovery expectations can help you in the long run.
Please note that this is an opinion blog and not an official research or investment advice. This blog aims to help retail investors make an informed decision if they are interested in the bond market. It neither encourages nor discourages you from investing in any particular asset class or platform.
