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Debentures

Debentures

Contents

What is a debenture?

When a company borrows money, a loan document will be given to the creditor. This document is called a debenture. It details the terms and conditions of the loan, including the rate of interest and repayment date.

Debentures are a more secure way of investing in a company than investing in shares. This is because the debenture usually gives the creditor a right to be paid a fixed rate of interest by the company. The company must make these interest payments before paying dividends to shareholders. Also, if the company goes into liquidation because it's unable to pay its debts, debenture holders will be repaid before the shareholders. Their chances of being repaid are increased if the debenture included security over the company's assets. This security will prevent the company from selling the assets without the creditor's consent. The security can also allow the creditor to sell the assets to recover the loan.

However, as these creditors have no share in the company, they have no voting rights at shareholders' meetings and have no direct control over the running of the company.

Typical terms of a debenture

Repayment date

The amount that your company borrows will have to be repaid at some future date. The loan can be repayable on a fixed date or repayable on demand.

Interest

The debenture must specify both how much and how often interest needs to be paid. The rate can either be fixed or else fluctuate according to bank rates.

Creating security

There is no need for the debenture to create security (called a 'charge') over some or all of the company's assets. However, creditors would often want security for their loan. This would give the creditor the right to appoint a receiver (discussed below) and/or the power to sell the assets covered by the charge if your company defaults on the repayments.

There are 2 types of charges: fixed charges and floating charges.

Fixed charge

A fixed charge is taken by a creditor over specific property of the company, e.g. land, buildings, fixed plant and machinery. Although your company will still be the legal owner of the charged asset, your company won't be able to sell or deal with the asset without the creditor's permission. If your company defaults on its loan, the creditor will be able to appoint someone (the 'receiver') to sell the property.

Floating charge

Unlike a fixed charge, a floating charge isn't attached to a specific asset. It 'floats' over a class of assets, allowing the company to buy, sell and deal with these assets in the normal course of business without needing to get the creditors' consent. This type of charge is generally held over assets like stock, which the business buys and sells on a daily basis. However, if one of the events specified in the debenture occurs, e.g. your company defaults on its loan, the charge will 'crystallise'. This means your company will lose the ability to sell or otherwise deal with these assets without the consent of the creditor. If the floating charge covers all or nearly all of your company's assets, the creditor might have a right to put your company into administration without asking the court's permission.

More than one charge over an asset

It's possible for your company to grant more than one charge over its assets. In the event that your company is unable to pay its debts, a fixed charge holder would have a right to be paid before a floating charge holder. If there are 2 charges of the same type, the creditors would be paid in the order that the charges were created. For example, if there are 2 fixed charges over an asset, the creditor of the charge created first will normally get paid first from the proceeds of the sale of that asset. It's only when this creditor is fully paid that the creditor with the fixed charge created second will get paid.

Creditors with fixed or floating charges will generally be paid before creditors with no security.

Registration

Once you've formally entered into a debenture, it's your company's responsibility to register the details of any charge contained in the debenture at Companies House. You should do so within 21 days of creating that charge by delivering a 'section 859D statement of particulars of the charge' (forms MR01 or MR08) along with a certified copy of the debenture and registration fee to Companies House.

If a charge isn't registered at Companies House, it's void against an administrator or liquidator of your company, and against any person who has an interest in the charged asset. This means that if your company goes into liquidation, the liquidator can ignore an unregistered charge and treat the creditor as an unsecured creditor. Unsecured creditors are generally repaid only after the secured creditors have been repaid, and are therefore less likely than secured creditors to get back all their money.

When a charge becomes void, the money secured by it becomes repayable immediately by the company.

As the consequences of non-registration of charges could be serious for the creditor, in practice the creditors normally register the charges themselves.

If a fixed charge is taken over land, it should be also registered at the Land Registry.

Your company should also keep details of any charges it creates in the company's own register of charges kept at its registered office.

Power to appoint a receiver and power of sale

The debenture that creates a fixed charge will give the creditor the power to appoint someone to act on the creditor's behalf if your company defaults on the loan. This person is known as the 'receiver'. The receiver's job is to take possession of the assets covered by the charge. The receiver might receive rent from property covered by the charge to satisfy the outstanding loan. Alternatively, the receiver might sell the asset to repay the outstanding amount, together with interest and the costs of sale.

Frequently, however, appointing a receiver and selling a company's assets can force the company into liquidation.

Generally, the debenture states that the receiver has the power to sell, although they might have this right by law anyway. The debenture can also set out other powers of the receiver, e.g. the power to take legal proceedings.

Power to appoint an administrator

A debenture that creates a floating charge over all or nearly all of the company's assets will generally contain a power to appoint an administrator if the company is unable to pay its debts. The court's permission won't be needed to do this. An administrator will try to rescue the company rather than liquidate it if it's possible. The administrator can run the company for the benefit of all the creditors and can sell it in order to rescue it. If the company can't be rescued, the administrator can sell the assets separately to pay the creditors.