Artha Rin Practitioners In Dhaka

A document which either creates a debt or acknowledges it, and any document which fulfills either of these conditions is a debenture”- explain and illustrate.

Introduction:

Usually a company issues debenture to raise their capital. Though there has some other ways to raise capital like issuing common stock or bond, debenture is the easy way to raise fund. A debenture is a means of company borrowing where the company agrees to repay the debt.  There may also be a charge over the company’s assets to secure the repayment of this debt.  Alternatively the company can raise finance from creditors such as banks or suppliers of goods and services.  A debenture generally is considered more secure than shares of stock or general bonds. A denture is a bond backed by the general credit of the issuer rather than any specific collateral. The issuer is required to pay a fixed sum annually until maturity and then a fixed sum to repay the principal. In short, debenture “a document which either creates a debt or acknowledges it”[1]. The laws behind debenture may vary country to country like in US debenture is unsecured but in UK it is secured by collateral[2]. However the core concept is the same.Throughout the paper I have tried to explain how a debenture creates debt or acknowledges it in terms of legal terms and regulation.

Definition of Debenture:

The word ‘Debenture’ is derived from the Latin term which means “to borrow”[3]. Share capital is the main source of finance of a joint stock company. Such capital is raised by issuing shares. Those who hold the shares of the company are called the shareholders and are owners of the company. Company may need additional amount of money for a long period. It cannot issue shares every time. It can raise loan from the public. The amount of loan can be divided into units of small denominations and the company can sell them to the public. Each unit is called a ‘debenture’ and holder of such units is called Debenture holder. The amount so raised is loan for the company. A Debenture is a unit of loan amount. When a company intends to raise the loan amount from the public it issues debentures. A debenture is a document issued under the seal of the company. It is an acknowledgment of the loan received by the company equal to the nominal value of the debenture. It bears the date of redemption and rate and mode of payment of interest. A debenture is therefore, a certificate of loan issued by a company. It is a type of security and a debenture holder is the creditor of the company. As per section 2(12) of Companies Act 1956, “Debenture includes debenture stock, bond and any other securities of the company whether constituting a charge on the company’s assets or not”[4]. A Debenture is a document given by a company as evidence of a debt to the holder usually arising out of a loan and most commonly secured by a charge.

The term “debenture” is not a strictly technical term but is applied to a security for money, called a debenture or a debenture deed, and providing for the payment of a certain specified sum to the owner or bearer, with interest in the meantime. It may be applied to any instrument showing that the party making it owes money and is bound to pay it.

In Canada it has been stated that the terms “bonds” and “debentures” are used without any distinction of meaning[5]. Usually words are included in the title of the obligation to indicate generally the type of security. The term ‘bond’ is applied to government obligations which ordinarily are unsecured and to corporate obligations which are secured by a specific mortgage. Corporate obligations which are secured by a first mortgage on immovable property are usually described as mortgage debentures[6]. An obligation may also be secured by a specific mortgage or charge on collateral security such as shares, bonds or other obligations of other corporations, in which case the obligation is usually called a collateral trust bond or debenture. The term ‘debenture” may be applied to any corporate obligation secured or unsecured as may the term “note”, although the latter term is usually confined to unsecured obligations.

Characteristics of Debenture:

v     It is in the form of a certificate, like a share certificate. In other words it is an instrument in writing, an oral promise in acknowledgement of a debt is not a debenture[7].

v     The certificate is an acknowledgement on indebtedness.

v     It is usually under the seal of the company but it is not necessary. A certificate signed by two directors of a company and without bearing the company’s seal is a valid debenture[8].

v     It is one of a series of like debentures. But a single debenture may be issued in case of a sole-lender of the company.

v     It usually provides for the repayment of a specified principal sum at a specified date, but a company may issue irredeemable debentures with no undertaking to repay.

v     It provides for the payment of interest at a specified rate until the principal sum is paid back.

v     It is generally secured by a charge, fixed or floating on any part of the company’s property or undertaking.

v     The holder of debentures is the creditor of the company and not its member.

v     The debentures carry no voting rights at any meeting of the company[9].

Types of debenture:

Debenture can be classified as under:

1. From security point of view:

(i) Secured or Mortgage debentures: These are the debentures that are secured by a charge on the assets of the company. These are also called mortgage debentures. The holders of secured debentures have the right to recover their principal amount with the unpaid amount of interest on such debentures out of the assets mortgaged by the company. In India, debentures must be secured.

Secured debentures can be of two types:

(a) First mortgage debentures: The holders of such debentures have a first claim on the assets charged.

(b) Second mortgage debentures: The holders of such debentures have a second claim on the assets charged.

(ii) Unsecured debentures: Debentures which do not carry any security with regard to the principal amount or unpaid interest are called unsecured debentures. These are called simple debentures.

2. On the basis of redemption:

(i) Redeemable debentures: These are the debentures which are issued for a fixed period. The principal amount of such debentures is paid off to the debenture holders on the expiry of such period. These can be redeemed by annual drawings or by purchasing from the open market.

(ii) Non-redeemable debentures: These are the debentures which are not redeemed in the life time of the company. Such debentures are paid back only when the company goes into liquidation. They are also known as perpetual debentures.

3. On the basis of Records:

(i) Registered debentures: These are the debentures that are registered with the company. The amount of such debentures is payable only to those debenture holders whose name appears in the register of the company.

(ii) Bearer debentures: These are the debentures which are not recorded in a register of the company. Such debentures are transferrable merely by delivery. Holder of these debentures is entitled to get the interest.

4. On the basis of convertibility:

(i) Convertible debentures: These are the debentures that can be converted into shares of the company on the expiry of pre decided period. The term and conditions of conversion are generally announced at the time of issue of debentures.

(ii) Non-convertible debentures: The debenture holders of such debentures cannot convert their debentures into shares of the company.

Legal consequences:

A debenture may be a mere promise to pay or a promise to pay secured by mortgage or charge, either in the debenture itself or in a covering trust deed[10]. As to what various classes of instruments are entitled to be described as debentures where Chitty J. said: “The term itself imports a debt – an acknowledgement of a debt – and, … generally, if not always, the instrument imports an obligation or covenant to pay. This obligation or covenant is in most cases at the present day accompanied by some charge or security.”[11]

An ordinary mortgage of freehold property is a debenture within the English Companies Act[12].

It is immaterial whether the document is styled a debenture by the corporation which issued it. If an instrument contains an acknowledgement of indebtedness, that is sufficient to constitute the instrument a debenture[13].

Irregularity in issuance

Debentures must be issued in accordance with any requirements of the by-laws, and subject also to the provisions, if any, of the articles of the corporation. See, for example, where debentures were held to be invalid as the articles of association required the authorization of a general meeting and this was never held. The holder of the debentures was deemed to know of the irregularity[14].

Where the issuance of debentures has been duly authorized, the form of the debenture may be left to be determined by the officers of the corporation without approval by a meeting of the board. If debentures are irregularly issued the rule that a bona fide holder for value without notice of the irregularity is protected applies but, of course, if he has notice he will not be protected[15]. (Note the practice in Guyana where a resolution of the Board of the corporation attesting to their intention to grant the debenture for the specific sum to the specific lending agency is required to be filed with the debenture).

Irregular and insufficient debentures for which a lender has bona fide advanced money may be evidence of an agreement on the part of the corporation to issue valid debentures, so that the holder may have a good equitable debenture on the principle laid down in where Lord Justice Turner said: “I apprehend, however, that where this Court is satisfied that it was intended to create a charge, and that the parties who intended to create it had power to do so, it will give effect to that intention, notwithstanding any mistake which may have occurred in the attempt to effect it.”[16]

Agreement to issue debentures

An agreement for consideration to issue debentures charging property constitutes a present charge of such property and the proposed debenture holder is thereby protected against an execution creditor who intervenes before the debentures are actually issued[17]; So also if a winding-up occurs before the debentures are issued the lender will be secured[18]. While these are true statements of the law in England I query given the statutory requirements in the Companies Act 1991 relating to registration which I have previously referred to, whether the principles stated in these cases can be of practical assistance.

When security enforceable

Default

The security may become enforceable under the provisions of the trust deed or independently thereof. It will become enforceable under the trust deed if any of the events of default therein specified occur, for example, non-payment of principal or interest, failure to pay taxes, suffering an execution to be levied against the mortgaged premises, etc., and if any period of grace therein provided for following a particular default has expired. Independently of any provision in the trust deed the security becomes enforceable, so far as the mortgage of the corporation’s undertaking is concerned, if the corporation ceases to carry on its business [19](appointment of a receiver); in [20](resolution for voluntary winding-up for purpose of reconstruction).

Jeopardy:

The security may also become enforceable in another type of situation. If, for example, judgments have been recovered against the corporation and executions are likely to issue, the debenture holders are entitled to have a receiver appointed even though the corporation is not in default[21]; or where the corporation proposed to distribute its reserve fund, which was practically its only asset, among the shareholders[22] or where a winding-up petition is pending[23]; or where a writ has been issued, other proceedings are threatened and the operations of the corporation are at a standstill.

This is called the doctrine of “jeopardy”, and the principle on which the court intervenes is that the debenture holders need not stand by and see the assets seized by unsecured creditors. It is not sufficient for the plaintiff merely to show that the proceeds of the assets if realized would be insufficient to pay off the bonds[24]. The power of the court to appoint a receiver manager on the ground of jeopardy is not dependent on the provisions of the trust deed. Whether a case of jeopardy has been made out depends on the circumstances of each case. The applicant must prove some peril to the property[25]. In that case the appointment of a receiver on the ground of jeopardy was refused. Proof of non-payment of interest, losses in the past, curtailment of operations in the steel department and the closing down of one of several plants, were regarded as insufficient grounds. Carroll J., whose judgment was affirmed on appeal, in contrasting the case with that of the Dominion Steel Company, where a receiver manager had been appointed. “In that case, however, it was abundantly proven that the company was no longer able to carry on;  its credit was gone;  it could not get funds to carry on its business, and it was faced with the immediate prospect of having to close down with outstanding contracts unfilled. It was in a state of suspended animation. It was a case in which the business of the company had come to an end. That is not the case here. Here we have a going concern, a live corporation, operating the property, which property is not threatened by creditors.”[26]

Remedies on security becoming enforceable:

On the security becoming enforceable by reason of default or jeopardy the trustee or the debenture holders (to the extent that independent action by debenture holders is not precluded by the trust deed) have the remedies of a mortgagee. These remedies include an action on the covenant for payment and an action to enforce the security; in the latter type of action a receiver or receiver manager many be appointed by the court. Certain other remedies may in particular cases be considered. The trust deed may provide in the event of default for the appointment of a receiver or receiver manager or for possession and sale independently of proceedings in the courts. Proceedings for the winding-up of the corporation or in insolvency may also be taken. These courses of action I will come to presently[27].

Advantages of a trust deed:

Trustees will now invariably be appointed when debenture stock is issued to a large number of persons. The mechanics of such an arrangement are that under the terms of the trust deed the property of the company is mortgaged to the debenture holders to secure payment of the money owing under the debenture(s). The contract is between the company and the trustees6. The trustee holds the benefit of the covenant by the company to repay the monies on trust for the holders of the debenture stock[28].

In practical terms there are various advantages in appointing a trustee:

Monitoring
A professional trust corporation would be familiar with this type of arrangement and have the requisite expertise. Further, the trust deed would usually give the trustee the power to call for certain information from the company. The trustee(s) can thereby ensure the company is complying with its obligations perhaps more readily than an individual debenture holder might be able to ensure compliance. The company has the advantage that it only needs to deal with one person[29].

Enforcement
The security and all enforcement powers in respect thereof are vested in the trustee as a single entity acting on behalf of all the debenture holders. This enables a coherent enforcement procedure rather than a series of disparate actions by different debenture holders. This is an advantage to the individual holders as it ensures organized action and parity of treatment. The trust deed would usually provide that all holders are paid proportionately and one action by the trustee prevents some holders recovering and not others. It is an advantage to the company as it means it does not have to defend a series of actions for what might be a trifling breach of any one provision[30].

Costs
Administration and enforcement by the trustee will be less costly than numerous parties dealing with the company[31].

Conclusion:

A Debenture is basically a way of giving loan to the Company. It is certificate given by the company which certifies that the company has taken loan from the Debenture holder and will redeem on the date of maturity. It is the most secured way of giving loan unlike shares as they create a charge on the company’s assets and in case of nonpayment the debenture holder can get his amount back by claiming his right over the asset. In case of a debenture interest will be paid to the debenture holder even if the company is incurring losses. Also in case of winding up of the company the debenture holder get priority over others. There are very detailed provisions ill statutes in the South pacific jurisdictions dealing with debentures and charges created over assets of a company whether fixed or floating. The vast array of provisions is bound to be confusing especially if not sufficiently and attentively studied. As a recipe for easy understanding, the following reading ingredients are recommended. Try then to understand that a secured creditor is entitled to be paid first in the event that a company is undergoing winding tip. It should not also be forgotten that priority of charges can be determined either from the date of creating the charges or from the date of registering the charge with the Registrar of Companies.

Bibliography:

1.       Levy v. Abercorris Slate Co. (1888), 37 Ch. D. 260 at 264.

2.       Online retrieve from http://en.wikipedia.org/wiki/Debenture

3.       Online retrieve from http://www.investopedia.com

4.       Companies Act 1956, section 2(12)

5.       Parsons v. Sovereign Bank of Canada, [1913] A.C. 160.

6.       Reid v. Explosives Co. (1887), 19 Q.B.D. 264.

7.       Re “Slogger” Automatic Feeder Co., [1915] 1 Ch. 478

8.       Whitley v. Challis, [1892] 1 Ch. 64 (C.A.)

9.       Maskelyne British Typewriter Ltd., [1898] 1 Ch. 133

10.   British India Steam Navigation Co. v. I.R.C. (1881), 7 Q.B.D. 165 at 172

11.   Company act 1967, section 538-554

12.   Company act 1974, section 172-224

13.   Company act 1994, section 755

14.   Corporate Law Economic Reform Program Act (CLERP) 1999

15.   Corporations Act chapter 2L s 283AA ff

16.   Edmonds v. Blaina Furnaces Co. (1887), 36 Ch. D. 215 at 219

17.   Knightsbridge Estates Trust Ltd. v. Byrne, [1940] A.C. 61

18.   Lemon v. Austin Friars Investment Trust Ltd., [1926] Ch. 1 (C.A.); R. v Findlater, [1939] 1 K.B. 594.

19.   Anderson Lumber Co. v Canadian Conifer Ltd., [1977] 5 W.W.R. 41 (Alta. C.A.)

20.   Duck v. Tower Galvanizing Co., [1901] 2 K.B. 314;

21.   Re Strand Music Hall Co. (1865), 3 De G. & Sm. 147,

22.   Simultaneous Colour Printing Syndicate v. Foweraker, [1901] I K.B. 771

23.   Tailby v. Official Receiver (1888), 13 App. Cas. 523; Re Hampshire Land Co., [1896] 2 Ch. 743

24.   Hodson v. Tea Co. (1880), 14 Ch. D. 859

25.   re Crompton & Co., [1914] 1 Ch.954

26.   re London Pressed Hinge Co., [1905] 1 Ch. 576

27.   Tilt Cover Copper Co., [1913] 2 Ch. 588;

28.   re Victoria Streamboats, Ltd.; Smith v. Wilkinson, [1897] 1 Ch. 158

29.   re New York Taxicab Co., [1913] 1 Ch. 1

30.   Eastern Trust Co. v. Nova Scotia Steel & Coal Co. (1926), 59 N.S.R. 123

31.   Moss Steamship Co. v. Whinney, [1912] A.C. 254. Salter v. Leas Hotel Co., [1902] 1 Ch. 332.

32.   Golden West Restaurants Ltd. V. Canadian Imperial Bank of Commerce

33.   Parsons v. Sovereign Bank of Canada, [1913] A.C. 160 at 167:

34.   Re Newdigate Colliery Ltd., [1912] 1 Ch. 468 (C.A.).

35.   Re Vimbos Ltd., [1900] 1 Ch. 470 M. Wheeler & Co. v. Warren, [1928] Ch. 840 (C.A.).

36.   Re Borough of Portsmouth Tramway Co., [1892] 2 Ch. 362

37.  Re C L Nye Ltd 1969

38.  Re Wallis & Simmins Ltd 1974

39.  Aluminium Industrie Vaassen W v Romalpa Aluminium Ltd 1976

40.  Pfeiffer Weinkellerei GmbH I v Arbuthnot Factors Ltd 1988

41.  Tatung (UK) Ltd v Galex Ltd 1989

42.  Newhart Dev v Coop Commercial Bank 1978

43.   Online retrieve from http://wiki.answers.com/Q/What_are_the_types_of_debentures

44.   Online retrieve from http://webjcli.ncl.ac.uk/2006/issue1/hanlon1.html

45.   Moss, “Fixed Charges on Book Debts – Puzzles and Perils” [1995] Insolvency International 25-28

[1] See on Levy v. Abercorris Slate Co. (1888), 37 Ch. D. 260 at 264.

[2] See http://en.wikipedia.org/wiki/Debenture (In the United States, debenture refers specifically to an unsecured corporate bond, i.e. a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bond’s maturity. Where security is provided for loan stocks or bonds in the US, they are termed ‘mortgage bonds’. However, in the United Kingdom a debenture is usually secured. )

[3] See on http://www.investopedia.com

[4] See on Companies Act 1956, section 2(12)

[5] Parsons v. Sovereign Bank of Canada, [1913] A.C. 160.

[6] Reid v. Explosives Co. (1887), 19 Q.B.D. 264.

[7] re “Slogger” Automatic Feeder Co., [1915] 1 Ch. 478

[8] Whitley v. Challis, [1892] 1 Ch. 64 (C.A.)

[9] Maskelyne British Typewriter Ltd., [1898] 1 Ch. 133

[10] British India Steam Navigation Co. v. I.R.C. (1881), 7 Q.B.D. 165 at 172

[11] Edmonds v. Blaina Furnaces Co. (1887), 36 Ch. D. 215 at 219

[12] Knightsbridge Estates Trust Ltd. v. Byrne, [1940] A.C. 61

[13] Lemon v. Austin Friars Investment Trust Ltd., [1926] Ch. 1 (C.A.); R. v Findlater, [1939] 1 K.B. 594.

[14] Anderson Lumber Co. v Canadian Conifer Ltd., [1977] 5 W.W.R. 41 (Alta. C.A.)

[15] Duck v. Tower Galvanizing Co., [1901] 2 K.B. 314;

[16] Re Strand Music Hall Co. (1865), 3 De G. & Sm. 147,

[17] Simultaneous Colour Printing Syndicate v. Foweraker, [1901] I K.B. 771

[18] Tailby v. Official Receiver (1888), 13 App. Cas. 523; Re Hampshire Land Co., [1896] 2 Ch. 743

[19] Hodson v. Tea Co. (1880), 14 Ch. D. 859

[20] re Crompton & Co., [1914] 1 Ch.954

[21] re London Pressed Hinge Co., [1905] 1 Ch. 576

[22] Tilt Cover Copper Co., [1913] 2 Ch. 588;

[23] re Victoria Streamboats, Ltd.; Smith v. Wilkinson, [1897] 1 Ch. 158

[24] re New York Taxicab Co., [1913] 1 Ch. 1

[25] Eastern Trust Co. v. Nova Scotia Steel & Coal Co. (1926), 59 N.S.R. 123

[26] Moss Steamship Co. v. Whinney, [1912] A.C. 254. Salter v. Leas Hotel Co., [1902] 1 Ch. 332.

[27] Golden West Restaurants Ltd. V. Canadian Imperial Bank of Commerce

[28] Parsons v. Sovereign Bank of Canada, [1913] A.C. 160 at 167:

[29] re Newdigate Colliery Ltd., [1912] 1 Ch. 468 (C.A.).

[30] Re Vimbos Ltd., [1900] 1 Ch. 470 M. Wheeler & Co. v. Warren, [1928] Ch. 840 (C.A.).

[31] Re Borough of Portsmouth Tramway Co., [1892] 2 Ch. 362

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