“A Document which either creates a debt or acknowledges it, any document which fullfill either of these condition is a debenture” explain and illustrate.

Introduction:

Debentures (or loan stock) exist as an alternative form of investing in a company that is more secure than investing in shares because interest payments must be made by the company and must be paid before dividends. Dividends, in contrast to debentures, are paid at the company’s discretion. Debenture holders also become preferential creditors if the company which issued the debentures fails. A disadvantage is that debenture holders have no share in the company and therefore have no control over it.

If a company borrows money, it will give its creditor a document confirming the existence and terms of the loan. This document is called a debenture. Under the debenture, the amount borrowed is repayable at a future date.

During the period of the loan, the company has to pay interest to the creditor in the same way people pay interest to banks on their mortgages. In order to improve the chances of recovering the debt from the company if it fails, a creditor may take a charge over some or all of the assets of the company. This means that the creditor has a legal interest in that asset and the company can’t sell it without either paying off the debt or getting the consent of the creditor. This increases the creditor’s chance of being repaid on the insolvency of the company as it has a preferential claim on money from the insolvency.

On the other hand, 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 Guyana the term is only used in relation to a security given by a corporate entity and never in relation to an obligation undertaken by a natural person. Any document which either creates a debt or acknowledges it is a debenture: Levy v. Abercorris Slate Co. (1888), 37 Ch. D. 260 at 264.

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.(Refer to observations of Lindley J. in British India Steam Navigation Co. v. I.R.C. (1881), 7 Q.B.D. 165 at 172, as to what various classes of instruments are entitled to be described as debentures) and Edmonds v. Blaina Furnaces Co. (1887), 36 Ch. D. 215 at 219 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.”

An ordinary mortgage of freehold property is a debenture within the English Companies Act: Knightsbridge Estates Trust Ltd. v. Byrne, [1940] A.C. 613.

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

In Canada it has been stated that the terms “bonds” and “debentures” are used without any distinction of meaning. I mention this because I believe that the persons who drafted our present Companies Act drew heavily on the Canadian model and practice. As applied to corporate obligations there is no legal distinction between the terms “bonds’, “debentures” and “notes” and the fact that one or another of such terms appears in the designation of the obligation cannot be relied on as an indication of the security (if any) behind the obligation. 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 and this is the most usual form encountered in Guyana. 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.

Description

Describe the contents and form of a Debenture:

Names of parties

Statement of consideration

Terms of repayment

Rate of interest

Obligations of the borrower e.g. to insure property and to provide accounts at stated intervals etc

Events of default

Powers of the lender following an event of default

Typical terms:

Listed below are some of the typical terms found in a debenture.

Repayment date:

The amount that the company borrows will have to be repaid at some future date. It can be a fixed loan where repayment is due on a particular date or a loan repayable on demand.

Interest :

The debenture must specify both the frequency and rate of the interest to be paid. The rate can either be fixed or else fluctuate according to bank rates.

Power to appoint a receiver:

If the company defaults under the terms of a debenture, the debenture holder’s right to recover the money owed to them is by the appointment of a receiver in accordance with the terms of the debenture. Thus, the power to appoint a receiver should be contained in the debenture.

The receiver’s job is to take possession of the assets that are subject to the charge. After making provision for payment of any prior creditors of the company, the receiver can sell enough of the charged assets to pay what is due to the debenture holder, together with interest and costs.

When this is achieved, the receiver retires from office and the company is allowed to carry on its business again. Frequently, however, the appointment of a receiver and the sale of its assets will force the company into liquidation.

Power of sale:

In order to recover the sum due to the debenture holder, a receiver appointed by the debenture holder will need the power to sell the assets, which are the subject of the charge. Thus, a power of sale should be included in the debenture.

Apart from the power of sale, it is advisable to list out in the debenture some other powers of a receiver, e.g. the power to take legal proceedings.

Security:

Although there is no need for a loan to be secured, the debenture holder’s position is improved if they do take a charge over the company’s assets. The security can be in the form of a fixed charge or a floating charge, or a combination of the two over the assets of the company.

Fixed charge:

A fixed charge is taken over specific property, e.g. land, buildings, fixed plant and machinery. Upon the giving of a fixed charge, the company, though still is the legal owner of the charged asset, cannot sell or deal with the asset without the consent of the charge holder.

Floating charge:

Unlike a fixed charge, a floating charge does not attach to a specific asset. It ‘floats’ over a class of assets, while the component parts of that class of assets may be changing as the company still has the power to deal with any of the assets within that class without the need to consult the charge holder.

A debenture can provide that the floating charge can ‘crystallize’ in specific circumstances. For example, when the company ceases to carry on business or goes into liquidation, or when the debenture holder appoints a receiver to enforce their security.

When a floating charge crystallizes, it no longer hovers over a class of assets which are subject to the charge, but becomes equivalent to a fixed charge because from the time of crystallization, the company cannot deal with any item within the class of assets without the consent of the charge holder.

Usually, debentures containing a floating charge also impose a prohibition on the company granting any fixed charges over the assets that are the subject of the floating charge. This is because fixed charges that are created after the floating charge would rank before the floating charge for payment in the event of insolvency of the company. In other words, despite the fact a fixed charge is registered after a floating charge, it would be paid in preference to the floating charge.

Registration :

Once the company has formally entered into a debenture, it is the company’s responsibility to register prescribed particulars of any charge contained in the debenture at Companies House within 21 days of creation of that charge.

If the debenture contains a floating charge and a prohibition on the creation of later fixed charges taking priority, the prohibition should be noted on the prescribed particulars as well.

Although it is primarily the responsibility of the company to register particulars of any charge, it is the chargee (i.e. the debenture holder) who suffers if the charge is not registered or is registered late.

So, in practice, the debenture holder normally registers the charge. If the charge is not registered at Companies House, it is void against an administrator or liquidator of the company and against any person who acquires an interest in the charged asset.

Any debts owed by the company to the debenture holder still remain outstanding but are treated as unsecured debt in the event of the company’s insolvency and will be added to all the other debts which the company owes to be paid right at the end of the insolvency process.

If a fixed charge is taken over land, it should be registered at the Land Registry. Details of any charge created by the company should also be kept in the company’s own register of charges at its registered office.

Registration requirements under the Companies Act 1991:

Registration is dealt with in Part III Division A  ss. 233 et seq of the Act.

(Deal with the requisite provisions from the Act itself).

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

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 : Duck v. Tower Galvanizing Co., [1901] 2 K.B. 314; but, of course, if he has notice he will not be protected. (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 Re Strand Music Hall Co. (1865), 3 De G. & Sm. 147, 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.”

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: Simultaneous Colour Printing Syndicate v. Foweraker, [1901] I K.B. 771; So also if a winding-up occurs before the debentures are issued the lender will be secured: Tailby v. Official Receiver (1888), 13 App. Cas. 523; Re Hampshire Land Co., [1896] 2 Ch. 743. 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

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: Hodson v. Tea Co. (1880), 14 Ch. D. 859 (appointment of a receiver); in re Crompton & Co., [1914] 1 Ch.954 (resolution for voluntary winding-up for purpose of reconstruction).

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.

Action to enforce the security:

Such a proceeding is a mortgagees’ action and is subject only to the laws and the rules of practice in force in the High Court. This should normally be a most expeditious procedure as the nature of a Roman Dutch mortgage in this country is such as does not permit or even entertain an equity of redemption, the deed being in the form of a “willing and voluntary” self condemnation, the Court being required only to “strengthen and confirm” that condemnation. However, as commercial practitioners know to their chagrin, as do their clients, the courts have in recent times exercised greater and greater leniency in favour of the mortgagor so that the term “security” is less and less applicable to the Guyanese mortgage.

The usual and proper course, in most cases, is to bring an action against the corporation to have the trusts of the trust deed where there is one carried into execution, to have a receiver or a receiver manager appointed, to have it declared that the trustee or the debenture holder is entitled to a mortgage and charge on the property and assets covered by the trust deed or debenture, to have the mortgage and charge enforced by sale, and for an order directing the taking of the necessary accounts and enquiries. Forthwith after action has been commenced an application is made to the court on motion for the appointment of a receiver or receiver manager.

The usual acceleration clause, whereby in the event of default for a stated period the whole principal sum becomes due, is a cumulative provision and does not interfere with the right of foreclosure which becomes immediately exercisable on the occurrence of default.

Winding-up petition:

A debenture holder may, if principal or interest is due and unpaid, file a winding-up petition. Re Borough of Portsmouth Tramway Co., [1892] 2 Ch. 362; and a debenture holder who has brought an action and obtained the appointment of a receiver is not thereby disentitled from petitioning to wind up.

Sometimes in order to obviate proceedings by the debenture holders and to save expense, the debenture holders, if the corporation is in liquidation, make an arrangement with the liquidator whereby he sells the assets and pays the claim of the debenture holders out of the proceeds.

Reconstruction with or without a sale:

Upon the security becoming enforceable it may become clear prior to or following the institution of enforcement proceedings that a satisfactory sale of the mortgaged premises cannot be effected for cash. In such circumstances it may become necessary to attempt to bring about a reconstruction under which the mortgaged premises will be sold for securities of another corporation (which may be a corporation specially formed for the purpose) which will be distributed to the debenture holders, or the debenture holders will accept new securities of the existing corporation in lieu of their bonds or agree to some modification of their existing securities. (See Division K ss.217 and 219 et seq of the Companies Act 1991).

Where the trust deed contains adequate provisions enabling a stated majority at a meeting of the debenture holders to consent to what is proposed, such provisions will frequently be utilised to effect a reconstruction. Such a reconstruction requires the co-operation of the shareholders and possibly of other creditors as well as the requisite approval of the court.

Effect of appointment on the corporation:

The appointment of a receiver by the court leaves the corporation in existence, but deprives the corporation of all power to enter into contracts, or to alienate, pledge or otherwise dispose of the assets of which the receiver is put in possession. The corporation’s powers are in abeyance: Moss Steamship Co. v. Whinney, [1912] A.C. 254.

The appointment of a receiver will ordinarily operate as a dismissal of the corporation’s servants: Reid v. Explosives Co. (1887), 19 Q.B.D. 264.

The appointment of a receiver does not necessarily put an end to all the corporation’s trading contracts. As the receiver is appointed to manage the corporation’s business, he is at liberty to continue with a contract or repudiate it: Parsons v. Sovereign Bank of Canada, [1913] A.C. 160. If the repudiation of a contract would destroy the goodwill of the corporation, which it is the duty of the receiver to preserve, the court will not permit the repudiation. In re Newdigate Colliery Ltd., [1912] 1 Ch. 468 (C.A.).

Procedure for appointment of receiver by the court:

As soon as the writ in an action to enforce the security has been issued and served an application may be made to the court for the appointment of a receiver or receiver manager.

The order usually requires the receiver manager to give security to be fixed by the Court. It is usually desirable that the order should permit the receiver manager to act at once and before giving security.

Types of Debenture

Security : i. Secured/ Mortgage debenture

ii. Unsecured/ Naked debenture

Tenure: i. Redeemable debenture

ii. Perpetual/ irredeemable debenture

Mode of Redemption:  i. Convertible debenture

a.               Fully convertible debenture

b.              Partly convertible debenture

Coupone rate:  i. Zero coupone rate

ii. Specific rate

Registration:  i. Redeemable debenture

ii. Bearer debenture

From the Point of view of Security

• Secured Debentures: Secured debentures refer to those debentures where a charge is created on the assets of the company for the purpose of payment in case of default. The charge may be fixed or floating. A fixed charge is created on a specific asset whereas a floating charge is on the general assets of the company. The fixed charge is created against those assets which are held by a company for use in operations not meant for sale whereas floating charge involves all assets excluding those assigned to the secured creditors.
• Unsecured Debentures: Unsecured debentures do not have a specific a charge on the assets of the company. However, a floating charge may be created on these debentures by default. Normally, these kinds of debentures are not issued.

From the Point of view of Tenure

• Redeemable Debentures: Redeemable debentures are those which are payable on the expiry of the specific period either in lump sum or in Instalments during the life time of the company. Debentures can be redeemed either at par or at premium.
• Irredeemable Debentures: Irredeemable debentures are also known as Perpetual Debentures because the company does not given any undertaking for the repayment of money borrowed by issuing such debentures. These debentures are repayable on the on winding-up of a company or on the expiry of a long period.

From the Point of view of Convertibility

• Convertible Debentures: Debentures which are convertible into equity shares or in any other security either at the option of the company or the debentureholders are called convertible debentures. These debentures are either fully convertible or partly convertible.
• Non-Convertible Debentures : The debentures which cannot be converted into shares or in any other securities are called nonconvertible debentures. Most debentures issued by companies fell in this category.

From Coupon Rate Point of view

• Specific Coupon Rate Debentures: These debentures are issued with a specified rate of interest, which is called the coupon rate. The specified rate may either be fixed or floating. The floating interest rate is usually tagged with the bank rate.
• Zero Coupon Rate Debentures: These debentures do not carry a specific rate of interest. In order to compensate the investors, such debentures are issued at substantial discount and the difference between the nominal value and the issue price is treated as the amount of interest related to the duration of the debentures.

From the view Point of Registration

• Registered Debentures: Registered debentures are those debentures in respect of which all details including names, addresses and particulars of holding of the debentureholders are entered in a register kept by the company. Such debentures can be transferred only by executing a regular transfer deed.
• Bearer Debentures: Bearer debentures are the debentures which can be transferred by way of delivery and the company does not keep any record of the debentureholders. Interest on debentures is paid to a person who produces the interest coupon attached to such debentures.

Conclusion

I trust that I have succeeded in giving you an overview of the topic of debentures and some practical information. I have also endeavoured to draw to your attention to the specific provisions of the Companies Act 1991, which have a lot to say on the subject. Practitioners would be well advised to carefully study the Act before attempting to function in this area of commercial law as the pitfalls are numerous and serious.

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