Debentures in company law may refer to secured debentures, unsecured debentures, registered debentures, bearer debentures, redeemable debentures, irredeemable debentures, and convertible debentures. Businesses usually raise capital by issuing shares in the company or by borrowing from lenders. A debenture is a way for a business to borrow in which the company agrees to repay the debt plus interest.

What Is a Debenture?

A debenture is a bond or promissory note that is issued by a business to a creditor in exchange for capital. The repayment and terms of the loan are completed based on the general creditworthiness of the business and not by a lien, mortgage, or any specific property. An indenture is a legal document that sets the terms for the transaction. Therefore, a debenture is commonly found within an indenture.

A debenture is usually a type of bearer instrument, a type of fixed-income security in which no ownership data is recorded, and the security is issued in physical form to the purchaser. The person holding the debenture at the time of payment will receive the funds even if they're not the original creditor. Coupons representing semiannual or annual payments of interest are attached. They are to be redeemed for payment on the due date.

The creation of a debenture acknowledges the fact that a debt is owed by the issuing company. The term "debenture" includes:

  • Stocks
  • Bonds
  • All other debt securities that were issued by the business

Ordinarily, a debenture is issued with secured borrowings and has either a floating or fixed interest payment attached to it. In less common scenarios, a debenture is issued with unsecured borrowings. In a commercial setting, the term "debenture" will typically refer to the legal document that describes the secured debt.

A debenture is considered a more secure way to invest in a business than purchasing shares because the company must pay the interest on the debenture before any dividend payments can be made to the shareholders. For example, if a company declares bankruptcy, the debenture holders will receive payment before the shareholders. The main disadvantage to being a debenture holder is that they have no control over the decision-making process of the company because they control no shares in the business.

The business has to pay interest to the debenture holder during the period of the loan. A debenture holder may take hold of some or all of the assets of the business as collateral. This would be done to improve the odds of recovering the entire debt from the organization. When a creditor takes control of the assets of a business, it carries a legal interest that the business will not be allowed to sell the assets without receiving permission from the debenture holder or paying off the debt.

Characteristics of Debentures

  • The repayment of funds is secured by:
    • The rights of the trustee over the business
    • The tangible assets of the business
    • The guarantor or cosigner
  • The tangible property or assets that make up the security are sufficient to meet the entire liability for the repayment.

Types of Debentures

  • Secured debentures: The assets of the issuing company are essentially held as collateral to encourage payment to its creditors.
    • The charge may be floating or fixed.
    • A floating charge is applied to the general assets, while a fixed charge is applied to a specific asset.
  • Unsecured debentures: There are no assets held as additional security.
  • Redeemable debentures: Payable at the end of a specific period or through installments
  • Irredeemable debentures: The business pays a specific interest rate regularly but provides no data on when principal will be returned.
  • Convertible debentures: Debentures that are convertible into shares or any other form of security that are exercised by option of the company or the holder
  • Subordinate debentures: Will be repaid after some other privileged debt has been satisfied
  • Convertible subordinate debentures: Is subordinate or subject to the prior repayment of other outstanding debts but which can convert into another type of security
  • Specific interest rate debentures: Issued with a specific interest rate
  • Zero interest rate debentures: Do not carry a specific interest rate
  • Registered debentures: All details of the debenture holder are entered in a register that's kept by the company.
  • Bearer debentures: The company doesn't keep a record of the debenture holder. Therefore, the debenture can be transferred by way of delivery.
  • Sinking debentures: The repayment is secured because the company is making systematic payments into a sinking fund.

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