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Debt financing is an important tool business owners use throughout their business’ lifecycle. In a legal context, a debenture is a document between a lender and borrower. This document gives the lender security over some or all of a company’s assets. In a non-legal context, a debenture is any document that details a debt between a company and its lenders. This article will explain the legal definition of debenture and how business owners can use debentures to help run their businesses.
Debentures Explained
If you borrow money from a bank, you are likely to encounter the word ‘debentures’. Debentures are a special kind of legal document between a lender and borrower. This legal document is crucial since it gives the lender security over part or all of the borrower’s assets.
What is a Security Interest?
Security refers to specific rights the lender has over the borrower’s assets. Security rights can come in many forms, such as a mortgage, a fixed charge or a pledge. As a condition of the loan agreement, a borrower will usually grant the lender security rights in certain assets.
If a borrower defaults on the loan, security rights allow the secured lender to take the borrower’s secured assets. This way, the secured lender can sell their assets and satisfy their debt. If any money is left over, the secured lender must distribute the money back to the borrower or to other unsecured creditors.
All or Part of the Borrower’s Assets?
Depending on the agreement, a lender can secure all or part of your company’s assets. Debentures tend to operate by securing all land through a mortgage. However, for non-land assets such as cars and equipment, a lender can use a fixed charge to secure these assets. Additionally, for assets you use in the ordinary course of business, such as to manufacture or sell products, the debenture will secure these assets by a floating charge.
Why Are Debentures Important?
Debentures give lenders a security right that can have priority over all other security interests in the asset. That is to say, a debenture signals to the world that one lender has a superior claim to an asset over all other present and future lenders.
For this priority to have any effect, the law requires you to register a debenture as a charge with Companies House. This lets the public see if a lender has granted security over all or part of a borrower’s assets. However, this public registration is not a carbon copy of the actual debenture itself. As such, you will not be able to determine which specific assets a lender has secured. However, you can generally infer that this lender has security over a sizeable portion of the company’s assets.
Debenture in a Non-Legal Context
If you are speaking to someone who is not a lawyer, their use of the word debenture is likely to be less strict than the legal sense of the word. In a broad sense, a debenture would refer to any document that details some debt between a company and its lenders.
In practice, this could refer to:
- secured loan agreements;
- unsecured loan agreements;
- offering memoranda and prospectuses related to bond issuances;
- private lending agreements between non-bank lenders and companies; and
- a loan agreement between two companies where neither company is a financial entity.
Ultimately, if you are dealing with another company in any capacity as a creditor, it will be helpful to know whether there is another creditor with a superior security right over the company’s assets. This is because if the company becomes insolvent, you may not get the first dibs on the company’s assets to satisfy your debt.
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Key Takeaways
In a legal context, a debenture is a document between a lender and borrower that gives the lender security over some or all of a company’s assets. If the borrower defaults on the loan, the security rights allow the lender to take the borrower’s secured assets and sell them to satisfy their debt. In a non-legal context, a debenture refers to any document that describes a debt between a company and its lenders.
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Frequently Asked Questions
Generally, a debenture is a document that grants a lender security over all or part of the borrower’s assets. For example, a mortgage over land or a fixed charge over non-land assets like a vehicle.
A security interest refers to the rights of a lender over a borrower’s assets. Security rights allow the lender to take and sell the borrower’s assets if the borrower defaults on the loan.
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