What are debentures, and what are the risks?

David Kirk answers some frequently asked questions about this form of loan agreement.

A debenture is a loan agreement in writing between a borrower and a lender that is registered at Companies House. It gives the lender security over the borrower’s assets.

Typically, a debenture is used by a bank, factoring company or invoice discounter to take security for their loans. A debenture can only be taken on a limited company or limited liability partnership; it can’t to be taken over a sole trader or standard partnership.

A director who has advanced or lent money into their own company could take a debenture to secure the loan. A private lender can also take a debenture.

How does a debenture holder enforce their security?

The lender (debenture holder) has the right to appoint an administrator to take control of the company if it defaults on the loan. This follows the lender calling in the loan for repayment.

The threat of appointing an administrator can often be enough to make a company repay the debt, or agree terms to repay it.

How does the debenture holder get their money back if the company becomes insolvent?

The administrator or liquidator must hand over assets caught by the debenture to the lender. Usually, the lender agrees for the administrator or liquidator to sell the assets for them for a fee.

Assets can fall into a fixed or floating charge category caught by the debenture.

Normally, the types of assets caught by a fixed charge are: book debts under a factoring agreement, freehold or leasehold property, and plant and machinery fixed to the floor.

Floating charge assets are items not caught by the fixed charge of the debenture, and are typically movable assets such as trading stock, equipment, furniture and computers.

I thought my debtors were a floating charge asset?

Debtors can fall into the fixed charge category under a factoring or invoice discounting agreement. It is the terms of the factoring agreement that decides whether the debtors are fixed or floating charge assets. Otherwise, they are usually a floating charge asset.

Do other creditors have priority over a floating charge asset claim?

Yes, preferential creditors do. One usual preferential creditor who has a prior claim is for the arrears of employee wages and holiday pay.

In addition, a liquidator or administrator can be paid their fees and expenses from floating charge asset realisations, but not fixed charge assets without the lender’s agreement.

How do I know if the bank or lender had registered a debenture against my company?

You will have had to sign the debenture as a director. Once the debenture is signed, it will be filed at Companies House, and you can use the Companies House website for free to find your company and look under the heading of charges. This will list any debentures charged on your company in date order.

Can I have more than one debenture registered on my company?

Yes, that is possible. The debentures then usually rank in order of the date created, unless one lender has given another a deed of priority. Sometimes, you will find a previous lender who has been repaid has not removed their debenture, and you should ask them to remove it.

What is a negative pledge?

This is an agreement not to give a debenture to someone else.

Does a debenture give a lender a lot of control over my company?

Yes, if you default on the loan. They can appoint an administrator or block you appointing your own choice of administrator, or stop you going into liquidation. The debenture holder does not normally get involved in your day-to-day trade, though.  

However, if you have given the bank a personal guarantee, you might be better off letting them have a debenture – as they would be able to use the company assets first to recover their loan.

Do I need the debenture holder’s consent to sell assets?

Consent is usually needed to sell assets subject to a fixed charge. If the sale of floating charge assets is out of the normal course of trade, for example, selling all the stock to a new business owner, this could count as out of the normal course of trade, and would normally need the lender’s consent.

It can be a surprise to a director who sells the business to find the sale may be invalid. However, the terms of the charge/debenture need to be checked for what consent is needed from the lender.

Does a debenture contain a personal guarantee as well?

Often yes, if issued by a high street bank or other business lender. You will have had to sign a personal guarantee, and if you are unsure, you will need to check with the lender. Usually, the lender will ask you to take independent legal advice if you are signing a guarantee.

What is a prescribed part of the debenture?

When a debenture crystallises, for example, because of insolvency, then floating charge assets can be used to have a portion set aside for unsecured creditors. This is the prescribed part.

This rule was brought in to give something back to unsecured creditors where there is a debenture that would have caught all the assets.

How do I know if the debenture is valid?

Usually, you would ask a solicitor to check its validity. Funds must be advanced at the same time as the debenture is created and registered within 14 days to be valid.

Will the bank block me from appointing my own choice of administrator or liquidator?

It usually depends on the level of debt. Many banks have a level where for borrowing in excess of that figure they require you to use one of their approved administrators.

Do I need the debenture holder's consent for a pre-pack administration?

It depends on the terms of the debenture, but almost certainly yes for any assets covered by the fixed charge, and again for any assets covered by the floating charge, because the sale is outside the normal course of trade.

If the sale is a pre-pack administration, the bank may want to know more about the terms of the sale.

About the author

David Kirk is a chartered accountant and licensed insolvency practitioner based in the south west, @kirksinsolvencywww.kirks.co.uk.

See also