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Monday, October 11, 2010

Debentures of a Company

A debenture is a written acknowledgement of a debt by a company, usually under seal and generally containing provision for payment of interest and repayment of capital; a simple or naked debenture carries no charge on assets; a secured debenture carries either a fixed charge on a specific asset or a floating charge an all or some of the assets. All form of loan stock is debentures.

A fixed charge is a mortgage on specific assets, under which the company losses the right to deal with the assets charged, except with the consent of the mortgagee. A floating is not a mortgage at all, since the charge is such that so long as the company continues to carry on its business and observe the terms of the charge, the directors are entitled to deal in any way they please in the ordinary course of business with the assets of the company, and may even make specific charges on property which, subject to the terms of the floating charge given, will have priority to the floating charge. The floating charge is a charge on a class of assets, present and future, which in the ordinary course of business is charging from time to time, and attaches to the priority included therein in priority to the general liabilities of the company. The floating charge hovers over or “floats” with the assets, until some event happens which crystallizes or fixes the charge.
A company may take more than one issue of debentures; issues subsequent to the first may rank on an equal footing with the original issue, or may confer a charge, subject to and following the first, according to whether the original debentures contained clauses allowing or forbidding subsequent on an equal footing issues. Where the debentures carry different priorities, they are usually designated first debentures, second debentures etc-a higher rate of interest usually being payable on those of lower rank to compensate for the lower degree of security.

A company can issue debentures within the limits of its borrowing powers, as set out in its memorandum and/or articles of association. A trading company’s borrowing powers are implied unless there are provisions to the contrary in the memorandum or articles.

Interest at the agreed rate is payable on the debentures whether the company makes profits or not, since the charge given covers both principle and interest. Income tax is deductible from the interest payable.

In liquidation, the debenture holders are entitled to the proceeds of their securities, if any, otherwise they rank equally with the unsecured creditors; if the proceeds of a security are insufficient to repay the debentures, the debenture holders rank as unsecured creditors for the balance still due to them.

The entries in the books of a company for an issue of debentures are similar to those on an issue of shares, installment accounts being debited with the various installments as they become due, and debentures account credited. If debentures are issued to the vendor as part of the consideration for a business acquired by the company, the vendors’ account is debited and the debentures account credited. The appropriate entry must also be made in the register of charges kept by the company.

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