A business can raise money by selling shares or borrowing funds, often through loans from banks or private lenders. One common way companies secure loans is by issuing Debentures, which are financial agreements where the company pledges its assets as collateral. Those who invest in these debentures become creditors, with their rights and obligations outlined in a legal document known as a Trust Deed.
The Trust Deed serves as a contract between the company and debenture holders, specifying voting rights, procedures for meetings, and other relevant terms. To ensure fairness and proper management, a trustee is appointed to oversee dealings between the company and its creditors to manage debt obligations and enforce agreements.
A debenture therefore serves as a financial instrument that confirms a company’s commitment to repay a specified amount along with interest, much like a loan certificate or bond. This article gives an overview of debentures in Nigeria, their legal enforcement, and their effectiveness as a means of securing credit.
What Is a Debenture?
The Companies and Allied Matters Act 2020 defines a Debenture as a financial instrument that signifies a company’s debt obligation. It serves as a written agreement detailing the loan amount, interest rate, repayment terms, and any security pledged by the company to back the debt.
Companies use debentures as a means of raising capital while maintaining full ownership control. Unlike shareholders, debenture holders are creditors, focusing solely on recovering their principal and interest rather than company profits. The terms and protections associated with debentures vary depending on their structure, which can range from secured instruments backed by assets to simple acknowledgments of debt.
Debentures fall into two main categories, namely Secured and Unsecured. Secured debentures are tied to company assets which offers lenders a safety net in case of default, while unsecured debentures lack collateral and carry higher risk.
The enforcement of secured debentures depends on the terms set out in the debenture agreement or trust deed, which may impose fixed or floating charges over the company’s assets. While holders can enforce their claims individually or collectively through a trustee, the extent of these rights often depends on the specific legal framework governing the debenture arrangement.
The law specifies these important key provisions must be included in every debenture agreement. These include:
- The principal sum borrowed by the company.
- The highest allowable discount for issuing or reissuing the debenture, as well as the maximum redemption premium.
- The interest rate applicable to the debenture, the scheduled payment dates, and the method of payment.
- The repayment schedule for the principal amount, whether through a lump sum payment, installments, or other agreed methods.
- For convertible debentures, the timeline and terms for conversion into shares, the credited amounts as paid-up capital, and any rights for debenture holders to subscribe for shares.
- The assets or security backing the debenture and the specific conditions under which the debenture will be enforced.
- The covenants, which define the obligations of the company, such as maintaining financial ratios and restrictions on additional borrowing.
Types of Debentures in Nigeria
Companies can issue different types of debentures depending on factors such as security, duration, and convertibility. Below are some common types:
1. Secured Debentures
Secured debentures are backed by the company’s assets, meaning a legal charge is placed on a specific property or the company’s general assets. If the company defaults on repayment, the asset can be sold to recover the debt. The charge may be fixed, which is attached to a specific asset, or floating, which covers all company assets.
2. Unsecured Debentures
Unlike secured debentures, unsecured ones do not have any collateral backing them. This means investors rely solely on the company’s financial stability and creditworthiness. Since these carry higher risks, they are less common in some markets.
3. Redeemable Debentures
These debentures must be repaid at the end of a specific period. The repayment can be made in full at maturity or in installments over time. The redemption can occur at face value (par), at a premium, or at a discount.
4. Irredeemable Debentures
Also known as Perpetual debentures, these do not have a fixed repayment date. The company is only required to repay the debenture when it goes into liquidation or at an unspecified future date.
5. Fully Convertible Debentures
These debentures allow the holder to convert them into equity shares of the company after a set period. Once converted, the holder becomes a shareholder and no longer a creditor.
6. Partly Convertible Debentures
In this case, a portion of the debenture can be converted into equity shares, while the remaining part remains a debt obligation. This makes the holder both a creditor and a shareholder in the company.
7. Non-Convertible Debentures
As the name suggests, these debentures cannot be converted into equity shares. They remain as debt instruments until their maturity date. Non-convertible debentures are among the most commonly issued debentures.
Enforcement of Debentures Agreements
The primary purpose of security in a debenture agreement is to ensure that creditors can recover their funds if the debtor defaults. The ability to enforce a debenture depends on whether the security is backed by a fixed charge or a floating charge.
Enforcement of Fixed Charges
A debenture secured by a fixed charge becomes enforceable under the following conditions:
- The company fails to pay principal, interest, or any agreed sum within one month of its due date.
- The company breaches any obligations set in the security agreement.
- The occurrence of specific events outlined in the debenture agreement that trigger enforcement.
- If the company is wound up.
- If the security is at risk.
Enforcement of Floating Charges
A floating charge, which covers general assets rather than specific ones, becomes enforceable under the same conditions as a fixed charge. Additionally, it may be enforced if:
- The company’s assets are subject to an execution process or a winding-up petition is filed.
- The company is unable to meet its debt obligations as they fall due.
- The company ceases business operations.
- The company’s asset value declines significantly, affecting the creditor’s ability to recover funds.
- A higher-ranking debenture holder enforces their security rights.
Methods of Enforcement
Once a debenture becomes enforceable, creditors can take several actions to recover their funds, including:
- Appointing a Receiver: A receiver may be appointed by debenture holders, trustees, or the court to manage and recover assets.
- Representative Action: A debenture holder can apply for a court order to enforce security or recover outstanding payments, provided other debenture holders approve.
- Foreclosure Proceedings: Creditors may seek to take ownership of secured assets through foreclosure.
- Winding-Up Petition: If necessary, creditors can initiate liquidation proceedings against the company.
- Other Remedies: Debenture holders can also exercise additional rights granted in the debenture agreement or trust deed, as long as they do not override the statutory protections under the law.
Do note that no clause in a debenture agreement can legally exclude or restrict these enforcement rights, and any such provision would be considered invalid.
Conclusion
Debentures provide an alternative financing option for companies without weakening its ownership structure. However, it may impose financial burdens due to interest payments and restrictive covenants.
Unlike shareholders who own a stake in the company, debenture holders act as external creditors, prioritizing the company’s financial stability to protect their investments. While debenture financing offers advantages such as secured lending and structured repayment terms, it also comes with risks, particularly for unsecured debenture holders.
Therefore, companies must carefully structure their debenture agreements to maintain financial stability, while investors should assess the security and enforceability of these instruments before committing funds. We recommend engaging the services of a corporate law firm for more advice and guidance on preparing a debenture agreement.
