A creditor may have registered security over a company's assets at Companies House.

What is a debenture?

A debenture is a loan agreement, in writing, between a company and its lender, which must be registered at Companies House.

Only a company or a limited liability partnership (“LLP”) can enter into a debenture.

Whilst it is usually a bank or other commercial lender that would secure its loan to a company using a debenture, there is nothing to stop any company, an individual or even the company’s directors and shareholders from doing the same.

A debenture will usually contain fixed charges over certain classes of assets, such as the company’s goodwill and freehold property, together with floating charges over classes of assets such as stock, movable equipment and furniture.

How many debentures can a company have?

There is no restriction on the number of debentures that a company can enter into. The order in which the proceeds from the sale of an asset subject to charges created by multiple debentures is determined firstly by the order in which the debentures were granted (the first having priority), but also taking into account whether one lender has given priority to another.

Some lenders will insist on a “negative pledge” not to give a debenture to any other creditor.

What power does a debenture holder have?

For debentures entered into after 2003, it is usual for the debenture holder to have the right to appoint an Administrator to take control of running the company away from the directors.

The holder of debenture will also get prior warning of the directors’ intention to put a company into Liquidation and can appoint an alternative Administrator to one proposed by the company.

If the company goes into an insolvency procedure does the debenture holder get its money first?

In respect of assets subject to a valid fixed charge, yes. Just because the debenture says an asset is subject to a fixed charge doesn’t necessarily mean that it is correct. An Administrator or Liquidator will usually take legal advice on whether a debenture’s charges are valid and what they attach to. The solicitor will check, amongst other things, that the debenture was registered at Companies House within 14 days of its creation.

If an asset or assets are subject to floating charges then any preferential creditors will need to be paid from the proceeds of sale first. Preferential claims are usually employees’ outstanding wages and holiday pay and secondary preferential status has now been given to HM Revenue & Customs for, primarily, VAT, PAYE and NI contributions.

After preferential and secondary preferential creditors have been repaid in full then there is a further deduction for post-2003 debentures called the “prescribed part”[1].

The prescribed part

This is a calculation[2] that the insolvency practitioner will undertake that equals:

1. 50% of the first £10,000; plus
2. 20% of the value of the company’s net realisations which exceed £10,000.

The total sum set aside for the prescribed part is limited to £800,000[3].

The money that is deducted from the sum which would otherwise have been available for the debenture holder is distributed amongst the company’s unsecured creditors. The debenture holder isn’t allowed to share in this money for any shortfall it may have.

Can a debenture holder ask for a personal guarantee as well?

Yes.

It may actually benefit you, if you have been asked to give a personal guarantee, for the lender to have a debenture as well, as this will increase the likelihood of them being repaid from the company’s assets without needing to call on the guarantee.

Does a company need the debenture holder’s consent to sell assets?

For classes of assets subject to a debenture’s floating charges, in the normal course of business, no. For example, there would be no need to contact the lender every time items were sold out of stock to customers.

However, for assets subject to a fixed charge and for disposals of floating charge assets outside of the normal course of business, then yes. The sale of some or all of a company’s business and assets would usually require the permission of a debenture holder.

I’ve heard that book debts are a special case?

Since about 2001 there has been a significant change in the interpretation of whether a debenture can create fixed or floating charges over book debts. Prior to the Brumark[4] and Spectrum[5] cases most insolvencies treated the proceeds of book debts that were stated to be subject to a fixed charge within the terms of a debenture as being due to the lender.

It is now the position that:

• It is still possible to take an effective fixed charge over book debts. The label (“fixed”) that the parties have given to the security may indicate the parties' intention but it is not conclusive.
• It is an essential characteristic of a fixed charge that assets can only be released from the security with the agreement of the lender.
• In order for a lender to take an effective fixed charge over book debts, there must be restrictions on the company's ability to use the book debts and their proceeds in the ordinary course of its business. The company must be required to pay the proceeds into a properly "blocked" account from which it cannot withdraw any sums without the lender's consent.
• An account from which the borrower is entitled to withdraw funds whenever it wishes is not considered “blocked” simply because the account is held by the lender.

Clearly who gets what in the event of insolvency is a critical part of any decision making prior to placing a company or LLP into an insolvency procedure.

Click for our Guide to debentures to print and keep.