Any company director who has taken out a loan will need to understand what a debenture is and how this works if the company becomes insolvent.
A debenture is an important document that outlines the terms and conditions of a loan. It works to offer security to the lender should the borrowing company become insolvent. For this reason, most lenders will ask a company to sign a debenture before they offer them finance, meaning company directors must ensure they know what is included in the document and its impact should their company become insolvent.
In this guide, Clarke Bell takes a closer look at what a debenture is and outlines everything directors must know about debentures in the event of insolvency.
What is a debenture?
A debenture is a document that lays out the terms and conditions of a loan. The debenture, therefore, offers lenders security should the company borrowing the money become insolvent.
The debenture is a formal written agreement that is drawn up between the lender and the borrower which outlines the interest rates for the loan, the total amount borrowed, the amount of time the loan will last, the repayment date and the charges secured on the loan, whether this is fixed or floating.
The director must sign the debenture and once this has occurred, it must be submitted to Companies House before any money is lent to the debtor.
Many lenders will also attach a floating charge or fixed charge to the debenture. This gives the lender priority over unsecured creditors when it comes to who is repaid first should the company enter into a formal insolvency procedure. This is due to the fact that during insolvency procedures, a secured creditor takes priority over an unsecured creditor.
How does a floating charge work?
First, we will look at how a floating charge works.
As the name suggests, a floating charge is not fixed to certain assets belonging to the business. Instead, a floating charge can be attached to any company asset which can be moved or sold as part of the normal proceedings of the business. This means that the company can continue to use these assets whilst they are still trading and operating.
Common assets that a floating charge might be attached to include cash, stock, materials and fixtures and fittings.
In fact, it is only when the company enters into insolvency that the floating charge is said to ‘crystalise’. In this instance, the floating charge becomes a fixed charge. This means that the asset or assets that the charge is attached to can no longer be dealt with or disposed of by the business without permission from the lender.
The floating charge becomes a fixed charge in the following instances:
- The company appoints the services of an insolvency practitioner
- The company fails to meet payments owed and the lender takes action to get back what they are owed
- The company is being threatened with being wound-up
It is important to note that all charges have to be recorded with the Company’s Register of Charges.
On the other hand, lenders might attach a fixed charge to a debenture.
What is a fixed charge?
Unlike a floating charge, a fixed charge is when the security is attached to one or more specific assets belonging to the company.
Fixed charges can be applied to a number of assets belonging to the business including land, machinery, vehicles and property. In the instance that the company enters into insolvency and can’t pay back the amount owed to the lender, the asset that has a fixed charge over it will be taken and sold to raise money to pay back the amount owed.
When assets have a fixed charge over them, the director must seek permission from the lender if they want to sell, dispose or transfer the particular asset.
What happens if my company becomes insolvent?
A director who has taken out a loan with a floating charge or fixed charge outlined in the debenture will need to understand what happens in the instance that their company enters into insolvency.
When the company becomes insolvent, there will be an order for which creditors are paid back first.
Firstly, fixed charge holders will have priority and will be repaid first. Then the expenses of the Insolvency Practitioner will be covered. This will be followed by preferential creditors, then secured creditors, unsecured creditors and finally shareholders.
It is for this reason that most banks will lend a company money and require a debenture to be signed as this ensures they will take priority of repayment should the borrower become insolvent.
Find out who gets paid first when a company goes into liquidation in our guide.
What are the advantages of debentures?
There are advantages to having debentures in place, both from the lender and the borrower.
The biggest advantage of a debenture to the lender is that it offers them protection should the borrower become insolvent. After all, without a debenture in place the loan would be classified as unsecured and the lender would be towards the bottom of the priorities for repayment.
For the limited company, the main advantage of having a debenture in place is that it offers them long-term funding with interest rates that are usually lower than unsecured lending.
Take a helping hand from Clarke Bell
If you are a company director who has taken out a loan and your company is now facing insolvency or is insolvent, you may (understandably) be worried about what will be coming next.
Clarke Bell is here to help you.
Our team of experts is on hand to get to know your circumstances in order to suggest the best way forward for you and your company. Whether that is closing the company through Creditors’ Voluntary Liquidation (CVL) or looking at options for business rescue such as a Company Voluntary Arrangement (CVA) we will work with you closely to get you on the right track.
For some initial, useful insolvency advice, simply get in touch with Clarke Bell today.