1911 Encyclopædia Britannica/Debentures and Debenture Stock
DEBENTURES and DEBENTURE STOCK. One of the many advantages incident to incorporation under the English Companies Acts is found in the facilities which such incorporation affords a trading concern for borrowing on debentures or debenture stock. More than five hundred millions of money are now invested in these forms of security. Borrowing was not specifically dealt with by the Companies Acts prior to the act of 1900, but that it was contemplated by the legislature is evident from the provision in § 43 of the act of 1862 for a company keeping a register of mortgages and charges. The policy of the legislature in this, as in other matters connected with trading companies, was apparently to leave the company to determine whether borrowing should or should not form one of its objects.
The first principle to be borne in mind is that a company cannot borrow unless it is expressly or impliedly authorized to do so by its memorandum of association. In the case of a trading company borrowing is impliedly authorized as a necessary incident of carrying on the company’s business. Thus a company established for the conveyance of passengers and luggage by omnibuses, a company formed to buy and run vessels between England and Australia, and a company whose objects included discounting approved commercial bills, have all been held to be trading companies with an incidental power of borrowing as such to a reasonable amount. A building society, on the other hand, has no inherent power of borrowing (though a limited statutory power was conferred on such societies by the Building Societies Act 1874); nor has a society formed not for gain but to promote art, science, religion, charity or any other useful object. Public companies formed to carry out some undertaking of public utility, such as docks, water works, or gas works, and governed by the Companies Clauses Acts, have only limited powers of borrowing.
An implied power of borrowing, even when it attaches, is too inconvenient to be relied on in practice, and an express power is always now inserted in a joint stock company’s memorandum of association. This power is in the most general terms. It is left to the articles to define the amount to be borrowed, the nature of the security, and the conditions, if any,—such as the sanction of a general meeting of shareholders,—on which the power is to be exercised. Under the Companies Act 1908, § 87, a company cannot exercise any borrowing power until it has fulfilled the conditions prescribed by the act entitling it to commence business: one of which is that the company must have obtained its “minimum subscription.” A person who is proposing to lend money to a company must be careful to acquaint himself with any statutory regulations of this kind, and also to see (1) that the memorandum and articles of association authorize borrowing, and (2) that the borrowing limit is not being exceeded, for if it should turn out that the borrowing was in excess of the company’s powers and ultra vires, the company cannot be bound, and the borrower’s only remedy is against the directors for breach of warranty of authority, or to be surrogated to the rights of any creditors who may have been paid out of the borrowed moneys.
A company proposing to borrow usually issues a prospectus, similar to the ordinary share prospectus, stating the amount of the issue, the dates for payment, the particulars of the property to be comprised in the security, the terms as to redemption, and so on, and inviting the public to subscribe. Underwriting is also resorted to, as in the case of shares, to ensure that the issue is taken up. There is no objection to a company issuing debentures or debenture stock at a discount, as there is to its issuing its shares at a discount. It must borrow on the best terms its credit will enable it to obtain. A prospectus inviting subscriptions for debentures or debenture stock comes within the terms of the Directors’ Liability Act 1890 (re-enacted in Companies Act 1908, § 84), and persons who are parties to it have the onus cast upon them, should the prospectus contain any misstatements, of showing that, at the time when they issued the prospectus, they had reasonable grounds to believe, and did in fact believe, that the statements in question were true; otherwise they will be liable to pay compensation to any person injured by the misstatements. A debenture prospectus is also within the terms of the Companies Act 1908. It must be filed with the registrar of joint stock companies (§ 80) and must contain all the particulars specified in § 81 of the act. (See Company.)
The usual mode of borrowing by a company is either on debentures or debenture stock. Etymologically, debenture is merely the Latin word debentur,—The first word in a document in common use by the crown in early times admitting indebtedness to its servants or soldiers. This was the germ of a security which has now, with the expansion of joint stock company enterprise, grown into an instrument of considerable complexity.
Debentures may be classified in various ways. From the point of view of the security they are either (1) debentures (simply); (2) mortgage debentures; (3) debenture bonds. In the debenture the security is a floating charge. In the mortgage debenture there is also a floating charge, but the property forming the principal part of the security is conveyed by the company to trustees under a trust deed for the benefit of the debenture-holders. In the debenture bond there is no security proper: only the covenant for payment by the company. For purposes of title and transfer, debentures are either “registered” or “to bearer.” For purposes of payment they are either “terminable” or “perpetual” (see Companies Act 1908, § 103).
The Floating Debenture.—The form of debenture chiefly in use at the present day is that secured by a floating charge. By it the company covenants to pay to the holder thereof the sum secured by the debenture on a specified day (usually ten or fifteen years after the date of issue), or at such earlier date as the principal moneys become due under the provisions of the security, and in the meantime the company covenants to pay interest on the principal moneys until payment, or until the security becomes enforceable under the conditions; and the company further charges its undertaking and all its property, including its uncalled capital, with the payment of the amount secured by the debentures. Uncalled capital if included must be expressly mentioned, because the word “property” by itself will not cover uncalled capital which is only property potentially, i.e. when called up. This is the body of the instrument; on its back is endorsed a series of conditions, constituting the terms on which the debenture is issued. Thus the debenture-holders are to rank pari passu with one another against the security; the debenture is to be transferable free from equities between the company and the original holder; the charge is to be a floating charge, and the debenture-holders’ moneys are to become immediately repayable and the charges enforceable in certain events: for instance, if the interest is in arrear for (say) two or three months, or if a winding-up order is made against the company, or a resolution for winding-up is passed. Other events indicative of insolvency are sometimes added in which payment is to be accelerated. The conditions also provide for the mode and form of transfer of the debentures, the death or bankruptcy of the holder, the place of payment, &c. The most characteristic feature of the security—the floating charge—grew naturally out of a charge on a company’s undertaking as a going concern. Such a charge could only be made practicable by leaving the company free to deal with and dispose of its property in the ordinary course of its business—to sell, mortgage, lease, and exchange it as if no charge existed: and this is how the security works. The debenture-holders give the directors an implied licence to deal with and dispose of the property comprised in the security until the happening of any of the events upon which the debenture-holders’ money becomes under the debenture conditions immediately repayable. Pending this the charge is dormant. The licence extends, however, only to dealings in the ordinary course of business. Payment by a company of its just debts is always in the ordinary course of business, but satisfaction by execution levied in invitum is not. This floating form of security is found very convenient both to the borrowing company and to the lender. The company is not embarrassed by the charge, while the lender has a security covering the whole assets for the time being, and can intervene at any moment by obtaining a receiver if his security is imperilled, even though none of the events in which the principal moneys are made payable have happened. If any of them has happened, for instance default in payment of interest, or a resolution by the company to wind up, the payment of the principal moneys is accelerated, and a debenture-holder can at once commence an action to obtain payment and to realize his security. At times a proviso is inserted in the conditions endorsed on the debenture, that the company is not to create any mortgage or charge ranking in priority to or pari passu with that contained in the debentures. Very nice questions of priority have arisen under such a clause. A floating charge created by a company within three months of its being wound up will now be invalid under § 12 of the Companies Act 1908 unless the company is shown to have been solvent at the time, but there is a saving clause for cash paid under the security and interest at 5%.
Trust Deeds.—When the amount borrowed by a company is large, the company commonly executes a trust deed by way of further security. The object of such a trust deed is twofold: (1) it conveys specific property to the trustees of the deed by way of legal mortgage (the charge contained in the debentures is only an equitable security), and it further charges all the remaining assets in favour of the debenture-holders, with appropriate provisions for enabling them, in certain events similar to those expressed in the debenture conditions, to enforce the security, and for that purpose to enter into possession and carry on the business, or to sell it and distribute the proceeds; (2) it organizes the debenture-holders and constitutes in the trustees of the deed a body of experienced business men who can watch over the interests of the debenture-holders and take steps for their protection if necessary. In particular it provides machinery for the calling of meetings of debenture-holders by the trustees, and empowers a majority of (say) two-thirds or three-fourths in number and value at such meeting to bind the rest to any compromise or arrangement with the company which such majorities may deem beneficial. This is found a very useful power, and may save recourse to a scheme or arrangement first sanctioned under the machinery of the Joint Stock Companies Arrangement Act 1870 (Companies Act 1908, § 120).
Registration of Mortgages and Charges.—A company is bound, under the Companies Act 1862, to keep a register of mortgages and charges, but the register is only open for the inspection of persons who have actually become creditors of the company, not of persons who may be thinking of giving it credit, and the legislature recognizing its inadequacy provided in the Companies Act 1900 (§ 4 of act of 1908) for a public register at Somerset House of all mortgages and charges of certain specified classes by a company. If not registered within twenty-one days from their creation such mortgages and charges are made void—so far as they are securities—against the liquidator and any creditor of the company, but the debenture-holders retain the rights of unsecured creditors. An extension of the time for registering may be granted by the court, but it will only be without prejudice to the rights of third persons acquired before actual registration. These provisions for registration as amended are contained in the Companies Act 1908 (§ 93).
Debentures Registered and to Bearer.—Debentures are, for purposes of title and transfer, of two kinds—(1) registered debentures, and (2) debentures to bearer. Registered debentures are transferable only in the books of the company. Debentures to bearer are negotiable instruments and pass by delivery. Coupons for interest are attached. Sometimes debentures to bearer are made exchangeable for registered debentures and vice versa.
Redemption.—A company generally reserves to itself a right of redeeming the security before the date fixed by the debenture for repayment; and accordingly a power for that purpose is commonly inserted in the conditions. But as debenture-holders, who have got a satisfactory security, do not wish to be paid off, the right of redemption is often qualified so as not to arise till (say) five years after issue, and a premium of 5% is made payable by way of bonus to the redeemed debenture-holder. Sometimes the number of debentures to be redeemed each year is limited. The selection is made by drawings held in the presence of the directors. A sinking fund is a convenient means frequently resorted to for redemption of a debenture debt, and is especially suitable where the security is of a wasting character, leaseholds, mining property or a patent. Such a fund is formed by the company setting apart a certain sum each year out of the profits of the company after payment of interest on the debentures. Redeemed debentures may in certain cases be reissued; see Companies Act 1908 (§ 104).
Debenture Stock.—Debenture stock bears the same relation to debentures that stock does to shares. “Debenture stock,” as Lord Lindley states (Companies, 5th ed., 195), “is merely borrowed capital consolidated into one mass for the sake of convenience. Instead of each lender having a separate bond or mortgage, he has a certificate entitling him to a certain sum, being a portion of one large loan.” This sum is not uniform, as in the case of debentures, but variable. One debenture-stockholder, for instance, may hold £20 of the debenture stock, another £20,000. Debenture stock is usually issued in multiples of £10 or sometimes of £1, and is made transferable in sums of any amount not involving a fraction of £1. It is this divisibility of stock, whether debenture or ordinary stock, into quantities of any amount, which constitutes in fact its chief characteristic, and its convenience from a business point of view. It facilitates dealing with the stock, and also enables investors with only a small amount to invest to become stockholders. The property comprised in this security is generally the same as in the case of debentures. Debenture stock created by trading companies differs in various particulars from debenture stock created by public companies governed by the Companies Clauses Act. The debenture stock of trading companies is created by a contract made between the company and trustees for the debenture-stockholders. This contract is known as a debenture-stockholders’ trust deed, and is analogous in its provisions to the trust deed above described as used to secure debentures. By such a deed the company acknowledges its indebtedness to the trustees, as representing the debenture-stockholders, to the amount of the sum advanced, covenants to pay it, and conveys the property by way of security to the trustees with all the requisite powers and provisions for enabling them to enforce the security on default in payment of interest by the company or on the happening of certain specified events evidencing insolvency. The company further, in pursuance of the contract, enters the names of the subsisting stockholders in a register, and issues certificates for the amount of their respective holdings. These certificates have, like debentures, the conditions of the security indorsed on their back. Debenture stock is also issued to bearer. A deed securing debenture stock requires an ad valorem stamp.
Debenture Scrip.—Debentures and debenture stock are usually made payable in instalments, for example 10% on application, 10% on allotment and the remainder at intervals of a few months. Until these payments are complete the securities are not issued, but to enable the subscriber to deal with his security pending completion the company issues to him an interim scrip certificate acknowledging his title and exchangeable on payment of the remaining instalments for debentures or debenture stock certificates. If a subscriber for debentures made default in payment the company could not compel him specifically to perform his contract, the theory of law being that the company could get the loan elsewhere, but this inconvenience is now removed (see § 105 of the Companies Act 1908).
Remedies.—When debenture-holders’ security becomes enforceable there are a variety of remedies open to them. These fall into two classes—(1) remedies available without the aid of the court; (2) remedies available only with the aid of the court.
1. If there is a trust deed, the trustees may appoint a receiver of the property comprised in the security, and they may also sell under the powers contained in the deed, or under § 25 of the Conveyancing Act 1881. Sometimes, where there is no trust deed, similar powers—to appoint a receiver and to sell—are inserted in the conditions indorsed on the debentures.
2. The remedies with the aid of the court are—(a) an action by one or more debenture-holders on behalf of all for a receiver and to realize the security; (b) an originating summons for sale or other relief, under Rules of Supreme Court, 1883, O. lv. r. 5a; (c) an action for foreclosure where the security is deficient (all the debenture-holders must be parties to this proceeding); (d) a winding-up petition. Of these modes of proceeding, the first is by far the most common and most convenient. Immediately on the issue of the writ in the action the plaintiff applies for the appointment of a receiver to protect the security, or if the security comprises a going business, a receiver and manager. In due course the action comes on for judgment, usually on agreed minutes, when the court directs accounts and inquiries as to who are the holders of the debentures, what is due to them, what property is comprised in the security, and gives leave to any of the parties to apply in chambers for a sale. If the company has gone into liquidation, leave must be obtained to commence or continue the action, but such leave in the case of debenture-holders is ex debito justitiae. A debenture-holder action when the company is in winding up is always now transferred to the judge having the control of the winding-up proceedings. The administration of a company’s assets in such actions by debenture-holders (debenture-holders’ liquidations, as they are called) has of late encroached very much on the ordinary administration of winding up, and it cannot be denied that great hardship is often inflicted by the floating security on the company’s unsecured creditors, who find that everything belonging to the company, uncalled capital included, has been pledged to the debenture-holders. The conventional answer is that such creditors might and ought to have inspected the company’s register of mortgages and charges. The matter was fully considered by the departmental board of trade committee which reported in July 1906, but the committee, looking at the business convenience of the floating charge, saw no reason for recommending an alteration in the law.
Reconstruction.—When a company reconstructs, as it often does in these days, the rights of debenture-holders have to be provided for. Reconstructions are mainly of two kinds—(1) by arrangement, under the Joint Stock Companies Arrangement Act 1870, amended in 1900 and 1907, incorporated in act of 1908 (§ 120), and (2) by sale and transfer of assets, either under § 192 of the act of 1908, or under a power in the company’s memorandum of association. By the procedure provided under (1) a petition for the sanction of the court to a scheme is presented, and the court thereupon directs meetings of creditors, including debenture-holders, to be held. A three-fourths majority in value of debenture-holders present at the meeting in person or by proxy binds the rest. Debenture-holders claiming to vote must produce their debentures at or before the meeting. Under the other mode of reconstruction—sale and transfer of assets—there is usually a novation, and the debenture-holders accept the security of the new company in the shape of debentures of equivalent value or—occasionally—of fully paid preference shares.
A point in this connexion, which involves some hardship to debenture-holders, may here be adverted to. It is a not uncommon practice for a solvent company to pass a resolution to wind up voluntarily for the purpose of reconstructing. The effect of this is to accelerate payment of the security, and the debenture-holders have to accept their principal and interest only, parting with a good security and perhaps a premium which would have accrued to them in a year or two. The company is thus enabled by its own act to redeem the reluctant debenture-holder on terms most advantageous to itself. To obviate this hardship, it is now a usual thing in a debenture-holders’ trust deed to provide—the committee of the London Stock Exchange indeed require it—that a premium shall be paid to the debenture-holders in the event of the security becoming enforceable by a voluntary winding up with a view to reconstruction.
Public Companies.—Public companies, i.e. companies incorporated by special act of parliament for carrying on undertakings of public utility, form a class distinct from trading companies. The borrowing powers of these companies, the form of their debenture or debenture stock, and the rights of the debenture-holders or debenture-stockholders, depend on the conjoint operation of the companies’ own special act and the Companies Clauses Acts 1845, 1863 and 1869. The provisions of these acts as to borrowing, being express, exclude any implicit power of borrowing. The first two of the above acts relate to mortgages and bonds, the last to debenture stock. The policy of the legislature in all these acts is the same, namely, to give the greatest facilities for borrowing, and at the same time to take care that undertakings of public utility which have received legislative sanction shall not be broken up or destroyed, as they would be if the mortgagees or debenture-holders were allowed the ordinary rights of mortgagees for realizing their security by seizure and sale. Hence the legislature has given them only “the fruit of the tree,” as Lord Cairns expressed it. The debenture-holders or the debenture-stockholders may take the earnings of the company’s undertaking by obtaining the appointment of a receiver, but that is all they can do. They cannot sell the undertaking or disorganize it by levying execution, so long as the company is a going concern; but this protecting principle of public policy will not be a bar to a debenture-holder, in his character of creditor, presenting a petition to wind up the company, if it is no longer able to fulfil its statutory objects. Railway companies have further special legislation, which will be found in the Railway Companies Powers Act 1864, the Railways Construction Facilities Act 1864 and the Railway Securities Act 1866.
Municipal Corporations and County Councils.—These bodies are authorized to borrow for their proper purposes on debentures and debenture stock with the sanction of the Local Government Board. See the Municipal Corporations Act 1882, the Local Authorities’ Loans Act 1875, and the Local Government (England and Wales) Act 1888.
United States.—In the United States there are two meanings of debenture—(1) a bond not secured by mortgage; (2) a certificate that the United States is indebted to a certain person or his assigns in a certain sum on an audited account, or that it will refund a certain sum paid for duties on imported goods, in case they are subsequently exported.
Authorities.—E. Manson, Debentures and Debenture Stock (London, 2nd ed., 1908); Simonson, Debentures and Debenture Stock (London, 2nd ed., 1902); Palmer, Company Precedents (Debentures) (3rd ed., London, 1907). (E. Ma.)