What Is a Debenture and How Does It Work?

A debenture is a legal instrument that grants a lender rights over a business's assets as security for a loan. It serves as a safeguard for the lender, ensuring that they can recover the debt in case of default. Debentures can apply to both fixed and floating charges, covering tangible and fluid business assets.

Fixed Charges: These are applied to specific, tangible assets like property, equipment, or machinery. If a default occurs, the lender can seize and sell these assets to recover the debt. You typically cannot sell or dispose of these assets without the lender’s consent.Floating Charges: These cover more flexible assets like stock, inventory, or receivables. If you default, the floating charge "crystallises," giving the lender control over these assets, even if their value fluctuates.

For businesses, debentures provide access to vital financing. For lenders, they reduce the risk of financial loss. However, signing a debenture comes with complexities and potential risks, making independent legal advice indispensable.

Why Is Independent Legal Advice Essential for Debentures?

When dealing with debentures, the stakes are high for both the borrower and the lender. Seeking independent legal advice ensures:

Clarity: You fully understand the implications of the debenture and its terms.Protection: Your rights and interests are safeguarded.Compliance: The agreement aligns with legal requirements, minimising potential disputes.Informed Decision-Making: You’re aware of all risks and obligations before committing.

Without professional guidance, you risk entering into agreements that could jeopardise your business and personal assets.

Common Issues with Debentures

1. Overarching Control by Lenders

Debentures often give lenders significant control over a business’s assets. This control can extend to appointing an administrator in case of financial difficulties, impacting your ability to manage your own business.

2. Crystallisation of Floating Charges

A floating charge can crystallise under specific conditions, such as default or insolvency. When this happens, the lender gains immediate control over assets that were previously flexible, potentially disrupting operations.

3. Restrictive Covenants

Some debentures include restrictive clauses that limit your ability to make independent business decisions, such as acquiring additional loans or selling assets.

4. Priority Over Other Creditors

Lenders with a debenture often have priority over other creditors. This can create challenges during insolvency, as it limits the options for distributing assets fairly among all creditors.

5. Impact on Future Financing

A debenture can deter other lenders from offering financing, as it signals that another lender already has significant rights over your business assets.