What is a debenture? - Legal Terms

What does debenture mean in legal documents?

A debenture is a type of debt instrument that is not secured by physical assets or collateral. It is a method of raising capital by offering financial certificates of debt to investors. Debentures are backed only by the general creditworthiness and reputation of the issuer, which could be a corporation or government entity. When an organization issues a debenture, it essentially means that the company borrows money from the debenture holder and promises to repay the principal sum along with predetermined interest rates at a later date, known as the maturity date.

The interest paid to debenture holders is a charge against the profits of the company, and since debentures are not backed by assets, they are often seen as riskier than secured loans or bonds. However, to mitigate this risk, debentures often come with a higher interest rate compared to secured debt. There are different types of debentures, such as convertible debentures which can be converted into equity shares after a certain period or under certain conditions, and non-convertible debentures which cannot be converted into equity.

One of the legal characteristics of a debenture is that it often includes a debenture indenture, which is a legal document that outlines the terms of the loan agreement, such as the interest rate, repayment schedule, and other conditions. It may also include covenants or clauses that impose certain operational limitations on the borrower to protect the interests of the debenture holders. For example, there might be restrictions on selling certain assets or making significant changes to the business without the consent of the debenture holders.

Debentures can be an attractive financing option for companies as they provide long-term funds without diluting ownership, unlike equity financing. For investors, they offer a fixed return and are considered a relatively safe investment, especially if the issuer has a high credit rating. However, in the event of a company's insolvency, debenture holders are considered unsecured creditors and they stand behind secured creditors in the hierarchy for claim settlements.

Understanding debentures is crucial for investors and companies alike. Investors need to assess the risk and the creditworthiness of the issuer before investing in debentures, while companies must carefully consider the terms and covenants associated with issuing debentures. Moreover, the legal implications of the debenture indenture should be meticulously reviewed by both parties to ensure clarity on the rights and obligations conferred by this financial instrument.

What are some examples of debenture in legal contracts?

Loan Agreement: "The company shall issue a debenture to the lender as evidence of the debt incurred pursuant to the terms of this Loan Agreement."
Corporate Trust Deed: In a Corporate Trust Deed, a debenture may secure the repayment of deposited funds with the company's assets.
Security Agreement: "As collateral for the loan, the borrower agrees to provide a floating charge debenture over all of the company's assets."
Bond Indenture: A debenture is often issued under a Bond Indenture, where it represents an unsecured bond, not backed by specific collateral.
Debt Restructuring Agreement: "The existing debt shall be restructured into a series of debentures, to be repaid over an extended period of time."
Intercreditor Agreement: "The debenture holders' claims will be subordinated to those of the senior secured creditors, as set forth in this Intercreditor Agreement."
Investment Memorandum: In an Investment Memorandum, the term debenture may describe a long-term security yielding a fixed rate of interest, issued by a company.
Prospectus: "The prospectus details the specific terms, rights, and obligations attached to the debentures being offered to the public."
Private Placement Memorandum: "Qualified investors are hereby offered debentures, the proceeds of which will be used to finance the expansion of the company's operations."