Debentures and Company Charges
Capital
Debentures and Company Charges
Syllabus tag: KASNEB CPA | Intermediate Level | CA21 Company Law | Topic 9 Debentures and Company Charges
Lesson objectives
By the end of this topic, you will be able to:
- Define a debenture and distinguish it from a share
- Distinguish a fixed from a floating charge
- Explain crystallisation
- State the consequences of failing to register a charge
- Explain priority between competing charges
Why this matters
A charge decides who gets paid when a company fails. The difference between a fixed and a floating charge, and whether the charge was registered in time, can decide whether a lender recovers everything or nothing.
Debentures
A debenture is a document acknowledging a debt owed by the company, usually secured by a charge over its assets.
| Share | Debenture | |
|---|---|---|
| Holder is | A member | A creditor |
| Return | Dividend, at the directors' discretion | Interest, payable whether or not there is profit |
| Return is paid | Out of distributable profits | As an expense, before profit |
| Voting | Usually yes | No |
| On winding up | Paid last | Paid before members |
| May be issued at a discount | No | Yes |
The last two rows connect. A debenture holder is a creditor, so the capital maintenance rules protecting creditors do not apply to them — which is why a debenture may be issued at a discount while a share may not.
Debentures may be redeemable or irredeemable, and convertible into shares at the holder's option.
Fixed and floating charges
A fixed charge attaches to a specific identified asset — land, a named machine — from the moment it is created. The company cannot dispose of the asset without the chargee's consent.
A floating charge hovers over a class of assets that changes — stock in trade, book debts. The company continues to deal with those assets in the ordinary course of business until the charge crystallises.
| Fixed | Floating | |
|---|---|---|
| Attaches to | A specific asset | A shifting class |
| Company may deal with the asset | No | Yes, until crystallisation |
| Priority on liquidation | Ahead of everything on that asset | Behind preferential creditors |
| Suits | Land, buildings, plant | Inventory, receivables |
The priority difference is the practical heart of the topic. A floating charge holder ranks behind the liquidator's expenses and the preferential creditors, so on a poor realisation there may be nothing left. A lender who can take a fixed charge always will.
Crystallisation
A floating charge crystallises — becoming fixed over the assets then in that class — on:
- The company entering liquidation
- The appointment of a receiver or administrator
- The company ceasing to carry on business
- The occurrence of any event specified in the charge document
Before crystallisation the company trades freely with the charged assets. After it, the charge fastens on whatever is there at that moment — which is why a floating charge over stock may secure a great deal or very little, depending on when it crystallises.
:::checkpoint A bank takes a floating charge over a company's inventory in January. In November the company sells nearly all its stock and does not replace it, then enters liquidation in December. Explain what the bank's charge now covers and why. :::
Registration of charges
A charge must be registered with the Registrar within the prescribed period of its creation, and particulars entered in the company's own register.
The consequence of failure is severe. An unregistered charge is void against a liquidator, an administrator and any creditor of the company. The debt itself remains valid and becomes immediately payable — but the lender is now unsecured and ranks with everyone else.
That is worth stating plainly: the lender does not lose the money owed. It loses the security, which in an insolvency is usually the same thing in practice.
A late registration may be permitted by the court where the omission was accidental or where it is just and equitable to allow it, but rights acquired in the meantime are protected.
Priority
The general principles:
- A fixed charge takes priority over a floating charge over the same asset, even if created later — because the company was free to deal with the asset under the floating charge
- Between charges of the same type, priority follows the order of creation, provided each was properly registered
- Registration gives notice to the world of the charge's existence
A negative pledge clause in a floating charge prohibits the company from creating a later fixed charge ranking ahead. It binds a later chargee only if they had notice of it, which is why such clauses are noted on registration.
:::checkpoint A company grants a floating charge to Bank A in March, registered promptly, and a fixed charge over the same machinery to Bank B in July, also registered. Bank A's charge contains a negative pledge of which Bank B was unaware. Advise on priority. :::