Debentures and the law of mortgages
Debentures are, in general, subject to the same principles as ordinary mortgages. Equitable principles protect mortgagors against ‘clogging the equity of redemption’, that is, making it difficult to redeem or placing some restriction on redemption. These clogs may include making the mortgage irredeemable or redeemable only after a long time or providing some commercial advantage to the lender of money as against the borrower of the money. In relation to debentures, there is no rule prohibiting debentures from being irredeemable or redeemable only after a long period of time. Section 739 of the Companies Act 2006 provides that:
A condition contained in debentures, or in a deed for securing debentures, is not invalid by reason only that the debentures are made irredeemable or redeemable only on the happening of a contingency (however remote), or on the expiration of a period (however long), any rule of equity to the contrary notwithstanding.
In Knightsbridge Estates Trust Ltd v Byrne  AC 613, a company that had secured a loan by mortgaging its property to the lender of the money argued that the provision that the mortgage would last for 40 years was void as an unreasonable restriction on the mortgagor. The court held that the mortgage constituted a debenture within the Companies Act and, therefore, was not void. Other restrictions placed upon the mortgagor may well be invalid. Thus, in Kreglinger v New Patagonia Meat & Cold Storage Co Ltd  AC 25, the court recognised that requiring the borrower to sell sheepskins to the lender of finance for a period of time could constitute an unfair clog on the equity of redemption. In the event, on the facts of the particular case, it was held not to be unreasonable. The agreement provided that for five years the borrower should sell the skins to the lender so long as the lender was willing to buy at the best price offered by any other person.
Every trading or commercial company has an implied power to borrow for the purposes of its business. Thus, for example, an auctioneer was held to have the implied power to borrow money in General Auction, Estate and Monetary Co v Smith  3 Ch 432. Clearly, any company incorporated under the Companies Act 2006 without any restriction on its objects may do so. Companies with objects clauses will be able to borrow money to achieve their objects unless there is some express prohibition in the objects clause.
A company’s articles may restrict the company’s powers to borrow money. There was such a provision in Table A of the Companies Act 1948, but there was no similar provision in the 1985 Table A. Nor do the model articles of private or public companies under the Companies Act 2006 contain any restriction.
The term debenture is used in many senses. Usually, debentures are secured, but they need not be. A debenture is generally under the company seal, but once again need not be.
There may be a single debenture, typically a secured loan from a bank. By contrast there may be an issue of debenture stock where a loan is raised, usually by means of an offer to the public via the Stock Exchange. Where there is debenture stock, there will be a debenture trust deed. The trust deed will set out the terms of the loan. There may also be a debenture trust deed where there is a series of debentures – that is to say, several separate loans made to people that rank for payment pari passu (equally one with the other). By virtue of s 738 CA 2006, a debenture covers any form of borrowing by a company whether secured or unsecured. The definition reads as follows:
‘Debenture’ includes debenture stock, bonds and any other securities of a company, whether constituting a charge on the assets of the company or not.
In practice, the term debenture is used to describe a secured borrowing. A mortgage that is created by a company is also a debenture: see Knightsbridge Estates Trust Ltd v Byrne (1940). The claimants owned freehold property in Knightsbridge. The property was mortgaged to a friendly society and the mortgage was to be repaid over a period of 40 years. The company wanted to redeem the mortgage early.
The House of Lords held that the company had no right to redeem the mortgage early as the equitable doctrine that provided for early redemption did not apply to mortgages granted by companies.
Debentures and shares have certain similarities. They are both collectively termed securities. Dealings in debentures on the Stock Exchange are carried out in much the same way as dealings in shares. Prospectus rules are applicable to both shares and debentures in much the same way. There are certain distinctions between shares and debentures, however.
The main distinctions are as follows:
(a) the essential distinction between the two is that a debenture holder is a creditor of the company whereas a shareholder is a member of the company;
(b) the company is free to purchase its own debentures;
(c) debentures may be issued at a discount whereas shares cannot be issued at less than par value (see s 580 CA 2006); and
(d) interest on a debenture when due is a debt which can be paid out of capital. There is no automatic right to a dividend and dividends are payable out of profits.
(See also section 4.1.)
Where there is a debenture trust deed, which there will be if debenture stock has been issued, the trustee acts as the company’s creditor. He acts on behalf of all debenture holders. It is his duty to ensure that the terms of the debentures are enforced.
The trustee of debentures may, for example, act to appoint an administrative receiver on behalf of all the debenture holders where there has been a breach of the terms of the debenture. The receiver (see Chapter 21) will be responsible for taking possession of the property that is the subject of the charge with a view to realising the property and paying off the debenture holders. This process is explained in Chapter 21 (see sections 21.3 and 21.4).
Certain conditions are uniform:
(a) a covenant to repay the amount of the loan at the appropriate time and to pay interest upon the due dates. In default of either of these requirements, the whole loan becomes immediately repayable;
(b) the creation of a floating charge over some or all of the company’s assets;
(c) the creation of a fixed charge over the company’s fixed assets;
(d) on the happening of certain events, the whole amount of the loan to become immediately repayable, for example, the company ceasing business;
(e) a covenant to keep the company’s property insured;
(f) a covenant to keep the company’s property in good repair; and
(g) the powers and the duties of the debenture trustee will also be set out in the debenture trust deed.
The advantages of a debenture trust deed are clear. It enables the company to deal with the trustee for debenture holders on behalf of all of the debenture holders and thus to act expeditiously. The trustee of debentures will be supplied with information by the company on the state of the company’s business. The trustee of debentures would generally be somebody expert in business and he will thus be able to act with alacrity and with expert knowledge where the debenture holders may lack the appropriate knowledge and would in any event find it difficult to act as promptly as the trustee for debenture holders.
Once it was common to exonerate trustees of debentures in advance for any breach of trust by a provision in the trust deed. Now such provisions are generally void (s 750 CA 2006). Debenture holders may give a release to a trustee for past defaults at a meeting of debenture holders by special resolution (s 750(2) CA 2006).
Section 751 CA 2006 also provides for the continuation of certain earlier provisions relieving trustees of debentures from liability.
Although technically, under s 738 CA 2006, any form of borrowing by a company is a debenture, in practice the term is used to describe a secured borrowing. The borrowing may be secured in one or both of two different ways. The debenture may be secured by a fixed charge. This is similar to an ordinary mortgage. The charge attaches to the property subject to the charge at the time of its creation. A fixed charge over land is the most common form of fixed charge. A fixed charge may be created over other assets, however. Thus a fixed charge may be created over investments held by the company. It seems in addition that a fixed charge may be created over a company’s book debts provided that these book debts are paid into a separate bank account: see Re Keenan Bros Ltd  BCLC 242 (Irish Supreme Court) and Siebe Gorman & Co Ltd v Barclays Bank Ltd  2 Lloyds Rep 142.
This latter case concerned R.H. McDonald Ltd, who executed a debenture in favour of Barclays Bank. This debenture charged, by way of a fixed charge, all book debts and other debts owing to McDonald Limited. McDonald were required to pay the proceeds of book debts into a separate account with Barclays. They were further prohibited from charging or assigning the proceeds to any other person. Later Siebe Gorman, a supplier of safety equipment to McDonald, who were chasing payment for unpaid debts, agreed to accept an assignment of certain book debts from McDonald.
McDonald went into liquidation and this case concerned a dispute between Barclays, claiming under the debenture, and Siebe Gorman, claiming under the later assignment.
Slade J held that the debenture conferred a fixed charge in favour of Barclays Bank. This fixed charge over book debts was effective.
However, in Re New Bullas Trading Ltd  1 BCLC 485, Knox J held that a charge over the company’s book debts constituted a floating charge. In this case, the charge was over book debts which also provided that money paid was to be paid into an account at a named bank. It was then for the chargee to direct how the money was to be used but, in default, the money was removed from the fixed charge and became subject to a floating charge. The Court of Appeal held that uncollected debts were subject to a fixed charge.
In the Privy Council appeal from the Court of Appeal from New Zealand, Agnew v Commissioner of Inland Revenue, re Brumark  2 AC 710, the case concerned a debenture that was closely modelled on the New Bullas debenture.
Lord Millett, delivering the judgment of the board in Agnew, held that the critical feature distinguishing a floating charge from a fixed charge lay in the chargor’s ability, freely and without the chargee’s consent, to control and manage the charge assets and withdraw them from the security. The Privy Council considered that New Bullas had been wrongly decided and the decision in Siebe Gorman was treated in guarded terms as a case in which Slade J had found sufficient restrictions on the use to which the chargor could put the collected debt payments to warrant that the charge was a fixed charge.
The issue arose once again in the House of Lords decision in Re Spectrum Plus Ltd (in liquidation)  2 AC 680. Here a charge over present and future book debts, where the chargor was required to collect and place the debts in a designated account with the chargee bank, but where the chargor was free to draw on the account for its business purposes provided the overdraft limit was not exceeded, was held in law to be a floating charge, even if it was expressed as being a fixed charge.
The House of Lords held that the unrestricted use by the chargor of the proceeds in the account was inconsistent with the creation of a fixed charge, since it allowed the debt and its proceeds to be withdrawn from the security.
The House of Lords held, following the Privy Council decision of Re Brumark in which New Bullas had been held to be wrongly decided, that Siebe Gorman was wrong and should be overruled. Although the decision in Re Spectrum overruled long-standing authority which had been relied upon for many years by banks and other commercial lenders, the House of Lords felt that it was inappropriate to depart from the normal circumstances in which a decision has retrospective effect and did not feel that this was an appropriate case for a decision that only had prospective effect.