Debenture

A debenture is a debt instrument that large companies use to borrow money for a medium to long term, typically at a fixed interest rate. Originally, the legal term described any document that created or acknowledged a debt, but in some countries it is now used interchangeably with bond, loan stock, or note. Debentures are freely transferable, and while holders cannot vote in general shareholder meetings, they may have separate meetings or votes on changes to their specific rights. The interest paid on debentures is treated as a charge against profit in the company’s financial statements.

Debentures are a form of movable property, issued as a certificate of indebtedness. They generally specify the dates for redemption, repayment of principal, and payment of interest, but may or may not create a charge on the company’s assets. The money raised becomes part of the company’s capital structure, but not share capital. Senior debentures are paid before subordinate ones, reflecting different levels of risk and payoff. In bankruptcy, debenture holders are paid before stockholders. Failure to pay interest can lead to bankruptcy proceedings, and bondholders may seize assets if the contract allows.

The term “debenture” is more descriptive than definitive, and a precise definition has proved elusive. As Lord Lindley noted, “what the correct meaning of ‘debenture’ is I do not know.” Historically, debentures gave rise to the practice of “clipping coupons,” where bondholders presented coupons to a bank for quarterly payments. Features that reduce risk include sinking funds, where the debtor pays part of the bond’s value after a set period, lowering risk and thus the interest rate. Convertibility allows creditors to turn bonds into equity if the company performs well. Companies may also reserve the right to call bonds early, often paying a premium if they do so before maturity.

Security varies by jurisdiction. In the United States, a debenture is an unsecured corporate bond; secured bonds are called mortgage bonds. In the United Kingdom, a debenture is usually secured. In Canada, a debenture is a secured loan instrument where security is over the debtor’s credit, not specific assets, giving priority over unsecured creditors in bankruptcy. In Asia, a loan secured by land is a mortgage; one secured by other assets is a debenture; and unsecured loans are notes or unsecured d