Debenture Stock in United Kingdom

History

One of the many advantages incident to incorporation under the English Companies Acts is found in the facilities which such incorporation affords a trading concern for borrowing on debentures or debenture stock. More than five hundred millions of money are now invested in these forms of security. Borrowing was not specifically dealt with by the Companies Acts prior to the act of 1900, but that it was contemplated by the legislature is evident from the provision in § 43 of the act of 1862 for a company keeping a register of mortgages and charges. The policy of the legislature in this, as in other matters connected with trading companies, was apparently to leave the company to determine whether borrowing should or should not form one of its objects.

The first principle to be borne in mind is that a company cannot borrow unless it is expressly or impliedly authorized to do so by its memorandum of association. In the case of a trading company borrowing is impliedly authorized as a necessary incident of carrying on the company’s business. Thus a company established for the conveyance of passengers and luggage by omnibuses, a company formed to buy and run vessels between England and Australia, and a company whose objects included discounting approved commercial bills, have all been held to be trading companies with an incidental power of borrowing as such to a reasonable amount. A building society, on the other hand, has no inherent power of borrowing (though a limited statutory power was conferred on such societies by the Building Societies Act 1874); nor has a society formed not for gain but to promote art, science, religion, charity or any other useful object. Public companies formed to carry out some undertaking of public utility, such as docks, water works, or gas works, and 902 governed by the Companies Clauses Acts, have only limited powers of borrowing.

An implied power of borrowing, even when it attaches, is too inconvenient to be relied on in practice, and an express power is always now inserted in a joint stock company’s memorandum of association. This power is in the most general terms. It is left to the articles to define the amount to be borrowed, the nature of the security, and the conditions, if any,—such as the sanction of a general meeting of shareholders,—on which the power is to be exercised.

Under the Companies Act 1908, § 87, a company cannot exercise any borrowing power until it has fulfilled the conditions prescribed by the act entitling it to commence business: one of which is that the company must have obtained its “minimum subscription.” A person who is proposing to lend money to a company must be careful to acquaint himself with any statutory regulations of this kind, and also to see:

• that the memorandum and articles of association authorize borrowing, and
• that the borrowing limit is not being exceeded, for if it should turn out that the borrowing was in excess of the company’s powers and ultra vires, the company cannot be bound, and the borrower’s only remedy is against the directors for breach of warranty of authority, or to be surrogated to the rights of any creditors who may have been paid out of the borrowed moneys.

A company proposing to borrow usually issues a prospectus, similar to the ordinary share prospectus, stating the amount of the issue, the dates for payment, the particulars of the property to be comprised in the security, the terms as to redemption, and so on, and inviting the public to subscribe. Underwriting is also resorted to, as in the case of shares, to ensure that the issue is taken up. There is no objection to a company issuing debentures or debenture stock at a discount, as there is to its issuing its shares at a discount. It must borrow on the best terms its credit will enable it to obtain.

A prospectus inviting subscriptions for debentures or debenture stock comes within the terms of the Directors’ Liability Act 1890 (re-enacted in Companies Act 1908, § 84), and persons who are parties to it have the onus cast upon them, should the prospectus contain any misstatements, of showing that, at the time when they issued the prospectus, they had reasonable grounds to believe, and did in fact believe, that the statements in question were true; otherwise they will be liable to pay compensation to any person injured by the misstatements. A debenture prospectus is also within the terms of the Companies Act 1908. It must be filed with the registrar of joint stock companies (§ 80) and must contain all the particulars specified in § 81 of the act. (See Company.)

The usual mode of borrowing by a company is either on debentures or debenture stock. Etymologically, debenture is merely the Latin word debentur,—The first word in a document in common use by the crown in early times admitting indebtedness to its servants or soldiers. This was the germ of a security which has now, with the expansion of joint stock company enterprise, grown into an instrument of considerable complexity.

Debentures may be classified in various ways. From the point of view of the security they are either:

• debentures (simply);
• mortgage debentures;
• debenture bonds.

In the debenture the security is a floating charge. In the mortgage debenture there is also a floating charge, but the property forming the principal part of the security is conveyed by the company to trustees under a trust deed for the benefit of the debenture-holders. In the debenture bond there is no security proper: only the covenant for payment by the company. For purposes of title and transfer, debentures are either “registered” or “to bearer.” For purposes of payment they are either “terminable” or “perpetual” (see Companies Act 1908, § 103). (…)

In the case of Floating Debentures, a floating charge created by a company within three months of its being wound up will now be invalid under § 12 of the Companies Act 1908 unless the company is shown to have been solvent at the time, but there is a saving clause for cash paid under the security and interest at 5%. (1)

Comparison between shares and debenture stock

Debenture Scrip History

Debentures and debenture stock are usually made payable in instalments, for example 10% on application, 10% on allotment and the remainder at intervals of a few months. Until these payments are complete the securities are not issued, but to enable the subscriber to deal with his security pending completion the company issues to him an interim scrip certificate acknowledging his title and exchangeable on payment of the remaining instalments for debentures or debenture stock certificates.

If a subscriber for debentures made default in payment the company could not compel him specifically to perform his contract, the theory of law being that the company could get the loan elsewhere, but this inconvenience is now removed (see § 105 of the Companies Act 1908).(2)

Resources

Notes and References

1. Encyclopedia Britannica (1911)
2. Id.

See Also

Further Reading