In its simplest term, a debenture is a legal document that gives the lender, a charge over a borrower’s assets. The holder of the charge has a legal right or means of collecting their debt if the borrower defaults on the terms of the loan.
Debentures are a critical aspect of the financial landscape, particularly in the lending space. The process of acquiring a debenture is quite simple, and for a borrower, it may not seem like a big deal. However, it is essential to understand the nature of debentures and the implications they carry in the long run.
Types of Debenture Charges
There are two primary types of debenture charges that a borrower may encounter: fixed charges and floating charges.
Fixed Charge
A fixed charge is a legal claim that a lender holds over a borrower’s assets. In this scenario, the lender becomes the primary creditor for the borrower, which means that in the event of a default, the lender has the right to take ownership of the asset and sell it to recover the outstanding debt.
Fixed charges apply to a wide range of assets, such as freehold and leasehold properties, building fixtures, trade fixtures, fixed plants, machinery, and motor vehicles. It is crucial to note that while there is an existing fixed charge on the property, the borrower cannot sell or trade the asset without the lender’s permission.
Floating Charge
A floating charge is a legal claim that a lender holds over all the assets of a borrower. Unlike a fixed charge, a floating charge is not attached to any specific asset. Instead, it is a general charge that applies to all of a company’s assets. It may be a class of specific assets such as raw materials, stock, or cash.
Floating charges are unique in the sense that it is assumed that the asset may change in nature over time, but the borrower is granted permission to sell or move the asset as part of their normal business process. However, if a lender decides to enforce a debenture, they can convert the floating charge to a fixed charge on the company’s asset. At that point, the borrower can sell or move the asset without the lender’s permission.
Deed of Priority
When lenders have outstanding debentures on a business, they will agree on a priority of payments among themselves. This is a deed of priority. When liquidation or insolvency occurs, floating charge holders have priority over unsecured debtors when payments are allocated.
Why Debentures Matter to Borrowers
For borrowers seeking funding, debentures play a critical role in determining the type of loan they can access. A lender’s decision to secure a debenture depends on the borrower’s creditworthiness and the nature of the loan. Debentures provide lenders with an additional level of protection, which can lead to lower interest rates and more favorable repayment terms for borrowers.
Debentures also provide transparency and clarity to both the borrower and lender. By identifying specific assets, the lender can clearly define the collateral securing the loan, while the borrower can better understand the level of risk involved in borrowing.
At Funding Bay, we understand the complexities of debentures and how they can impact your borrowing experience. Get in touch with us today to learn more about our range of lending options and how we can help you secure the funding you need.
