The Procedure of Bank Loan Against Debenture

Most banks issue loans against debentures but there is some certain procedure of bank loan against debenture. A debenture is a document issued by a company usually under its common seal acknowledging the indebtedness of the company either to the bearer or to the registered holder of the document.

The debts may be redeemed

  1. At a fixed future date, or
  2. By periodical drawings

not redeemable while the company is a going concern. The last class is called an irredeemable debenture.

Types of debenture

A debenture is a loan to a limited company bearing a fixed rate of interest. Interest is payable whether the company makes a profit or not. Denatures any be secured either by a fixed charge or a floating charge on the company’s assets.

If there is no charge, debentures are clean or unsecured; these are sometimes called naked debentures. In the case of winding up of the company, the secured debenture holders can have recourse to the property charged.

If unsecured, they will rank with ordinary creditors. Debenture holders are the creditors. They are not shareholders. There are different kinds of debentures.

Procedure of Bank Loan Against Debenture
Bank Loan Against Debenture

1. Debenture to Bearer: Debenture is payable to the bearer, with or without power for the bearer, to have them placed on the register or to have them at any time withdrawn from it. These are transferable and have been recognized by courts and negotiable instruments are transferable by delivery.

2. Registered Debenture: This debenture is payable to the registered holder. Any transfer of these must be registered with the company.

3. Simple or Naked Debenture: Simple or Naked debentures are those where no security is given for payment of interest or repayment of principal. These do not carry any charge on the assets of the company. They contain only a simple promise to pay.

4. Mortgage Debenture: Any debenture secured by a charge, where specific or floating, on the whole, or part of the assets of the company, is called a mortgage debenture.

5. Redeemable or Irredeemable debenture: Redeemable debentures indicate that the company agrees to repay the money lent at a stipulated time or after a certain period of notice. Irredeemable or perpetual debentures have no date for repayment and the company can repay debentures at any time it may choose to do so. They shall, however, be repaid when the company goes into liquidation or makes a default in the payment of interest.

Debenture as Banker’s Security

Banker advances money on a debenture issued by companies. Debentures are accepted by banks as security if they are readily marketable. Their marketability, however, depends upon their safety and yield, the reputation and profit of the company, and public opinion about the integrity and capacity of the company’s directors.

When banks speak of debentures as security for advances, they invariably mean debentures carrying a charge on some property of the company. This charge may be “fixed” or “floating”. The fixed charge creates a legal mortgage on some specific property of the company like land, building, fixed plant, machinery, etc., in favor of the debenture holders.

Where there is a charge on some specific part of the company’s property, it is usually done by a trust deed by which a specific part of the property of the company is vested in trustees for the benefit of the debenture holders. The names of the trustees are mentioned as mortgagees in the debenture trust deed.

Where there is a fixed charge, the debenture holders are free from the danger of anyone securing a prior charge and the trustees are given the power to sell the property charged if that becomes necessary.

A floating charge is an equitable charge on floating assets (such as stock-in-trade) or on the whole of the company’s undertakings of a going concern. Where a large number of secured debentures are issued in a series, the security given will usually be a floating charge on the whole of the company’s undertaking.

A floating charge given by a company over its undertaking and property enables the company to continue dealing in the ordinary course of business with any of the assets charged, selling them, and reinvesting the proceeds in fresh assets as it wishes until the floating charge crystallizes.

A floating charge becomes fixed or crystallized if anything causes the money secured to become immediately repayable and, in addition, the banker takes legal proceedings to secure the debt.

Until positive action is taken, e.g., the appointment of a receiver, the floating charge does not crystallize. It needs hardly be stressed that merely calling up the debt does not crystallize the charge.

A floating charge does automatically crystallize when liquidation commences or when the company ceases to carry on the business but the bank would still appoint the receiver in either circumstance if it becomes necessary to protect its position. Bank’s specific mortgage over the property will take priority over a floating charge and has to be satisfied first, out of the assets.

Precaution and checks for bank loan against debenture

In considering the value of a debenture as security, it is necessary to know the terms on which it has been issued and the manner in which it has been secured.

While taking debenture as security, the banker should, therefore, take the following precautions:

1. The authority of the company to issue debentures. The issue of debentures is tantamount to borrowing by the company. The banker must, therefore, inspect the Memorandum of association to find out whether it gives the company power of borrowing, though, in the case of trading companies, this power is implied.

2. The banker should satisfy himself as to the financial position and reputation of the company whose debentures are to be accepted as securities.

3. The borrower is the registered holder of the debenture to be mortgaged.

4. The banker should accept the only mortgage of secured debenture as securities. Unsecured debentures should not be accepted.

5. The banker should preferably accept debentures with a fixed charge than debentures with a floating charge because, in the matter of repayment, the debentures with a fixed charge to specific assets have priority over the debentures with a floating charge in the event of the liquidation of the company.

6. While advancing against secured debentures, the banker should inspect the register of charges maintained by the Registrar of Joint Stock Companies to ascertain whether any prior charge exists or not. When debentures with a fixed charge on some assets are accepted as security for advance, the banker should see that title deeds of the property, evidencing the title of the company to the property, are deposited with him.

7. Debentures accepted as security should be readily marketable and a sufficient margin, at least 25%, should usually be maintained subject to credit restrictions laid down by Bangladesh Bank.

8. There is regularity in payment of interest and no arrear interest is brought into account on the Balance Sheet.

9. Are the funds being accumulated periodically by the company for the redemption of debenture? This can be ascertained by referring to the specific investment in the Balance Sheet “Redemption Reserve Fund Investment Account” of the company.

10. Mere possession of debenture will not give any title to the banker. The deposit of debentures should be accompanied by a memorandum of deposit. The memorandum of deposit should authorize the banker to sell the debenture given as securities in the default of the borrower in repaying the advance.

Documents required for bank loan against debenture

  1. Application for advance.
  2. Demand Promissory Note.
  3. Letter of continuity (in the case of overdraft account).
  4. Letter of Lien.
  5. An irrevocable letter of the mandate for the collection of interest etc addressed to relative companies by the debenture holder.
  6. Letter of authority given by the borrower to sell the debenture in default of borrower in repaying the advance.

Hope you find all procedure of bank loan against debenture otherwise please comment below.

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3 thoughts on “The Procedure of Bank Loan Against Debenture”

  1. I think most of the bank are not giving loan against debenture. You mention some great information which helps me a lot but more important if you can provide a list of some bank who give this kind of loan.

    1. Thank you, sir, for your kind information as I know most of the bank give loan against debenture whatever you ask a list of bank but you don’t mention for which country better you search on google hope you find it.

      Thanks again

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