I was intrigued recently when the owner of a sizeable business got in touch because he said he’d read a blog of mine from 2011 and that it was still the most helpful thing he could find on the internet about Mortgage Debentures. Flattering perhaps, but I’ve checked it and there isn’t much out there! He’d been asked to provide one for a business loan and was told it was ‘standard procedure’ but he was the sort who wanted to understand what he was signing.
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I also, coincidentally, met an accountant last week who said that he was concerned about how readily his clients signed these.
I hasten to add that I’m not saying that company directors should not signed these documents – in fact they probably wont get borrowing if they don’t – but I feel strongly that they should know what they are signing.
So…what is a Mortgage Debenture and what does it mean to provide this security to the bank (or any lender to the business)?
There was a time that a bank only asked for this security from a company with significant assets borrowing a size able amount. It wasn’t considered cost effective to do this for smaller loans/businesses because the cost of recovering assets if things go wrong was seen as prohibitive – it was also, understandably, cynically viewed that those assets wouldn’t still be there when it came to it.
But now it is standard for most loans, and that includes ‘peer to peer’ platform lending – and the increasing tendency for buy-to-let portfolio owners to borrow in the name of a limited company has raised its profile in that market too. For many B2L owners this could the first time they have encountered this form of security.
So.. A debenture is, in simple terms, a written agreement between a lender and a borrower which is filed at Companies House and gives the lender priority over other creditors in the event of the failure of the borrower.
The debenture document provides the lender with two types of legal charge.
- The first is a ‘fixed charge’ which is a charge over a nominated asset of the business. That could be a property (which would be specifically scheduled in the document) but of most interest to a lender is a fixed charge over the company’s debtor book. They own the rights to the Company’s invoices. This is why companies that take up ‘Invoice Discounting’ packages find that they can run into conflict with their bank as the Invoice Discounting lender demands such a first charge and the bank will have to be prepared to give it priority, or cancel their debenture.
- The second form of charge that it provides to the bank is what’s called a ‘floating charge’ over all other assets the company might own – at any time. The ‘floating nature’ of the charge makes it a form of ‘umbrella’ security and the company can operate and trade these assets without the bank’s permission, but they will always be caught whilst the company owns them. This might apply for example with plant, equipment and vehicles – the company can sell them but the bank will automatically have a charge over any replacements.
However, the main reason that banks now take these charges as standard is the other rights that they provide – and key to this is the ‘step in rights’. This is not always well understood but it is crucial as it gives the bank the right to appoint a Receiver (where they can argue it is justified) who can enter the company’s business or property and take control of it – with the aim of disposing of assets to repay the bank debt (and that is really their main responsibility). At this point both forms of charges (the fixed and the floating charges) are said to have been ‘Crystallised’ and the Receiver becomes known as a ‘Fixed Charge Receiver’.
Another aspect of a debenture which is not well understood is that they are considered to cover ‘All Monies’ – not just the specific loan that the business took out – so they secure existing and future loan advances and also Overdrafts.
So, if a Mortgage Debenture gives such powers to a lender, why aren’t Company Directors more aware of what these charges can do and the risks they could create?
One simple answer to this is that ‘the Company’ is the entity providing the charge, so there is no requirement for a Director to take ‘Independent legal Advice’ from a solicitor. This would be insisted upon if they were giving a Personal Guarantee of course – the rules effectively treat this as them giving a charge over their personal assets. A Director can therefore just sign a Debenture with a Board Resolution and not have it explained to them at all. And, of course, they are legal forms which cover every eventuality and not a light bedtime read!
Another reason is they have become ‘the norm’ and if the company needs the loan then there seems little room for negotiation or discussion. So they just get signed.
However, and not many people know this – there is also an opportunity for Directors created by Mortgage Debentures:
Not many Directors are aware that they could take out a Mortgage Debenture on their own company when it owes them money – such as when they have provided a Directors Loan. A simple example would be where you voted to pay yourself a dividend, but you don’t draw those funds out. It is an interesting concept because it means that if the company is ‘wound up’ your loan takes priority over other creditors (including ‘preferential’ creditors). This assumes of course that you have not already given a debenture to another lender.
It also follows that if your company is a lender to another company – such as a debtor who is not paying on time – you could (with their agreement) take out a mortgage debenture over their assets to give you priority if they fail (although legal advice would need to be taken by all parties in this situation as just the act of giving the mortgage debenture could give the company involved a problem).
A final point: Please note that I’m not a lawyer, I’m just an experienced old banker, and none of the above is to be treated as legal advice or opinion. If anyone is in any doubt about the facts or any decision they are taking they should seek advice from a commercial lawyer.
We deal with the practical issues and help in understanding bank security packages and where necessary support Directors in negotiations with banks.
Please feel free to ask us for help – email on steveleverton@cornmillassociates.co.uk