Debt is an obligation that one party owes to another party, to pay back a borrowed sum.

Debt financing is when a firm raises money, by selling debt securities to lending institutions, individuals and investors. In return for lending the money, the individuals or institutions become creditors and receive a promise that the principal and interest on the debt will be repaid.1 In finance, debt is a means of using anticipated income and future purchasing power in the present before it has actually been earned. Some companies use debt as a part of their overall corporate finance strategy.2 Companies can raise debt finance by issuing debt securities directly into the capital markets or by borrowing from banks and other lenders. UNSECURED DEBT In finance, unsecured debt refers to any type of debt that is not collateralized by a lien on specific assets of the borrower in the case of liquidation or failure to meet the terms for repayment. In the event of the bankruptcy of the borrower, the unsecured creditors will have a general claim on the assets of the borrower after the specific pledged assets have been assigned to the secured creditors, although the unsecured creditors will usually realize a smaller proportion of their claims than the secured creditors.3 OVERDRAFTS An overdraft is a form of debt financing provided to a customer by his bank, through his current account. An overdraft arises when a company draws on its current account to such an extent that a negative balance is produced. Usually, an arrangement to overdraw up to a certain limit is made in advance between a company and its bank, for the purpose of which the company might be required to pay a commitment fee. If a company makes an unauthorized drawing, it can be viewed conceptually as

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http://www.investopedia.com/terms/d/debtfinancing.asp http://en.wikipedia.org/wiki/Debt 3 http://en.wikipedia.org/wiki/Unsecured_debt
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9 Some matters and warranties that are covered by the representation and warranties are: (i) The capacity of the company to enter into the loan agreement and the authority of its directors and officers to do so 4 5 Barclays Bank Ltd. A bank is not under any obligation to give time to a company to raise funds that it does not have. 5 An overdraft is generally repayable on demand. if a bank that agrees to give an overdraft acts in such a manner. a bank is only required to give sufficient time to the company to effect the mechanics of payment.an offer by the company 4 and if the bank meets the drawing. in order to repay the overdraft and in such cases. The borrower can be given the option of early repayment.7 However. 6 Williams and Glyn’s Bank v Barnes [1981] Com LR 205 7 [1894] AC 586. the bank can rightly sue the company for not repaying immediately. The term loan agreement specifies the principal amount of the loan. the agreement also provides whether the repayment is to be made at once or in installments over a period of time. Legal Opinions (Sweet & Maxwell. The agreement can provide for the borrower to draw all the loan amount of the loan at once or draw the amount at specific intervals of time. HL. The loan agreements contain representations and warranties. regarding the overdraft. 2007) ch 4 . it constitutes an acceptance. A provision should be included in the agreement. enabling the lender to demand early repayment in case a number of specified of defaults occur.8 TERM LOANS These are loans which are given for a specified period of time. which perform an investigative function. Similarly. 596 per Lord Hershell LC 8 Cripps (Pharmaceutical) Ltd v Wickenden [1973] 1 WLR 944 9 nd PR Wood. Bonds. V WJ Simms Son & Cooke [1980] 1 QBD 699 Id. International Loans. it would cause serious damage to the business. Even though there is no legal obligation to abstain from doing so. without giving notice. 2 Edn. it was explained that no party contemplates a bank to sue for recovery of money granted as overdraft immediately.6 In Rouse v Bradford Banking Co. Guarantees. resulting in formation of a contract between the two parties. the currency in which it is denominated and the way in which it will be made available to the borrower.

in the event of default of the lender to repay the debt. the pari passu rule applies to the unsecured creditors. SECURED DEBT A debt is a secured debt when a lender has control over the assets of the borrowing company. there are some implied covenants which are to be followed.(ii) (iii) The financial position of the borrower Any pending litigations or claims against the borrower which may adversely effect his capability to perform obligations under the loan agreement Covenants under a loan agreement Covenants in a loan agreement serve the purpose of restricting the borrower in carrying out his business and give the lender certain control over the way in which the borrowers business is conducted. Covenants are divided into two kinds. These covenants are presumed to be implied but are not included in the loan agreement due to their obviousness. Positive covenants include acts that the borrower promises to do. in the size proportionate to their claim. in case the lender becomes insolvent. Their primary purpose is to ensure that the borrower’s credit rating does not decline while the debt remains pending. while negative covenants contain acts which the borrower promises to refrain from doing. implying that each unsecured creditor gets repaid out of the company’s assets. When a Company’s assets are not sufficient to pay off all the debts at the time of insolvency. A few types of covenants are: (i) (ii) (iii) (iv) (v) Reporting covenant Financial covenant Disposal of assets covenant Change of business covenant Negative pledge covenant Apart from these. which are the security and can enforce his claims against those assets. This puts the secured creditors in a position which is much stronger than unsecured creditors. . This rule does not apply to the secured creditors and they get priority of payment in case of insolvency over the unsecured creditors.

Mortgage Mortgage is a transfer of ownership as security for a debt which is to be retransferred once the debt has been discharged. Pledge and Lien Pledge involves the assets of the debtor being transferred to the creditor as security for the debt. as soon as the debtor has repaid the debt. Also. When an agreement is entered into. the debtor has the right to detain the property but not to sell it. Forms of Security Security is divided into four types – pledge. for providing a property as security over which the debtor will have ownership in the future. If the debtor fails to repay the dent in due time. Mortgages and charges are the more commonly used security due to their practicality. Charges 10 11 Re Hardwick. at the time of the agreement being concluded.11 The creditor may further sub-pledge the pledged asset. Because possession is required to be made over the subject matter by the creditor in pledge and lien. the creditor can sell the pledged asset to account for the amount of the debt and returning the surplus amount to the debtor. A debtor may also grant security in an asset which he is going to acquire in future. In a legal mortgage. will not imply the creditor having security interest in the said property. he is entitled to immediately hold possession of the pledged property. A creditor cannot claim an interest over the security even when there is no outstanding debt. they have limited practical significance. mortgage and charge. ex p Hubbard (1886) 17 QBD 690. However. lien. A debtor may mortgage his own property or a third person may mortgage his property on behalf of the debtor but he does not require taking the liability of repaying the debt upon him.A security interest is linked only with the debt for which it is given as security.10 In lien. a security interest arises in a property that the debtor owns. CA Donald v Suckling (1866) LR 1 QB 585 . the legal title to the mortgaged property needs to be transferred to the creditor.

These are described in brief below. It can be converted into fixed charge. A charge is normally created by an agreement between parties along with a consideration or in the form of a deed. i. Floating Charges Floating charges are charges on a class of assets. charge includes mortgage. 12 13 Re Bond Worth Ltd. [1980] Ch 228 per Slade J Re Sectrum Plus Ltd [2005] 2 AC 680. HL per Lord Scott . In fixed charges. the holder of the secured property immediately has all the rights in relation with the secured property and the holder can restrict the company from disposing off or destroying the secured property. unless he proves that he is a bonafide purchaser not having knowledge of fixed charge. an equitable charge can also be created by the charger declaring himself a trustee of the relevant assets for the purpose of security. through a process called crystallization.A charge gives its holder rights relating to the property which is given as security but does not require a transfer of the legal or beneficial ownership of the property. If the charger sells any security that is subject to fixed charge. Fixed Charges A charge is fixed when it is made specifically to cover definite and ascertained assets of permanent nature. the buyer obtains the property along with the charge. Floating charges majorly differ from fixed charges in the sense that the charger can deal with the security and can transfer the assets even though they are the subject matter of security. 1956.12 Under Section 124 of the Companies Act. or future and changes from time to time in the ordinary course of business. 13 Floating charge normally extends to future as well as existing property of the company. However. A floating charge does not always need to remain floating. fixed charges and floating charges. which may be in the present.e. Charges are of two kinds.

investopedia. a charge is a floating charge if: (i) (ii) (iii) It is a charge on a class of assets of a company present and future The class will change from time to time in the ordinary course of business and It is contemplated by the charge that till the time some further actions are taken by the persons interested in the charge. In some cases.In Re Yorkshire Woolcombers Ltd. which is typically money to be earned from future operations. The backing for the bond is usually the payment ability of the company. the company's physical assets may be used as collateral for bonds. According to Romer LJ.14 The most important criteria to determine a floating charge is the extent the company will be free to deal with assets which form subject matter of the security.. the company can carry on its business ordinarily in such class of assets.15 DEBENTURES Section 2(12) of the Companies Act. bonds and any other securities of a company whether constituting a charge on the company’s assets or not”.asp . A floating charge crystallizes in the following situations: (i) (ii) (iii) (iv) When the company is liquidated When the company ceases to carry on its business When creditors take steps to enforce the security On happening of any event that has been specified in the deed CORPORATE BONDS Corporate bonds are debt securities issued by a corporation and sold to investors.com/terms/c/corporatebond. 14 15 [1903] 2 Ch 284 CA http://www. characteristics to deteremine whether a charge is a floating charge were mentioned. 1956 defines debenture as follows: “Debenture includes debenture-stock.

These give a bonafide title to the acquirer of the debenture and enable the bearer to sue the company in his own name.The definition so provided in the statute fails to explain the meaning of a debenture and it’s nature. explained the meaning of debenture as follows: “Debenture means a document which either creates a debt or acknowledges it and any document which fulfills either of those conditions is a debenture”. the company has the right to pay back the debenture holders and have it’s assets released form charge or mortgage. (iv) Redeemable Debentures These are issued for a specified period of time.16 There are certain characteristic features that a debenture possesses which are as follows: (i) (ii) (iii) It is a movable property It is issued by the company in the form of a certificate of indebtedness It specifies the date of redemption and also provides for repayment of principal and interest at specified date o dates. Chitty J. [1888] 37 Ch. Following are the kinds of debentures: (i) Bearer debentures These are negotiable instruments transferrable by delivery. (ii) Registered debentures These debentures are payable to those persons whose name appears in the register of debenture holders. D. 16 Levy v Abercorris Co. (iii) Irredeemable debentures These debentures do not contain any clause with regard to payment or contain a clause that they shall not be repaid. on the expiry of which. (iv) It usually creates a charge on the undertakings of the company There are different kinds of debentures that companies issue in order to raise finance. 260 .

Once converted into shares. they cannot be converted back to debentures. ZERO COUPON BONDS These bonds are sold at discount on the nominal value and are redeemed at nominal value at the end of the maturity period. (b) Partly Convertible Debentures These are partly convertible and partly non-convertible. These are further classified into: (a) Fully Convertible Debentures These are converted into equity shares on the expiry of a specified period of time.(v) Convertible Debentures An option is given to holders of these debentures to convert them into equity or preference shares at stated exchange rates after holding them for a certain period of time. while the convertible part is converted into equity shares at the expiry of such period of time. The non-convertible part is redeemed after a specified period. .