LOAN CAPITAL / DEBT FINANCING

Debt capital is a common method of financing business enterprise and for successful

companies, particularly listed companies. Debt capital represents the obligation of a

company to repay the loan made by the debt holder. A company is bound by contract

to make payments of principal and interest on a fixed schedule. Companies may

borrow money in many ways; by making short term commercial notes, taking

shareholders loan, accepting bank lines or credits and issuing debt securities/

stocks. Debt financing can be from outside third parties or inside shareholders.

DEBENTURE

In corporate finance, a debenture is a medium- to long-term debt instrument used

by large companies to borrow money, at a fixed rate of interest.

The legal term “debenture” originally referred to a document that either creates a

debt or acknowledges it, but in some countries the term is now used interchangeably

with bond, loan stock or note. A debenture is thus like a certificate of loan or a loan

bond evidencing the fact that the company is liable to pay a specified amount with

interest and although the money raised by the debentures becomes a part of the

company’s capital structure, it does not become share capital. Senior debentures get

paid before subordinate debentures, and there are varying rates of risk and payoff

for these categories.

Debentures are generally freely transferable by the debenture holder. Debenture

holders have no rights to vote in the company’s general meetings of shareholders,

but they may have separate meetings or votes e.g. on changes to the rights attached

to the debentures. The interest paid to them is a charge against profit in the

company’s financial statements.

✍🏽Edited by Daudi B. Mswahela, LLB III Student Mzumbe University, 2021.

The term “debenture” is more descriptive than definitive. An exact and all-

encompassing definition for a debenture has proved elusive. The English commercial

judge, Lord Lindley, notably remarked in one case: “Now, what the correct meaning

of ‘debenture’ is I do not know. I do not find anywhere any precise definition of it.

We know that there are various kinds of instruments commonly called debentures.”

The most usual form of borrowing by a company is by issue of debentures. According

to section 2 of the Companies Act,1 debenture includes debenture stock, bonds and

any other securities of a company, whether constituting a charge on the asset of a

company or not.

In Levy vs. Abercorris Slate & Slab Co.2 Debenture was said to mean a document

which either creates a debt or acknowledges it.

In Edmonds vs. Blaina Co.3 Chitty J: the meaning of debenture was described as

follows:” the term itself imports a debt or an acknowledgment of debt and

obligation or covenant to pay. This obligation or covenant is in most cases
accompanied by some.”

As a general matter debt do not have the participation, voting, conversion and

redemption rights that constitute the fundamental ingredients of equity securities/

stocks. It is not uncommon for a company to issue debentures that are convertible

at holder’s option into specified equity securities or that are redeemable at the

holder’s option (“put” debentures). Generally, the issue of debt securities/stocks

1 Cap 212 R:E 2002.

2 (1897) 37 Ch. D 260.
3 (1887) 36 Ch.D 215.

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(like entering into any other contractual arrangement) is a matter left to board’s

discretion.4

Companies have frequently to borrow large sums of money. The loan requirement of

a company may not, therefore, be met by a single lender. The loan may have to be

split into several units. One very convenient method of doing so is to borrow by

issuing debentures. As a matter of fact the term ‘debenture’ does not have any

precise legal meaning. The term as used in the modern commercial parlance is of

extremely elastic character. The most referred meaning of debenture indicates that

it is a document which either creates a debt or acknowledges it and any document

which fulfills either of these conditions is a debenture.

Company can collect money from outsiders by issuing debentures if permitted by

article and memorandum of association. Company pays interest for debenture and

during liquidation debenture-holder’s claim is to be satisfied at first.

Features of Debenture:

1. Debenture is a kind of acknowledgement of company’s loan

2. It contains in it the amount of loan and the rate of interest

3. The time and procedure of payment of both principal and interest is mentioned

in the debenture

4. It has a number, company’s name and seal on it

5. It is mostly secured by charge.

4 Ombella, J.S & Massawe,MP., “Elementary Company Law in Tanzania:” Thrust Publications
Ltd: Dar es Salaam, Tanzania, (2013). at page 85.

✍🏽Edited by Daudi B. Mswahela, LLB III Student Mzumbe University, 2021.

Classification of Debenture:

1. On the basis of security:

a) Ordinary debenture

b) Mortgage debenture

a) Ordinary Debenture: When the company acknowledges the debt by debenture

but no security is promised to the creditor, it is ordinary debenture. The ordinary

debenture-holders have secondary right after the secured creditors.

b) Mortgage Debenture: When the company takes loan in exchange of its property

as mortgage, it is called mortgage or secured debenture. In case of default in

payment by the company, the creditor will have the right to sell the property in

mortgage and receive his money out of proceeds.

Mortgage debenture may be of two kinds—

i. Mortgage debenture of fixed charge

ii. Mortgage debenture of floating charge

Mortgage debenture of Fixed Charge: If the company mortgages a fixed property

as security for the loan, it is called mortgage debenture of fixed charge. Company

cannot use or alienate such property without the consent of the creditor.

Mortgage debenture of floating charge: When the company mortgages all of its

present and future property as security, the debenture is called mortgage

debenture of floating charge. In such case, the creditor will have the right to sell

any of the company’s property in order to take back his principal and interest. The

company can alienate or use the property without the consent of the creditor.

2. On the basis of payment:

a) Redeemable Debenture

b) Irredeemable debenture

✍🏽Edited by Daudi B. Mswahela, LLB III Student Mzumbe University, 2021.

a) Redeemable Debenture: When the company issues debenture on the condition

that, the loan shall be repaid gradually with the interest, it is called redeemable

debenture. A Separate fund is maintained by the company for the purpose of

redemption of its debenture. A redeemed debenture can be re-issued.

b) Irredeemable debenture: When the Company issues debenture on the condition

that the principal will be returned only at the time of liquidation, the debenture is

irredeemable. It is also known as perpetual debenture.

3. On the basis of Registration:

a) Registered Debenture

b) Unregistered Debenture

a) Registered Debenture: If a Register book is maintained by the company to keep

all the information about the debenture-holders, the debentures are called

registered.

b) Unregistered Debenture: When the debenture is like a negotiable instrument

which may be easily transferable and no information about the holder is maintained

by the company, it is called unregistered debenture.

Convertible debenture: Some debentures are issued on the condition that they will

be converted into shares after a certain period of time; these debentures are called

convertible debenture.

✍🏽Edited by Daudi B. Mswahela, LLB III Student Mzumbe University, 2021.

Distinction between Share & Debenture:

1. Share is a part of capital but debenture is part of Company’s loan

2. Shareholders are the members of the company but debenture-holders are not

members, they are outsiders

3. Shareholders receive dividend from the company whereas debenture-holders

are entitled to interest.

4. Shareholders bear the liability of the company but debenture holders do not

5. Shareholders participate actively in the company’s management but debenture

holders do not have such right

6. Shareholders have voting right but debenture holders do not have such right

7. No security is required for allotment of share but debenture is mostly

secured by charge

8. Shareholders claim is satisfied at last during liquidation but debenture

holders claim is satisfied before shareholders.

Issue of debenture:

1. Public company limited by share can issue debenture by a resolution in the

Board of meeting. They must issue a prospectus in this regard.

2. Private companies cannot issue debenture.

Rights of a Debenture holder:

According to section 89 (1) of the Companies Act5 the debenture holder can receive

copies of all deeds creating mortgage or security for loan which are submitted to

the Registrar for registration and inspect the register of mortgages.

If he is not allowed his right under section 89 (1) company will be liable for

compensation. [Section 89 (2)]

5 Cap 212 R:E 2002.

✍🏽Edited by Daudi B. Mswahela, LLB III Student Mzumbe University, 2021.

According to section 89, all register of debenture must be kept open for inspection,

and they can receive copies by paying fees.

Debenture holder can claim the copy of trust deed which ensures repayment. In case

of default company will be liable for compensation.

Remedies of Debenture holders in case of non-payment:

Unsecured creditors –

a) Creditors can file a suit against company for loan and interest

b) They can apply to the court for compulsory liquidation

Secured creditors –

a) Sell the mortgaged property and receive their principal and interest

b) Apply for appointment of a receiver

c) Claim liquidation

d) Resist sale or redemption of mortgaged property.

RECEIVER:

If the company fails to pay interest on loan, then creditor can claim appointment of

receiver who will protect the interest of the creditors. Receiver may be appointed—

a) According to the trust deed or conditions of debenture

b) By an order of court on application of creditors

Duties of receiver:

1. Take possession of the mortgaged property and make arrangement of sale

2. Manage the property until the creditors’ claim is satisfied

3. Manage the company if required

4. he is entitled to remuneration for his services

5. Advantages and Disadvantages of Debenture.

✍🏽Edited by Daudi B. Mswahela, LLB III Student Mzumbe University, 2021.

Advantages of Debentures

i. Investors who want fixed income at lesser risk prefer them.

ii. As a debenture does not carry voting rights, financing through them does not

dilute control of equity shareholders on management.

iii. Financing through them is less costly as compared to the cost of preference

or equity capital as the interest payment on debentures is tax deductible.

iv. The company does not involve its profits in a debenture.

v. The issue of debentures is appropriate in the situation when the sales and

earnings are relatively stable.

Disadvantages of Debentures

i. Each company has certain borrowing capacity. With the issue of debentures,

the capacity of a company to further borrow funds reduces.

ii. With redeemable debenture, the company has to make provisions for

repayment on the specified date, even during periods of financial strain on the

company.

iii. Debenture put a permanent burden on the earnings of a company. Therefore,

there is a greater risk when the earnings of the company fluctuate.

Types of Debenture

1. Secured and Unsecured:

Secured debenture creates a charge on the assets of the company, thereby

mortgaging the assets of the company. Unsecured debenture does not carry any

charge or security on the assets of the company.

✍🏽Edited by Daudi B. Mswahela, LLB III Student Mzumbe University, 2021.

 2. Registered and Bearer:

A registered debenture is recorded in the register of debenture holders of the

company. A regular instrument of transfer is required for their transfer. In

contrast, the debenture which is transferable by mere delivery is called bearer

debenture.

3. Convertible and Non-Convertible:

Convertible debenture can be converted into equity shares after the expiry of a

specified period. On the other hand, a non-convertible debenture is those which

cannot be converted into equity shares.

4. First and Second:

A debenture which is repaid before the other debenture is known as the first

debenture. The second debenture is that which is paid after the first debenture has

been paid back.

[Source - Lawyers & Jurists, Barristers, Advocate & Legal Consultants – U.K, 2017.]

✍🏽Edited by Daudi B. Mswahela, LLB III Student Mzumbe University, 2021.

CHARGE ON ASSETS OF A COMPANY

Capital is the most crucial aspect of establishing any business. It is pivotal for

creating infrastructure, producing goods, rendering services to the consumers,

carrying out operations; so much so that it is the quintessential pre-requisite of any

start-up. There are many ways to acquire capital. However, when certain

requirements cannot be met by the existing capital, a company may grow its capital

is by taking loans. These loans, which are usually taken from the financial institutions

or individuals, require security on behalf of the borrower/debtor. The security is

given in the form of assets/property of the company. This secured loan is called a

mortgage wherein the loan is tied to any property until the debt is fully discharged.

Therefore, the concept of ‘charge’ comes into the picture.

Whenever a company has power to borrow; it has as an incident to such power, a

power to security for the debt by a charge on all or any its property. A power to

borrow includes, if there is nothing to the contrary in the memorandum and the

articles, the power to charge uncalled capital of the company Jackson vs. Rainfford

Coal Co.6

6 (1896) 3 Ch 360.

✍🏽Edited by Daudi B. Mswahela, LLB III Student Mzumbe University, 2021.

What is a Charge?

In general, ‘charge’ is the interest of the creditor in the assets provided by the

debtor as security to the former in the event of a secured loan. Charge gives a right

of lien over the property to the creditor, i.e., the creditor can have the possession

of the property till the debt is fully repaid to him by the debtor.

A charge means an interest or right which a lender or creditor obtains in the

property of the company by way of security that the company will pay back the debt.

Or it can be defined as a right of a lender to be paid from a borrower’s assets if the

debt is not paid on time.7

A company cannot however borrow on the security of its reserve capital. In Re May

fair Property Co.8 A company’s memorandum and articles gave it power to charge

uncalled capital. The company passed a special resolution in a general meeting not to

call the last D 5 per share remaining uncalled except in the event of and for the

purpose of the winding up of the company. Later the directors charged the

undertaking including the uncalled capital by issuing debentures. It was held that

“the reserve capital of D 5 per share was not subject to the chargeD 5 per share.”

7 Ombella, J.S & Massawe,MP., “Elementary Company Law in Tanzania:” 89.

8 (1898) 2 Ch. 28.

✍🏽Edited by Daudi B. Mswahela, LLB III Student Mzumbe University, 2021.

A charge means an interest or right which a lender or creditor obtains in the

property of the company by way of security that the company will pay back the debt.

Charges are of 2 types: -

Fixed Charge

A fixed charge is created on fixed assets like property which includes land, buildings,

or anything static (which does not change) and specific. Apart from the tangible

ones, it also extends to intangible assets like trademarks, copyrights, patents,

etcetera. Here, though the possession is with the debtor, control over the property

is with the creditor. If the debtor wants to sell, buy or in any way transact on the

charged asset, he/she has to obtain the prior permission of the creditor since the

hold on the property lies with the latter. A fixed charge is very solid and assuring

given the nature of assets involved (constant).

Floating Charge

A floating charge is created on assets which are involved in the ordinary course of

business that is dynamic in nature. As these assets are not ‘fixed’ in nature, they are

known as floating charges. A company may also dispose of such assets without the

permission of the creditor. For example, if the security for a loan is in the form of

‘a building’, it is a fixed charge on the property for the creditor because it does not

change or fluctuate in its state of being. But if the security is on goods in a

✍🏽Edited by Daudi B. Mswahela, LLB III Student Mzumbe University, 2021.

warehouse, the type of charge created is a floating charge because of the dynamic

nature of the assets. To be specific, every business transacts on a daily basis with

goods, the availability of which could be either high or low.

So, when a floating charge is created on such goods which are not constant and keep

changing from time to time, the creditors own whatever goods are left after the

actual transactions by the company. This is because the creditor cannot lay

restrictions on the business activities which make money if he wants his debt to be

paid off by the debtor. Since the assets are not specific and hence the rights over

such assets are also not specific, the charge created is called a floating charge.

Crystallization of Floating Charge

There are instances where a floating charge may become a fixed charge. This

conversion of floating charge into a fixed charge is usually called Crystallisation of

floating charge. When such conversion takes place, the floating charge is no more

floating, even on the assets that are not static.9 It becomes a fixed charge so that

the whole control over particular assets belong to the creditor in the event of

default in repayment of debts. Such an event happens under the following

circumstances:

9 Ombella, J.S & Massawe,MP., “Elementary Company Law in Tanzania:” pg. 92.

✍🏽Edited by Daudi B. Mswahela, LLB III Student Mzumbe University, 2021.

 1. The debtor is unable to pay off the debts.

2. The company is about to wind up.

3. The business couldn’t be carried out when the creditor takes action against

the debtor for not repaying the.

Registration of Charges

Whenever a charge is created, it has to be registered with the Registrar of

Companies within 30 days from the creation of the Charge. A charge so registered

acts as a notice to the public about the interest of the creditor in charged

assets/property so that no one would interfere with the same.

Registration of charges: Every company must keep at its registered office a register

of charges in which all the charges and mortgages specifically affecting the property

of the company must be entered. The register must contain short description of the

property charged, the amount of the charge, the name of the person entitled to the

charge, etc. The company must keep at its registered office, a copy of every

instrument creating any charge requiring the registration.

The Registrar of Companies issues a Certificate of Registration and a Certificate of

Modification for the registered and modified charges, respectively. If the charges

are not registered at all, then the creditor will not be given priority during the

settlement of claims in the event of dissolution of the company, even if he/she

✍🏽Edited by Daudi B. Mswahela, LLB III Student Mzumbe University, 2021.

remains a creditor whose debt is to be repaid. These details must be updated in a

register, which is to be maintained by the company wherein all the details regarding

the charges shall be entered without fail.

At a Glance

1. Floating and fixed charges are concepts which everybody concerned with loans

has to be aware of to know the consequences of debtors’ non-repayment of

debt or the rights available to the creditors in case of default in repayment.

2. Crystallisation, as discussed above, is a process where the floating charge is

converted into a fixed charge. This is like instilling confidence in a creditor to

make sure he gets something out of the transaction when things get worse.

3. The companies have to maintain a register consisting of all the details

concerning the charges and avoid any unwanted litigation in future. For

creditors, it is very much advisable to get the charges registered to not lose

their preferential position in case of settlement of claims.

Charges requiring registration

A company must file within 42 days of creation of a charge with the Registrar

complete details of the charge together with the instrument of charge or its

verified copy in respect of certain charges, see Section 97 of the Companies Act,10

10 Cap 212 R:E 2002.

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Otherwise the charge will be void. This does not mean that the creditors cannot

recover their dues. It merely means that the benefit of the charged security will

not be available to them. The following charges are compulsorily registrable: -

1. a charge for the purpose of securing any issue of any debentures.

2. a charge on uncalled share capital of the company.

3. a charge created or evidenced by an instrument which, if executed by an

individual, would require registration as a bill of sale.

4. a Charge on land, whenever situated, or any interest therein.

5. a charge on book debts of the company.

6. a floating charge of on the undertaking or property of the company.

7. a charge on calls made but not paid.

8. a charge on ship, or aircraft, or any share in a ship.

9. a charge on goodwill, or any intellectual property.

Effects of Registration:

Once a charge is registered, it acts as a notice to the public at large that the charge

holder has an interest in the charged property. No person can take a defense against

the charge holder that he was not aware that a charge was created against the

property. That person will be entitled to the property subject to the interest of the

✍🏽Edited by Daudi B. Mswahela, LLB III Student Mzumbe University, 2021.

charge holder. Once certificate of charge is issued by the Registrar, it is conclusive

evidence that the document creating the charge is properly registered.

Consequences of Non-Registration

1. A charge which is compulsorily registerable but which is not registered is void.

This does not mean that the creditors cannot recover their dues. It merely

means that the benefit of the charged security will not be available to them.

In Monotholic Building Co. (1915) 1 Ch. 643. In March, M ltd mortgaged land

to T, to secure a loan of D 500. The charge was not registered. In December,

the company issued debentures secured by a floating charge on all company’s

assets to J, who knew of the charge in favor of T to secure D 500. These

debentures were registered. It was held that J had priority over the claim of

T.

2. Although the security becomes void by non-registration, it does not affect

the contract or obligation of the company to repay the money thereby

secured.

3. Omission to registrar particulars of charge as required is punishable with fine.

A company or every officer of company is in default shall be liable to fine.

✍🏽Edited by Daudi B. Mswahela, LLB III Student Mzumbe University, 2021.

Memorandum of satisfaction

The registrar may, on evidence being given to his satisfaction that the debt for

which any registered charge was given has been paid or satisfied, order that a

memorandum of satisfaction be entered on the register, and shall, if required

furnish the company with a copy thereof. See section 104 of the Companies Act.11

✍🏽EDITED AND PREPARED BY DAUDI B. MSWAHELA, LLB III STUDENT

MZUMBE UNIVERSITY, 2021.

Daudymswahela@gmail.com

SOURCES

The Companies Act [Cap 212 R:E 2002].

Ombella, J.S & Massawe, MP., “Elementary Company Law in Tanzania:” Thrust

Publications Ltd: Dar es Salaam, Tanzania, (2013). P 84-9.

THANK YOU GOD BLESS U.

🙏🏿🙏🏿🤝🤝

11 Cap 212 R:E 2002.

✍🏽Edited by Daudi B. Mswahela, LLB III Student Mzumbe University, 2021.