Legal Definitions - debenture

A debenture is a type of long-term debt instrument, essentially an unsecured bond, issued by corporations or governments to raise capital. Unlike a secured bond, a debenture is not backed by specific assets or collateral. Instead, its value and repayment depend solely on the issuer's general creditworthiness, reputation, and ability to generate future earnings.

Debenture holders receive regular interest payments and the principal amount at maturity. In the event of bankruptcy, debenture holders have a claim on the issuer's assets that ranks higher than common stockholders but lower than creditors holding secured debt. It's important to note that while debentures are typically unsecured in the United States, the term can refer to secured debt instruments in many other countries, such as the United Kingdom and Canada.

• Example 1: Corporate Expansion

  Imagine "GlobalTech Innovations," a well-established software company with a strong financial track record, decides to expand its research and development division to create a new product line. Instead of taking out a bank loan secured by its intellectual property or physical assets, the company issues $100 million in debentures to the public.

  This illustrates a debenture because GlobalTech Innovations is raising funds based on its overall financial health and reputation, not by pledging specific assets. Investors trust the company's ability to repay the debt and interest from its future profits, making the debentures an unsecured form of borrowing.

• Example 2: Government Funding for Public Services

  The city of "Riverbend" needs to upgrade its public transportation system but does not want to use property taxes or pledge specific city assets like its municipal buildings. Instead, the city council approves the issuance of municipal debentures to fund the project, relying on the city's stable tax base and general revenue streams for repayment.

  Here, Riverbend uses debentures as an unsecured way to finance a public project. The debentures are not tied to specific city assets; rather, their security comes from the city's general financial stability and its ongoing ability to collect taxes and generate revenue, which assures investors of repayment.

• Example 3: Priority in Bankruptcy

  "FashionForward Inc." issues debentures to fund its operations. Years later, the company faces severe financial difficulties and declares bankruptcy. FashionForward also has a bank loan secured by its warehouses and equipment, and it has numerous common stockholders.

  In this situation, the debenture holders would rank above the common stockholders in the distribution of any remaining assets after the company's secured creditors (like the bank holding the loan on the warehouses) have been paid. This demonstrates that while debentures are unsecured, they still offer a higher priority for repayment than equity holders in a bankruptcy scenario in the US.