A REVIEW OF THE PROTECTION OF DEBENTURE HOLDERS UNDER THE NIGERIAN CORPORATE SYSTEM

A company has the legal authority to generate capital through share sales or debt financing, which is commonly done by obtaining loans from financial institutions or third parties.[1] ^[1] Loans for companies are typically obtained through debentures, in which the company promises its assets as security.[2] ^[2]

These lenders who are investors become debenture holders, or creditors with rights stated in a Trust Deed.[3] ^[3] Trust Deed is a contractual arrangement between the debenture holders and the company, specifying their voting rights and meeting procedures, and in this form of arrangement, a trustee is chosen to oversee interactions between the company and the debenture holders.[4] ^[4] Trustees serve as debt-holder representatives and facilitate administrative procedures for debt recovery.[5] ^[5]

This article will examine the legal framework governing the protection of debenture holders’ rights, with a focus on maintaining trust in the debt capital market through efficient enforcement mechanisms.

What is Debenture

According to the Companies and Allied Matters Act 2020, debenture is explained as a document that acknowledges or creates a debt, typically issued by a company. It represents a written instrument containing the terms of the debt, including the repayment terms, interest rate, and any security or charge granted by the company to secure the debt.[6] ^[6]

Debentures serve as a fundraising tool for companies, granting holders creditor status rather than shareholder membership.[7] ^[7] Unlike shareholders, debenture holders prioritize the repayment of the principal sum and accrued interest, irrespective of company profits. Their rights can vary due to diverse forms of debenture, ranging from mortgage-backed instruments to simple debt acknowledgements.[8] ^[8]

Furthermore, there are two types of debentures; secured and unsecured. Secured debentures offer protection through charges on company property or assets, whereas unsecured debentures lack such backing.[9] ^[9] The enforcement of secured debenture hinges on the specific events agreed in the debenture or trust deed, potentially involving fixed or floating charges on company assets. Debenture holders can enforce collective security either individually or through a trustee. However, uncertainties regarding individual enforcement rights and representative actions remain.[10] ^[10]

Legal Nature of Debenture in Nigeria’s Corporate System

Debentures, serve as contractual obligations between creditors and the company and often include a charge on the company’s assets, akin to a mortgage transaction.[11] ^[11] Unlike shareholders who hold ownership stakes, debenture holders are considered outside creditors, with interests primarily focused on the company’s financial stability to safeguard their investments. [12] ^[12]Despite this difference, debenture holders may possess certain rights akin to shareholders, such as the ability to appoint directors, share in profits, and attend meetings, though their voting power may be limited regarding significant corporate resolutions.[13] ^[13]

The introduction of debenture stock, representing a collective loan fund divisible among lenders, offers an alternative avenue for companies to effectively handle debt obligations within legal parameters.[14] ^[14] Unlike individual debentures, which represent distinct debts, debenture stock amalgamates these obligations into a unified loan fund.[15] ^[15] Each lender is issued a debenture stock certificate indicating their stake in the total loan. This consolidation facilitates streamlined debt management by enabling efficient fund allocation and simplified administrative processes.[16] ^[16] By consolidating multiple debentures into a single fund, companies can mitigate administrative burdens associated with managing disparate individual debts while adhering to legal standards.[17] ^[17]

Moreover, debenture stock certificates provide clarity and transparency regarding the quantum of interest held by each lender in a company’s overall indebtedness.[18] ^[18] Overall, the introduction of debenture stock offers companies a practical and efficient mechanism for managing their debt portfolios while providing lenders with clear documentation of their respective entitlements.[19] ^[19]

While shares represent ownership stakes in a company, conferring specific rights and obligations to shareholders, including responsibilities for capital maintenance and adherence to strict repayment regulations, debentures function primarily as financial instruments utilized by external creditors. They do not grant ownership privileges but rather represent contractual obligations between the company and its creditors.[20] ^[20] Unlike shares, debenture holders enjoy more flexible repayment options and are often entitled to repayment directly from the company’s capital. Additionally, debentures may be issued at a discount, providing a financial advantage not available to shareholders under stringent regulations governing shares.[21] ^[21]

Despite these differences, debenture holders play a crucial role in company insolvency, being prioritized over shareholders in the repayment hierarchy. This underscores their pivotal position in safeguarding investments and ensuring financial stability within the corporate structure.[22] ^[22]

Protection of Debenture Holders under Nigerian Corporate Law Practice: Prospects and Challenges

Despite commendable strides in modernizing company law and strengthening shareholder protections, the plight of debenture holders, characterized as creditors endowed with limited rights and involvement in corporate affairs, remains conspicuously unresolved. In light of this situation, there is a clear need for legislative action to address the evident disparity between the treatment of debenture holders and shareholders. The Companies and Allied Matters Act 2020 emerges as a crucial instrument for reform, presenting an opportune moment to adjust the legal framework and strengthen protections for debenture holders within Nigeria’s corporate governance purview.[23] ^[23]

The challenges faced by debenture holders in Nigeria include:

1. Lack of participation in the creation of a Trust Deed and appointment of a Trustee.

   One of the primary challenges in safeguarding debenture holders’ rights lies in their limited involvement in the creation of debenture trust deeds or the appointment of trustees on their behalf within a company.[24] ^[24] Debenture holders are not involved in appointing trustees or participating in drafting the debenture trust deed, despite being contractually bound by its terms. Consequently, debenture holders find themselves in a contractual relationship with the company, governed by terms over which they have no control or influence.[25] ^[25]

The absence of debenture holders’ participation in crucial decision-making processes within the company underscores a significant disparity in their treatment compared to shareholders. While shareholders possess the right to attend general meetings, vote on resolutions, and even take derivative actions against fraudulent directors, debenture holders are often relegated to a passive role.[26] ^[26] Their ability to influence corporate governance or challenge unauthorized actions by the company or directors is limited, primarily restricted to invoking contractual covenants in the trust deed. Despite their contractual obligations, debenture holders lack agency in shaping the terms of their agreement with the company, as the appointment of trustees and the formulation of the trust deed are executed without their input.[27] ^[27] This asymmetry in power dynamics underscores the need for legislative reforms to address the inherent vulnerabilities faced by debenture holders within the legal framework.[28] ^[28]

The current legal landscape in Nigeria exacerbates these challenges, as debenture holders grapple with limited avenues for recourse or remedy against unfavourable terms in the trust deed. While shareholders have the statutory authority to appoint directors, debenture holders are deprived of similar rights to appoint trustees. Even in instances where conflict of interest arises, debenture holders can only apply to the court for the removal of trustees, further illustrating their marginalized position in corporate governance. Consequently, there is a compelling argument for legislative reforms to afford debenture holders greater participation and protection within the corporate structure. Such reforms would not only enhance transparency and accountability but also ensure equitable treatment for all stakeholders involved in the company’s affairs.[29] ^[29]

2. Poor terms and Covenants in the Contractual arrangement

Another fundamental weakness or challenge stems directly from deficient legal safeguards for investments. Typically, the borrowing company, often a Public Limited Company (PLC), dictates the terms of the loan, aiming to minimize restrictions on its operations while attracting lenders with lucrative interest rates. However, most debenture holders, lacking the requisite knowledge and capacity to assess an investment’s true merits, are primarily drawn to high-interest rates without fully comprehending the terms and conditions of the loan.[30] ^[30]

The Companies and Allied Matters Act (CAMA) makes provisions for debentures, including the requisite trust deed through which trustees are appointed. While these provisions outline the minimum contents of the trust deed in compliance with Sections 184 and 185 of the Act, companies are afforded latitude to incorporate additional terms, conditions, and covenants. These additional clauses primarily serve to safeguard the interests of the borrowing companies and trustees to debentures, often to the detriment of debenture holders who face minimal protection. Such covenants may encompass various restrictions, including affirmative pledge clauses, conditional negative pledge clauses, and absolute no-pledge clauses, thereby complicating debenture holders’ rights and entitlements.[31] ^[31]

Moreover, subordination agreements within debenture trusts further compounded the challenges debenture holders face. These agreements typically involve a common debtor owing to unsecured debts to multiple creditors, with one creditor accepting junior or subordinated debt that is subordinate to certain senior debts. Consequently, debenture holders find themselves in a precarious position, exposed to the risks of loss and investment peril due to inadequate protection within the trust deed. The trustee for debentures must therefore advocate for clauses that safeguard debenture holders’ interests, including restrictions on dividend payments, mergers, asset sales, investments, and early warning provisions, among others.[32] ^[32]

Recommendations

In light of these challenges, several recommendations can be proposed to enhance the protection of debenture holders’ rights in Nigeria, they include;

• Legislative reforms should be prioritized to ensure that debenture holders have a more active role in decision-making processes and the formulation of trust deeds.
• There should be stricter regulations governing the contents of trust deeds, with provisions aimed at safeguarding the interests of debenture holders against unfavourable terms and conditions imposed by borrowing companies.

Regulatory bodies tasked with overseeing corporate governance should be equipped with enhanced enforcement mechanisms to ensure compliance with legal provisions and protect the rights of debenture holders. This could involve strengthening regulatory oversight, imposing penalties for non-compliance, and providing avenues for debenture holders to seek redress in cases of misconduct or breaches of trust.