What Is a Trust Indenture?
A trust indenture is an agreement in a bond contract between a bond issuer and a trustee that promotes the bondholder’s interests by stressing the rules and obligations each party must comply with. It could also reveal the source of the bond’s revenue stream.
How a Trust Indenture Works
Bonds are issued to lenders or investors to raise money for a corporate or governmental entity. To issue a bond, the issuer appoints a third-party trustee—typically a bank or trust company—to act on behalf of bond buyers. The trust indenture is the contract between the issuer and the trustee.
A trust indenture is a binding legal agreement to safeguard bondholders’ interests. The document outlines the terms and conditions that the issuer, lender, and trustee must abide by during the bond’s life and includes the trustee’s name and contact details. The trustee’s function section is crucial since it outlines precisely how unanticipated events will be handled. For example, if a conflict of interest affects the trustee’s fiduciary function, the matter must be handled within 90 days under some trust indentures. If not, a new trustee will be appointed.
The bond’s features, such as its face value, coupon rate, maturity date, payment schedule, and issuing purpose, are also included in a trust indenture. The conditions and procedures surrounding a default are outlined in one part of it. If the issuer defaults, the indenture creates a collective action process that enables bondholders or creditors to collect fairly and orderly. To appropriately respond if such a scenario arises, a bondholder needs to be informed of and comprehend the correct sequence of activities.
Particular Clauses in a Trust Indenture
In a trust indenture, provisions that are restrictive or protective are emphasized. A trust indenture, for instance, could specify whether an issued bond is callable. The indenture will include call protection for the bondholder if the issuer can “call” the bond. This is when the issuer cannot buy back the bonds from the market. The initial call date and any future call dates on which the issuer may exercise its right to call may be included in the indenture after the call protection period. It specifies the call premium or the amount to be paid if the issuer repurchases the bond.
Subordination clauses, which stipulate that all subsequent debts are subordinate to prior debts and limit the additional debt the issuer can incur, are found in almost all indentures. Without these restrictions, an issuer could issue an infinite amount of debt, increasing bondholders’ default risk.
Which bonds have indentures of trust?
Since some government bonds reveal comparable information (the obligations and rights of the issuer and bondholders) in a document known as the bond resolution, trust indentures may not be incorporated in every bond deal.
Enacted in 1939 to safeguard bondholders and investors, the Trust Indenture Act (TIA) sets down many regulations that apply to trust indentures today.
All corporate offers, however, are required to contain a trust indenture. For corporate bonds with total principal issues of at least $5 million, a copy must be submitted to the Securities and Exchange Commission (SEC). Filing trust indentures with the SEC for corporate offerings under $5 million, municipal bonds, or government bonds is optional. If they do not comply with federal laws, these exempt organizations may draft to reassure potential bond purchasers.
Conclusion
- A trust indenture is a legally enforceable agreement between a bond issuer and a trustee to safeguard the bondholder’s interests.
- The features of the bond and its callability are outlined in a trust indenture. It also outlines the procedures and conditions in the event of issuer default and the maximum amount of additional debt that the issuer may take on.
- A trust indenture must be included with most corporate bond offerings exceeding $5 million, and a copy must be submitted to the SEC.
