Understanding a Trust Indenture

A trust indenture is an agreement that is included in the contract of a debt security. The trust indenture defines the rules of the particular contract and dictates responsibilities and how conflicts should be resolved. In some cases, the trust indenture identifies the source of the income that will be used to repay the lender and consequently is used as a claim against assets. This is particularly relevant in the case of the borrower filing bankruptcy because secured debt is paid first using the proceeds from the sale of the underlying assets. All parties to the debt security should be familiar with the details of the trust indenture to continue properly.

Origin and Purpose

Securities laws became a large focus shortly after excessive fraudulent security transactions during the Great Depression. The requirement to appoint a qualified trustee as an agent with a fiduciary duty to the holders of debt securities was established in the Trust Indenture Act of 1939. This requirement aims to increase transparency and protect all parties in debt transactions. Investors are therefore more protected than they otherwise would be without a trust indenture requirement because the trust indenture provides them with a legal platform on which to take action against debt issuers who commit securities fraud. Likewise, the debt issuers are afforded this same protection against illegal investor activity, which reduces the risk of entering into debt agreements and therefore increases the efficiency of the debt markets.

Debt Securities without Trust Indentures

One notable exception to the trust indenture requirement, established by the Securities Exchange Commission (SEC), is that government securities can define the rights and responsibilities of the parties in the bond resolution. In this case, there is no trustee assigned to the security because the issuer is a government entity and thus assumed to operate within the law. The SEC can trust that government debt will not be issued fraudulently or go into default.

Debt Securities Explicitly Requiring Trustees

Current securities laws require that corporate bonds, unsecured corporate debt and notes with values above $10 million must include a trust indenture with an appointed trustee to protect the debt holders and ensure that no party’s rights are compromised. An overwhelming majority of new corporate debt issuances are valued above $10 million, and all of them fall under the trust indenture requirement. Many investors are protected from securities fraud in most cases. There are many investors involved in a single debt issuance since corporate bonds are normally issued as a collection of $1000 denominations. As long as the investor owns at least one of the $1000 value bonds, they are equally protected under the trustee of the security, regardless of how many of the bonds any particular investor holds.

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