The trust deed, colloquially known as debenture trust deed or trust indenture, has become widely known in legal and economic circles as an instrument used to protect the rights and claims of debenture holders of the debt securities issued by a borrowing company. Often times, a company needs to generate funds to finance its projects or expand its operations. In order to avoid approaching financial institutions, the corporation may choose to generate a substantial amount of money by directly requesting contributions from the general public. This is done by issuing debenture stock[1] as a kind of loan fund, thus making the investors buy the securities of the company and assume the role of lenders or debt holders. Because of the dispersed composition of the investors, a trustee is appointed on behalf of the debenture holders and the company will only interact with an appointed trustee[2]. Consequently, the trustee executes the debenture trust deed with the company, which debenture holders rely on for protection of their advanced legal capital.[3]
Debenture holders have extensively used the contractual provisions in the trust deed as a protective shield in major conflicts with stockholders in leveraged buyouts[4], bond defaults by corporate issuers in bankruptcies[5], and defaults on junk bonds which are mostly publicly-issued bonds[6].
[1] Davies P. 2008, “Davies and Gower Principles of Modern Company Law” p. 1140 (Hereinafter “Principles of Modern Company Law”). See also s.738 C. A 2006 U.K.
[2] Indenture Trustees are typically financial institutions. See THOMSON FIANCIAL US CAPITAL MARKET REVIEW: TRUSTEES (FIRST QUARTER 2007) (Mar. 2006) available at http://www.thomson.com/financial/league_table/de/1Q2007/1Q07_DE_US_Trustee accessed July 26, 2024.
[3] Bayless Manning, A concise text book on legal capital. (2nd edn. The Foundation Press, Inc. 1977). Discussing statutory legal capital schemes that regulate flow of assets to shareholders- “the legal apparatus built by common Law and statute around the concept of striking a partial accommodation of the conflict of interests between owners and creditors, p.l. [hereinafter MANNING]
[4] Kenneth Lehn & Annette Poulsen, “Contractual Resolution of Bondholder-Stockholder Conflicts in Leveraged Buyouts” (1991) Journal of Law and Economics Vol. XXXIV. pp. 645 – 674. Arguing that the evolution of event-risk covenants in bond contracts may have mitigated the need for bondholders to hedge their investment through convertible bonds and cross-ownership of firm’s bonds and stocks.
[5] For example, the rating agency, Moody’s Investors Service in 2006 reported thirty-three defaults of the worst type – payment defaults (majorly bankruptcies) in the United States alone on nearly $7.8 billion of bonds by corporate issuers. See MOODY’S INVESTORS SERVICE, SPECIAL COMMENT: CORPORATE DEFAULT AND RECOVERY RATES, 1920 – 2006, at p.4 (Feb. 2007) available at http://www.moodys.com/cust/content/Content.ashx?source=StaticContent/Free%20Pages/Regulatory%20Affairs/Documents/default_and_recovery_rates_02_07.pdf(reporting on payment defaults, bankruptcies and distressed bond exchanges) accessed July 25, 2024.
[6] See Olivia Raimonde & Alicia Clanton, “Junk-Bond Market Gets Riskier With Erosion in Credit Quality” (February 20, 2024) available at https://www.bloomberg.com/news/articles/2024-02-20/junk-bond-market-is-getting-junkier-that-makes-it-riskier-too> accessed July 24, 2024.
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