What is a 'Trust Indenture'

A trust indenture is an agreement in a bond contract made between a bond issuer and a trustee that represents the bondholder's interests by highlighting the rules and responsibilities that each party must adhere to. It may also indicate where the income stream for the bond is derived from.

BREAKING DOWN 'Trust Indenture'

Bonds are issued to lenders or investors to raise money for a corporation or governmental body. To issue a bond, the issuer hires a third-party trustee, usually a bank or trust company, to represent the interests of its bond investors. The agreement entered into by the issuer and the trustee is referred to as the trust indenture.

A trust indenture is a legal and binding contract that is created to protect the interests of bondholders. The trustee’s name and contact information is included in the document, which highlights the terms and conditions that the issuer, lender, and trustee must adhere to during the life of the bond. The section on the trustee's role is important, as it gives a clear indication of how unforeseen incidents will be dealt with. For example, if a conflict of interest comes up involving the trustee's role as a fiduciary, in certain trust indentures, the issue must be resolved within 90 days, otherwise a new trustee will be hired.

A trust indenture also includes the characteristics of the bond, such as maturity date, face value, coupon rate, payment schedule, and purpose of the bond issue. One section of the trust indenture dictates the circumstances and processes surrounding a default. The indenture establishes a collective action mechanism under which creditors or bondholders can collect in a fair, orderly manner if default takes place. A bondholder should be aware of these situations because understanding the proper sequence of events will allow them to take the proper course of action if a default occurs.

Protective or restrictive covenants are highlighted in a trust indenture. For example, a trust indenture may indicate whether an issued bond is callable. If the issuer can “call” the bond, the indenture will include a call protection for the bondholder, which is the period during which the issuer cannot repurchase the bonds from the market. After the call protection period, the indenture may list the first call dates and any subsequent call dates that the issuer may exercise its right to call. The call premium, that is, the price that will be paid if the bond is repurchased by the issuer is also indicated on the trust indenture.

Almost all indentures include subordination clauses that limit the amount of additional debt that the issuer can incur, and all subsequent debts are subordinated to prior debts. Without such restrictions, bondholders will be exposed to default risk if an issuer is allowed to issue unlimited amount of debt.

A copy of the indenture must be filed with the Securities and Exchange Commission (SEC) for corporate bonds with aggregate principal issues of at least $5 million. Corporate issues for less than $5 million, municipal bonds, and bonds issued by the government are not required to file trust indentures with the SEC. In fact, these exempted entities may choose to create a trust indenture to reassure prospective bond buyers, not to adhere to any federal law. In addition, trust indentures may not be included in every bond contract, given that some government bonds disclose similar information (the duties and rights of the issuer and bondholders) in a document called the bond resolution.

RELATED TERMS
  1. Indenture

    An indenture is a legal and binding contract between a bond issuer ...
  2. Trust Indenture Act of 1939

    The Trust Indenture Act (TIA) of 1939 is a federal law that prohibits ...
  3. Bond Trustee

    A bond trustee is a financial institution with trust powers, ...
  4. Indentured Servitude

    Indentured servitude is a voluntary labor contract requiring ...
  5. Soft Call Provision

    A soft call provision is a feature added to convertible fixed-income ...
  6. SEC Form T-1

    SEC Form T-1 is statement of eligibility for an corporate trustee ...
Related Articles
  1. Investing

    Here's What Happens When a Bond Is Called

    Learn why early redemption occurs and how to avoid potential losses.
  2. Investing

    Corporate High-Yield Bonds Vs. Equities

    Equities and corporate bonds often play a significant role in the diversification of a portfolio.
  3. Investing

    Six biggest bond risks

    Bonds can be a great tool to generate income, but investors need to be aware of the pitfalls and risks of holding corporate and/or government securities.
  4. Financial Advisor

    Don't Invest in Bonds Without Asking These 7 Questions

    There are a number of questions every beginner and seasoned investor should ask before investing in bonds. Here are seven of them.
  5. Retirement

    The Responsibilities and Liabilities of Being a Trustee

    Being named a trustee needs to be taken seriously because it comes with great responsibility.
  6. Investing

    The Basics Of Municipal Bonds

    Investing in municipal bonds may offer a tax-free income stream, but such bonds are not without risks. Check out types of bonds and the risk factors of muni-bond.
  7. Investing

    Advanced Bond Concepts

    Learn the complex concepts and calculations for trading bonds including bond pricing, yield, term structure of interest rates and duration.
RELATED FAQS
  1. What are the risks of investing in a bond?

    Are you thinking of investing in bond market? Learn more about bond market investment risk, including interest rate risk, ... Read Answer >>
  2. What determines bond prices on the open market?

    Learn more about some of the factors that influence the valuation of bonds on the open market and why bond prices and yields ... Read Answer >>
Trading Center