Bond Mechanics

Payment Obligations

Bonds have the common feature that the issuer i.e. debtor promises to pay the bearer or holder of the bond a specified sum on a specified date. The terms and conditions of the bond are ultimately a matter of commercial agreement.

Formerly most bonds were issued on an unsecured basis. There may be a clause by which the company agreed not to further incumber its asset. Many bonds in more recent times are asset backed.

A guarantor may guarantee the  bonds obligations in certain circumstances. Specialist guarantor insurance companies exist.

The  maturity of bonds reflects the date of repayment. Bonds may arrange from short to very long term. One, two, seven and ten years are common.

Shorter term bonds with maturity of less then seven years are sometimes refer to as notes. Bonds of less than one year are described as commonly described as commercial paper.

Bond Terms

The obligations in a bond document may be much the same as in a loan agreement. See our chapters on the, common provisions in loan agreements. If bonds are to be listed on a stock exchange they must be transferable.

A bond may contain a negative pledge not to permit any of its assets to be subjected to further security. The bond investors as between themselves rank equally. With a negative pledge clause, they may rank equally with other unsecured creditors.

The bond documentation will specify events of default. Upon default the obligation to pay the entire loan may arise so that the loan monies may be demanded, so that it is triggered and become issue. The terms of default will depend on the documentation. It may range from obvious defaults such as non-payment to failures to  meet trading, financial and other covenants. The trigger could be a change in credit rating.

The trustee will have the right to trigger an acceleration of the loan repayment obligation, under the default clause. The trustee will have right to bring legal proceedings to enforce the debts.

Issue

Bonds may be offered directly. However, certain intermediary entities such as firms and investment firms may not be permitted by the rules to invest in unlisted security.

Bonds were commonly issued in bearer negotiable form. This means that they could be negotiated in the same way as a cheque  or promissory note. Now, that a largely paperless market exists bonds are held in electronic forms in entries in the books of intermediary.

Bonds are often issued internationally in order to tap international capital markets. Bonds issued in other currencies were formally described as Eurobonds (before the Euro became established as the European currency. These gave businesses the opportunity to seek funds in a currency other than their domestic currency.

Bond issuers usually undertake to pay a amount net of any domestic withholding tax. This requires that the sum be gross up.

Trust or Fiscal Agent

A trust may be and commonly is used in bond transactions. The trust deed protects the interest of the investor. The trust is commonly required but not mandatory.  The investors are beneficiaries under the trust in this case.

The trust company is usually a trust corporation.  In monitoring the issue, its role is passive rather than investigatory.A paying agent may be appointed if there is a trustee.

The fiscal agent in contrast pays the bond monies and performs, administrative  duties. A fiscal agent is agent of the insurer and does not owe duties to the bondholder. There is a distinction between the fiscal agent who acts for the issuer of the bond and the trustee who acts for the investors. This latter gives the investors a stronger protection by way of the benefit of the fiduciary obligations of the trustee.

Trustee

The trustee has ongoing obligation once the issue has been made. It has the sole right to sue and enforce the bond. The trustee distributes payments pro-rata if partial payment only is provided. The trustee may allow a certain degree of flexibility as it may agree to minor variations and  waiver of breaches.  It may convene a bondholder meeting to deal with significant issues. The trustee enables the issuer to deal with a single entity.

The trustee has duties to the bondholders. His duties may be limited though  not in respect of gross negligence default or fraud.

The trustee will generally be appointed only if the nature of the bond requires it.  This maybe the case if the issue is convertible, secured, subordinated or requires monitoring in terms of ongoing undertaking. A trustee would not be used in respect of a sovereign issuer.

The trustee protects the investors. It has powers to intervene in the event of any default or irregularity. The bond trustee will pay a key role in relation to monitoring enforcement with covenants and may act on  and / or waive breach. The trustee may enforce a payment and obligations on behalf of the investors / beneficiaries. The trustee has administrative duties in terms of making payments of interest and capital to investors.