Indenture

Updated on April 12, 2024
Article byWallstreetmojo Team
Edited byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

Indenture Meaning

Indenture refers to a legal agreement or a deed between two or more to meet its respective obligations and is a common term used in the bond market to give the lender and the borrower the required comfort in the transaction with regards to one party defaulting the other in payments or in any other way that will affect the contract as a whole.

An indenture contract is one of the most important aspects of any debit transaction to be executed, real estate in particular since the legalities involved in that are much more than other sectors. It gives the lender and the borrower a lot of comforts to trust the other party by inserting the right number of clauses in the contract.

Key Takeaways

  1. It is a phrase frequently used in the bond market to provide the lender and the borrower with the necessary assurance in the transaction regarding one party’s default on payments to the other.
  2. Indenture includes call & put options, purpose, interest rates, covenants, and repayment schedule.
  3. Indentures are beneficial since it is a legal contracts. Therefore, all parties involved in the transaction are obligated to carry out their respective obligations by the terms of the agreement.
  4. They have cons because the contract’s departure options are constrained because they cannot be transferred.

Indenture Explained

Indenture is a term that comes from an English terminology named “ Indenture of RetainerRetainerA retainer is an arrangement between the firm and service provider wherein the service provider is paid an advance for services that will likely be needed in future. Retainers are commonly used in areas like law, accounting, HR.read more” which means it’s a legal contract prepared in duplicate in one single sheet and divided by a cutting edge and each part is handed over to the respective parties so that the same can be verified in future by reattaching the same.

Earlier, the defaulters in a deal were given the indentured servant status while in current times it is used as an instrument to execute debt transactions especially real estateReal EstateAt its most basic principle, Real Estate can be defined as properties that comprise land and its tangible attachments. The land includes the actual surface of the earth and any permanent natural objects such as water, dirt, or rock and any minerals or particulars under the surface. read more deals.

In the case of debt instruments like bondsBondsBonds refer to the debt instruments issued by governments or corporations to acquire investors’ funds for a certain period.read more, the indenture shows the pledge or the promises made by the issuer to the lender that he will meet all the agreed-upon covenants ( financial & non-financial) and pay the installments of the debt raised on time.

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Components

A bond indentureBond IndentureBond indenture or bond resolution is a core legal document that serves as a contract binding upon the bond issuer and the bondholder. It comprises all the bond-related information, like details of the issue, its purpose, bond issuer's obligations and rights of the bondholders.read more will include the below-mentioned components in it:

Indenture

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Examples

To let us understand what is an indenture, it is important to checkout some examples. Below mentioned are some examples of a Bond indenture agreement that both parties have agreed upon :

Example #1

In the case of an NBFC, Capital Ratio is maintained at 15% and any breach below that will trigger the event.

In the above example, both parties have agreed upon this condition to maintain the capital ratio to more than 15%. the borrower is obliged to maintain this ratio over the tenure of the loan and is expected to infuse even further capital is required if the ratio starts depleting thus giving the lender comfort on his funds.

Example #2

Bullet Payments for Debt Raised

In the above example, the borrower has signed an agreement with the lender to make the debt obligations as per the repayment schedule agreed upon. In this case, since the lender has agreed on the bullet payment for the principal component, the borrower is free to make only the interest payments at the initial stages and pay the principal amount at the tail end of the tenure.

Example #3

Maintenance of Debt-Equity Ratio

In this, both the parties agree to maintain a debt-equity ratioDebt-equity RatioThe debt to equity ratio is a representation of the company's capital structure that determines the proportion of external liabilities to the shareholders' equity. It helps the investors determine the organization's leverage position and risk level. read more in order to curb the borrower from raising more debt from the market since there is existing debt on the books which needs to be cleared first.

Example #4

Pari-Passu Clause for Assets Pledged with Lender in Case of Default

In this, the agreement may clearly state that in case of default or insolvency, there will be pari –passu charge on all the assets and the cash flows of the companyCash Flows Of The CompanyCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. read more and the existing lenders will be paid first as compared to other lenders on the books.

Advantages

Below mentioned are some of the advantages of the bond indenture :

Disadvantages

Below mentioned are some of the disadvantages of the indenture :

  • There is no liberty to the parties involved in the indenture since all are restricted to playing their part in the transactions and cannot deviate from the same in any manner till the maturity date of the same.
  • It is non-transferable; hence exit opportunities are limited in the contract due to the legality of the same.
  • The contract cannot be canceled at any stage without the consent of all the parties in it.
  • A minor mistake in the indenture can cost any of the parties financially, which can have huge repercussions on the contract also.
  • It comes with a legal cost to the company, and it has to be drafted in the right manner so that neither of the parties is at risk.

Frequently Asked Questions (FAQs)

What kind of a contract is an indenture?

The indenture agreement is a technical document that details all of the bond’s terms and how the bond is operated daily.

What makes bond indentures crucial?

The word is frequently used in the bond market to give the lender and borrower the security they need to complete the transaction if one party defaults.

What does a property law indenture mean?

A contract entered into by two or more persons who are not acting together. The term “indenture” dates back to when a piece of parchment would be inscribed with the necessary number of copies of a deed.

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