Indenture

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.

Components of Bond Indenture

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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Source: Indenture (wallstreetmojo.com)

Examples of Bond Indenture

Below mentioned are some of the examples of a Bond indenture agreement that both the parties have agreed upon :

Example #1

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

In the above example, both the 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 a 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 of Indenture

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

Disadvantages of Indenture

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 play 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.

Conclusion

Indenture 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 as compared to other sectors. It gives a lot of comfort to the lender and the borrower to have trust in the other party by inserting the right number of clauses in the contract.

Recommended Articles

This has been a guide to what is Indenture and it’s meaning. Here we discuss components and examples of indenture. Here We also discuss the advantages and disadvantages. You can learn more about accounting from following articles –

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