The financial crisis has highlighted the need for more efficient processes to indemnify bond trustees so that they can consider litigation against a defaulting issuer more rapidly.
One of the major boxes to tick when issuing a bond or other debt security is the appointment of a reputable and experienced trustee. They police the covenant and the security underpinning the bond. During periods of financial calm, while issuers continue to comply with their obligations set out in the various transaction documents, this part of the trustee’s role is kept to a minimum.
However, once an event of default or similar breach of covenant occurs and is not remedied within the timescale allowed under the trust deed, the trustee often has to act quickly to accelerate the bonds – carrying out the rapid collection of interest and principal and termination of the contract.
Increased activity
As the number of corporate defaults has inched upwards over the past few years, most trustees have been increasingly busy. This begs the question: how willing should trustees be to pursue litigation and what role should they play in litigation? Accelerating the bonds and enforcing security has been a topic of discussion within various professional bodies, such as the Association of British Insurers (ABI), for some years.
This is because the trustee needs the bondholders to indemnify them before taking any action against the issuer. As in most litigation cases the cost of such action can run into hundreds of thousands or even millions of pounds and, given the trustee is not a commercial party or the lender or investor, it will always seek to obtain an indemnity to its satisfaction from the bondholders for whom it acts.
Indemnification matters, but the process of obtaining this indemnity can mean that accelerating the bonds, or taking any other enforcement action, may cause delays.
The trustee may immediately inform the bond issuer that they are not waiving the event of default and reserve all of their rights in relation to it. Suffice to say that the events of recent years have only reinforced how important the prior indemnification right is for trustees. Despite all this, trustees still face reluctance from bondholders to sign up to such indemnity.
Trustees do not factor in the risk of future liability or expenditure to their fee structures and accordingly charge modest fees for undertaking a (relatively) risk-free role. It is clear that trustees, issuers, bondholders and arrangers must come up with new ways of allowing trustees to act more quickly in an event of default situation.
The trustee’s right to accelerate the bonds can be done in two ways. It either acts on its discretion, or if directed by the requisite percentage of the bondholders (subject to satisfactory indemnity, etc).
Hope on the horizon
It is the latter point that offers a glint of light. How can trustees obtain the requisite percentage of the bondholders in the quickest and most efficient way? Some ideas are:
- Voting may be made easier, possibly electronically, with the meeting provisions being reviewed and amended. This point has been on the discussion table for a few years now without much success due to the lack of acceptable systems that contain adequate protections and acceptable alternative wording.
- A pre-funded account can be set up to hold monies that will enable the trustee to begin acceleration and enforcement with an indemnity to follow. This sum will vary with each transaction but must always be sufficient to cover the trustee’s initial costs, including legal costs.
- A form of standard joint and several indemnities may be discussed and agreed with trustees, lawyers, issuers, bondholders, trade bodies such as the ABI and arrangers, and then attached as a schedule to all relevant documents. This may avoid delays in negotiating the form of indemnity after an event of default has occurred.
A good trustee should be able to do all this anyway. They should also have the experience in (and full understanding of) all capital market transactions – thereby enabling bondholders to know that issuers will comply with all their obligations under the various transactions documents.
What is less discussed is the importance of the trustee’s independence. Some argue that a trustee should have no associations with the arranger because it could lead to a position of conflict. Where a bank is both the arranger/adviser and trustee, who would the bank represent upon acceleration and enforcement of a bond? Clearly, the bank cannot represent both and should therefore consider abdicating one of its roles. It is an area worth further examination.
What seems clear is that an independent, experienced trustee able to navigate quickly and efficiently through the indemnification issue is valuable, in the absence of any new regulations to make the process smoother.
Tony Petrou is head of corporate trusts, Prudential Trustee Company
