FINRA STUDENTS | FINANCIAL REGULATION COURSES
An indenture — also called a trust indenture or deed of trust in the bond context — is the legal contract that governs every publicly issued bond, specifying the complete terms of the debt obligation between the issuer and the bondholders and establishing the rights, duties, and authority of an independent corporate trustee appointed to represent bondholders collectively. It is the foundational document of every bond issuance, the definitive reference point in any dispute between the issuer and bondholders, and the instrument through which the Trust Indenture Act of 1939 imposes mandatory investor protection requirements on publicly offered corporate debt.
The Historical Origins of the Indenture
The word indenture derives from the medieval English practice of writing a legal contract in duplicate on a single sheet of parchment, then cutting the two copies apart along a jagged or toothed — indented — line. The matching teeth of the two parts could later be fitted together to confirm the authenticity of each copy and prove the documents originated from the same instrument. In modern usage the term has shed this physical meaning entirely, but in the bond context it retains its essence as a bilateral legal contract between an issuer and its counterparties — the bondholders — executed through an intermediary trustee acting on the bondholders' behalf.
The Trust Indenture Act of 1939 — The Statutory Requirement
The Trust Indenture Act of 1939 was enacted as an addendum to the Securities Act of 1933 following the wave of corporate bond defaults during the Great Depression that revealed a critical gap in investor protection. Many bond issuers had structured their indentures so that corporate trustees had virtually no practical authority to act on behalf of bondholders, leaving investors without effective representation when issuers defaulted. Congress responded by establishing minimum standards that every publicly offered corporate bond indenture must satisfy.
The Trust Indenture Act requires that any debt security — bond, note, debenture, or evidence of indebtedness — offered publicly in interstate commerce with an aggregate principal amount exceeding five million dollars must be issued pursuant to a qualified indenture meeting the Act's requirements. The five million dollar threshold is the figure confirmed by multiple exam preparation sources and bond law texts. Some sources cite a ten million dollar threshold reflecting a subsequent regulatory update — candidates should note that the examination typically tests the concept of the TIA requirement rather than the precise dollar threshold, which has been subject to adjustment.
The indenture must be filed with the SEC as an exhibit to the bond's registration statement before the offering can become effective. The trustee must satisfy independence requirements — it cannot have a disqualifying conflict of interest with the issuer — and must be a corporation organised under applicable state or federal law with authority to exercise trust powers. Section 310(b) of the Trust Indenture Act specifies conditions that constitute disqualifying conflicts of interest for the indenture trustee, including holding more than five percent of the issuer's voting securities in its own name — though holding securities in a representative or fiduciary capacity may be permissible.
The Trust Indenture Act's requirements are deemed incorporated into every qualified indenture as a matter of law. Section 318(c) of the Act provides that Sections 310 through 317 — the core trustee eligibility, duties, and bondholder rights provisions — are part of and govern every qualified indenture whether or not physically contained in the document.
The Content of the Indenture — What It Specifies
A bond indenture is a comprehensive legal document that addresses every material aspect of the bond obligation. Its core contents include the following.
The financial terms — coupon rate, interest payment dates, maturity date, and face value — are specified in full. For shelf registration programs under which an issuer may offer multiple series of debt over time, the base indenture establishes the legal framework while supplemental indentures define the specific terms of each series offered, consistent with SEC guidance on open-ended shelf indenture structures.
The security provisions describe whether the bonds are secured by specific collateral — and if so, the nature of the collateral, the lien priority, and the conditions for releasing the collateral — or unsecured. Secured bond indentures include detailed collateral provisions, lien perfection requirements, and collateral maintenance obligations. Unsecured debenture indentures rely instead on covenant protections to maintain the issuer's creditworthiness.
The call provisions specify whether the issuer has the right to redeem the bonds before maturity, the earliest call date, the call price schedule, and the notice requirements for exercise of any call. The make-whole call provision, when included, specifies the formula for calculating the redemption price based on Treasury yields at the time of call.
The event of default provisions define the circumstances that constitute a default — including payment default, covenant breach, cross-default on other indebtedness, insolvency, and material misrepresentation — and specify the remedies available to the trustee and bondholders upon default, including the right to accelerate all outstanding principal and demand immediate repayment.
The amendment and waiver provisions specify the voting thresholds required to modify the indenture after issuance. Most indentures distinguish between non-material amendments — which may require only majority consent or may be made by the issuer and trustee without bondholder approval — and material amendments — which typically require the consent of holders of at least a majority or in some cases two-thirds of outstanding principal amount. Certain core terms — the payment terms, the maturity date, and the principal amount — typically cannot be modified without unanimous bondholder consent, providing the strongest protection against unilateral alteration of fundamental economic terms.
The Indenture Trustee — Role and Responsibilities
The indenture trustee is the central institutional innovation of the Trust Indenture Act. Because a publicly issued bond may be held by thousands of dispersed investors — none of whom individually has the resources, information, or legal standing to monitor the issuer continuously and enforce the indenture independently — the trustee provides the collective representation and enforcement capacity that individual bondholders cannot.
The trustee accepts its duties to bondholders at the time the indenture is executed, agreeing to monitor the issuer's compliance with indenture covenants, receive and distribute coupon and principal payments, maintain records of bondholder ownership, and take enforcement action on behalf of all bondholders when an event of default occurs. The National Association of Bond Lawyers confirms that the trustee accepts these duties, establishes the trust estate that serves as security for bond repayment, and holds any collateral pledged under the indenture for the benefit of bondholders.
The trustee's obligations before a default and after a default are deliberately different. Before a default, the trustee is typically obligated only to perform the ministerial functions of payment administration and covenant monitoring — it is not required to take affirmative action to protect bondholders from risks that have not yet materialised. After an event of default, the trustee's duties intensify substantially — it is required to exercise the rights and powers vested in it under the indenture and applicable law in the interest of bondholders with the care a prudent person would exercise in the conduct of their own affairs.
If the trustee determines that an event of default has occurred, it must notify bondholders within ninety days, subject to specific exceptions. Upon direction from the requisite percentage of bondholders — typically a majority in principal amount — the trustee may accelerate the outstanding principal, initiate legal proceedings against the issuer, and pursue other remedies specified in the indenture.
Protective Covenants — The Bondholder's Contract Protection
Because indenture covenants are the primary mechanism through which unsecured bondholders protect their credit position after committing capital, the covenant structure of an indenture is one of the most analytically important dimensions of bond credit analysis.
Negative covenants restrict the issuer from taking specified actions without bondholder consent or unless specified financial tests are satisfied. Typical negative covenants include the negative pledge clause — prohibiting the issuer from pledging assets to secure subsequent debt without granting equal security to existing bondholders — limitations on additional indebtedness above a maximum leverage ratio, restrictions on dividends and share repurchases when earnings fall below specified thresholds, and limitations on asset sales and mergers that could alter the issuer's credit profile.
Affirmative covenants require the issuer to take specified positive actions — maintaining required financial ratios, delivering audited financial statements within specified timeframes, maintaining insurance on pledged assets, and paying all material taxes and obligations when due. Breach of an affirmative covenant may constitute an event of default giving the trustee the right to accelerate principal.
The degree of bondholder protection provided by covenants is inversely related to the bond's yield, as the bond law educational resource confirms: the stronger the covenants protecting bondholder interests, the lower the yield required to attract investors because the credit risk is better managed through contractual constraint. Issuers who accept more restrictive covenants can borrow at lower interest rates. Issuers who retain maximum operational flexibility must pay higher yields to compensate investors for the reduced contractual protection.
High yield bond indentures are typically far more detailed and restrictive in their covenant packages than investment grade indentures, reflecting the higher credit risk of high yield issuers and the correspondingly greater need for contractual constraint to protect bondholders. Investment grade issuers — whose financial strength and credit ratings provide substantial comfort to bondholders — operate under more permissive covenant frameworks that afford management greater operational flexibility.
The Indenture in Municipal Bond Transactions
In the municipal bond market, the bond resolution or trust indenture serves the equivalent function as the corporate indenture — establishing the terms of the bond, the security structure, the flow of funds for revenue bonds, the covenants, and the events of default. Municipal indentures are not subject to the Trust Indenture Act of 1939, which explicitly excludes securities issued by state and local governments from its coverage. Municipal bond investors are protected instead by the combination of the Official Statement disclosure document, the bond resolution, and the applicable state law governing the rights of municipal creditors.
For revenue bonds — municipal bonds repaid from the revenues of a specific project or enterprise rather than from general tax revenues — the indenture establishes the pledge of revenues to bondholders, the flow of funds waterfall specifying the priority in which revenues are applied among different uses, the rate covenant requiring the issuer to maintain rates sufficient to cover debt service and operating expenses, the additional bonds test specifying the financial conditions under which additional parity bonds may be issued, and the reserve fund requirements maintaining a specified cushion of liquidity to cover debt service in periods of revenue shortfall.
Examination Relevance and Key Takeaways
The indenture is tested on the SIE, Series 7, and Series 65 examinations in the context of bond structure, the Trust Indenture Act of 1939, the role of the corporate trustee, and protective covenants.
The key points to retain are these.
An indenture is the legal contract governing a bond issuance that specifies all material terms including the coupon rate, maturity date, security provisions, call features, events of default, and bondholder protections through affirmative and negative covenants. The Trust Indenture Act of 1939 — enacted as an addendum to the Securities Act of 1933 — requires that publicly offered corporate bonds above the statutory threshold be issued under a qualified indenture with an independent corporate trustee, with the indenture filed with the SEC as an exhibit to the registration statement.
The trustee represents the collective interests of all bondholders — monitoring covenant compliance, administering payments, and enforcing bondholder rights upon default. The trustee must be independent of the issuer — Section 310(b) of the Trust Indenture Act specifies disqualifying conflicts of interest — and corporate in form with trust powers.
After a default the trustee must give notice to bondholders within ninety days and upon direction from the requisite bondholder majority must accelerate principal and pursue available remedies.
Negative covenants prohibit specified issuer actions — including the negative pledge protecting against structural subordination — while affirmative covenants require positive conduct. Stronger covenant protection is inversely related to yield because contractual constraint reduces credit risk. The Trust Indenture Act does not apply to municipal bonds, which are governed instead by bond resolutions and applicable state law.
