The panel discussion where I spoke about the role of the trustee was convened by the law firm Schiff Hardin LLP, and the recording is available here‡.
Pre-default trustee role
In my remarks, I noted briefly the role of the trustee prior to a default. This more familiar role is established by the Trust Indenture Act of 1939, which states that debt securities cannot be sold unless issued under a trust indenture administered by an independent and qualified trustee.
This requirement does not apply to municipal or governmental securities, but it is nonetheless customary for a trustee to be appointed for those securities as well.
Pre-default, the trustee is responsible for distributing funds and has no fiduciary duties to the bondholders. Practically speaking, the trustee’s relationship is largely with the borrower.
Post-default role of trustee
Those responsibilities change drastically in the event of a default. The trustee’s relationship now shifts to the investors, which the trustee serves under a “prudent person” fiduciary standard.
Following are some of the key aspects of that service to investors:
- Learn identities of bondholders
- Obtain execution of non-disclosure agreements
- Convene such restricted holders and obtain a sense of their intentions on whether there should be a restructuring or temporary forbearance
- Be the voice of the bondholders to the borrower or obligated group and its underwriter or financial advisor (FA)
- Solicit direction from the investors on selection of counsel and an FA
- Generally act on informal direction from the investors
- Coordinate between counsel, the FA and the bondholders
- Take responsibility for keeping the marketplace informed on developments in a restructuring or distressed transaction
In carrying out these and other activities, it’s vital for the team members at the trustee to see themselves as an integral part of a debt workout. If the trustee doesn’t actively partner with investors, recovery strategies can get bogged down.
Investors need nimble and proactive solution-finding. No two indentures are alike, and a wide range of potential problem areas may come up in a workout process. Some examples include:
- How should the trustee proceed if there are only retail holders?
- What is the role of the trustee when the investors do not agree on a course of action?
- To what extent can or should the trustee advance funds to the trust estate without bondholder consultation to protect the collateral of bondholders- for example, by paying real estate taxes?
- Should the trustee take title to operating assets such as a nursing home or low-income housing development?
- Can a trustee successfully disclaim responsibility by informing the marketplace that it does not intend to take action unless it is indemnified?
There aren’t necessarily right or wrong answers to these questions, which is why it’s essential to work with an experienced and communicative team.
Post-default, the trustee’s role is to protect the investors as much as possible. Experienced trustees have many tools in their toolboxes, and with a likely wave of defaults coming, all those tools will be needed.
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