Mitigating Bond Trustee Conflict Risk
For financial services professionals, it’s essential to understand the various conflict of interest risks that can arise in bond trustee arrangements. These conflicts primarily concern the relationship between bond trustees, issuers, and bondholders. Here’s an overview of these conflicts and how they are typically addressed:
Types of Conflicts of Interest:
– Issuer vs. Trustee: Under English law, trustees have a fundamental fiduciary duty not to place themselves in a position where their duty and interest conflict. Bond trustees must act independently and in the best interests of bondholders. However, since bond trustees do not have substantial obligations to issuers, conflicts with issuers are unlikely.
– Trustee vs. Bondholders: Conflicts of interest may arise between bond trustees and bondholders, especially in scenarios like:
– Representing holders of different series of bonds issued by an issuer or other creditors. Diverging interests or possessing confidential information can lead to potential conflicts.
– Being part of an institution with other commercial relationships with the issuer, such as being a lender or bondholder. These roles may require actions that don’t align with the trustee’s interests as an institution.
There is case law in various jurisdictions to the effect that a “no-action clause”, a clause designed to protect the issuer from frivolous claims from noteholders, cannot be applicable in situations where the trustee would be placed in a position of conflict or has shown unjustifiable unwillingness to take action.
How to Deal with Conflicts of Interest:
– Resignation or Removal: Most bond issuances have contractual terms for trustee resignation or removal, typically with notice periods of 60 to 90 days. Resignation is a complete solution to conflicts but may require the appointment of a successor.
– Bondholder Consent: Significant conflicts may necessitate bondholder consent, following full disclosure of the issue, to allow the trustee to continue in the role.
– Appointment of Additional Trustee: The trustee may appoint a co-trustee or additional trustee under the trust deed to handle the part of the role giving rise to the conflict.
– Delegation of Role: The trustee might delegate all or part of its role to another party to avoid conflicts.
In all cases, the fundamental principle is that the bond trustee must act in good faith and in the interests of the bondholders as a class above all else when resolving any conflict situation.
From a New York Law perspective, trustees are allowed to have business and financial relationships with issuers, but they must adhere to their basic fiduciary duties, including the duty of loyalty, which prevents blatant self-dealing and conflicts of interest.
Financial institutions typically have internal conflict of interest policies, and they may take up various roles in debt securities offerings, including trustee roles. Resignation provisions in the indenture provide flexibility for trustees to step down in the event of identified conflicts.
Conflicts Case Studies:
Real-life conflict situations for bond trustees have included scenarios where:
– The same financial institution serves as both a bond trustee and lender to the bond issuer. To prevent information sharing conflicts, the trustee delegates its role to a third party when the issuer has defaulted.
– The financial institution had significant commercial relationships with the bond issuer, making it challenging to take appropriate enforcement actions upon issuer default. In such cases, the trustee chose to resign, allowing an independent replacement trustee to act.
These case studies illustrate the practical challenges trustees may encounter but also the pragmatic steps that can be taken to address conflicts and preserve value, in the best interests of the bondholders.