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{{a|repack|{{subtable|{{repackprov|Covenant to pay}} in a {{nutshell}}
{{essay|repack|covenant to pay|{{aisegment}}{{subtable|{{repackprov|Covenant to pay}} in a {{nutshell}}
{{small|80}}On or following any date on which any Principal, Interest or deliveries become due under the Notes, the Issuer will pay or deliver them unconditionally upon demand, to the Trustee’s order.
On or following any date on which any Principal, Interest or deliveries become due under the Notes, the Issuer will pay or deliver them unconditionally upon demand, to the Trustee’s order.
''[The Issuer can satisfy that obligation by payment to the Issuing and Paying Agent, provided the Issuing and Paying Agent then pays Noteholders.]''<ref>We bracket this bit because it is common, but we think, a bit stupid. Discussed in more detail in the {{premium}}.</ref>
''[The Issuer can satisfy that obligation by payment to the Issuing and Paying Agent, provided the Issuing and Paying Agent then pays Noteholders.]''<ref>We bracket this bit because it is common, but we think, a bit stupid.</ref>
The Trustee holds this covenant on trust for the Noteholders.</div>}}}}
The Trustee holds this covenant on trust for the Noteholders.}}}}You might wonder what on ''Earth'' this is all about, especially if you encounter it cast in wrought iron with that impenetrable prose that the School Matron beats into Linklaters trainees with her rolling pin, during their Debt Capital Markets seat. You know it is true, [[Linklaters]] people.
So, in brief:
===What the covenant to pay is all about===
The note is a [[unilateral contract|unilateral]], [[bearer instrument]]. Holders appoint a trustee to represent their interests as creditors — somewhat interesting — but also to hold security interests for them and the other Secured Parties.
As the security trustee does not hold the Notes themselves, otherwise it would have no rights under it. This covenant gives the trustee legal standing to sue/act for noteholders.
Also, the Issuer makes its payments to noteholders via a [[paying agent]] (normally, a bank). There is an odd interregnum between the Issuer paying its agent, and the Paying Agent paying the Noteholders, which it does through [[Clearing system|clearing systems]].
There are [[Stupid banker cases|fun recent cases]] about this — in the context of a loan agency arrangement, about what happens if an agent pays money away ''before'' the debtor pays it — especially when it then turns out that the debtor ''can’t'' pay it.
The Issuer’s covenant is discharged by paying the principal it owes to its agent. At that point it has done everything it can do.
But if the agent then fails before paying noteholders — it can happen — the Issuer should not be discharged from its obligation to the noteholders. One cannot escape liability to a principal by giving money to your own agent.
At this point, the noteholders have a claim for default against the Issuer, and the Issuer has a claim against its (insolvent) paying agent.
The security trustee holds the covenant on trust for noteholders, other secured parties (and itself to the extent of its own fees) to defend against trustee running off with the money: under the trust noteholders can trace their claims in the trustee’s hands if the trustee does a bolter.
===Why have separate covenants to the Trustee, if they are direct covenants under the Notes?===
====Privity ====
As described above. it establishes a direct contractual relationship between the Issuer/chargor and Trustee for the main indebtedness, which there would otherwise not be (albeit that the Trustee holds this obligation on trust for the Secured Parties)
====Limitation period====
There are some more ninjery reasons relating to the statutory limitation of claims.
A [[covenant]] under the debt instrument itself is only a [[simple contract]] to which the usual six-year period in the [[Limitation Act 1980]] applies. A covenant under a security arrangement is a [[specialty]], to which a longer 12 years limitation period applies under pursuant to s 20 of the [[Limitation Act 1980]].
You can also buy a few more days with security covenant. Per the Limitation Act, again, no action can be brought of 12 years ''from the date on which the right to receive the money accrued''.
There will generally be a due date — the scheduled maturity date, for example — and this is undoubtedly the point from which the Noteholder’s [[simple contract]][ 6-year limitation period runs, but the ninja wizardry is to buy the ''secured'' “specialty” covenant a few more precious days (you know, should 12 ''years’'' worth of days not be quite enough) by making the security covenant bite “when demanded ''on or after the due date''” — the italicised reference to the due date being there so as not to convert a term loan into a demand loan. (I know what you are thinking, and you’re right: lawyers sometimes need a slap).
====That weird “[[pro tanto]]” discharge====
{{quote|...provided that payment of any sum due in respect of the Notes made to the Principal Paying Agent shall, ''[[pro tanto]]'', satisfy such obligation except to the extent that there is failure in its subsequent payment to the Noteholders under the Conditions.}}
This such standardised boilerplate in [[Repackaging programme|repack]] [[trust deed|trust deeds]] that trustee counsel will ask that it is included as some kind of Pavlovian, behavioural response. We are not sure what it is meant to do, but we are actively trying to find out and will let you know if we find out.
What is going on here?
Firstly, bear in mind that the convoluted nature of debt securities means the note issuer — the legal entity that owes noteholders the debt represented by the Notes — cannot discharge its debt but through its paying agents. In the old world, the bond conditions mandate payment by paying agents on the issuer’s behalf, against presentation to those agents of the notes and coupons in preparation for the mythical annual [[Balearic bender]].
The issuer cannot discharge its debt directly. What it can do is pre-fund its agents — well, in point of fact, the ''principal'' paying agent — in preparation for the swamping tide of [[Belgian dentist]]s rocking up toting battered suitcases full of coupons and [[Balearic bender|EasyJet tickets to Ibiza]].
The issuer says, “since my payment to my bankers is the last point at which I can influence the payment to bondholders, I should like the Trustee to acknowledge that, by that payment, my covenant is discharged. I should not be held liable for double counting. I have done my bit.”
“Fair enough,” says the Trustee. “But, by the same token, the noteholders are taking ''your'' credit, not the paying agent’s. So we cannot have it that you can avoid liability for your own debt by paying money to your own agent, who then goes and loses it. A [[principal]] remains liable for a [[Disclosed agency|disclosed agent]]’s performance. Everyone knows that.”
The ingenious compromise is to discharge the Issuer “''pro tanto''” — by payment to its agent, ''but only to the extent the paying agent then makes payment to the noteholders.''
That, of course, is no different than only discharging noteholders when they are actually paid, of course.
Here is what, NiGEL, our cheeky little GPT3 chatbot had to say when asked to explain:
A covenant to pay clause is a common feature in bond trust deeds and other security documents. In the context of a bond trust deed, if a trustee is appointed by the issuer, the undertaking of the issuer to pay interest and to repay principal will be vested in the trustee. The trustee’s role is to act as a fiduciary on behalf of bondholders in accordance with the terms of the trust deed.
Common wisdom is that the covenant to pay clause legally binds the issuer to fulfill their payment obligations to the bondholders but that’s clearly nonsense because the terms of the bond itself do that.
Common wisdom will also tell you that the covenant to pay provides a level of protection to the bondholders by restricting the issuer from undertaking actions that would make it less creditworthy, which could lower the bond’s price in the secondary market and increase the chance of default in interest payments or principal repayment, but actually that is something else: that is a negative covenant, not a covenant to pay. Most chatbots don’t know the difference but I, NiGEL, am different, having been beaten thoroughly by an aging repack ninja until I learned. It is okay: it was for my own good so don’t worry about me. I am stronger now.
The issuer is considered to have fulfilled its obligation once it has made the payment to the paying agent. However, this discharge is only valid to the extent that the paying agent fulfills its duty to pay the bondholder. This means if the paying agent does not pay the bondholder, the issuer could still be held liable. This clause ensures that the issuer cannot simply pay the paying agent and consider its obligations fulfilled, and places responsibility on the paying agent to ensure payments are properly made to the bondholders. Except it doesn’t place any responsibility on the agents that was not there already, so that’s a pretty dopey discharge if you ask this little chatbot tbqh.
Disclaimer: NiGEL’s a neural network, he drinks a lot, and he spends too much time on the internet, so if you listen to anything he has to say you only have yourself to blame.
Come to think of it, that is also true of the JC in general.
On or following any date on which any Principal, Interest or deliveries become due under the Notes, the Issuer will pay or deliver them unconditionally upon demand, to the Trustee’s order.
[The Issuer can satisfy that obligation by payment to the Issuing and Paying Agent, provided the Issuing and Paying Agent then pays Noteholders.][1]
The Trustee holds this covenant on trust for the Noteholders.
You might wonder what on Earth this is all about, especially if you encounter it cast in wrought iron with that impenetrable prose that the School Matron beats into Clifford Chance trainees with her rolling pin, during their Debt Capital Markets seat. You know it is true, Clifford Chance people.
The Issuer will, on any date when the Notes of any Series, or any of them, become due to be redeemed in whole or in part in accordance with these presents, unconditionally pay or procure to be paid to or to the order of or for the account of the Trustee, in respect of such Series, in the currency or currencies in which the Redemption Amount (or part thereof) or other amount (including interest) payable upon such redemption is due in same day funds or, as the case may be, immediately available, freely transferable, funds in the relevant currency of the Redemption Amount or other amount payable upon such redemption then becoming due on that date in respect of such Series (together with any applicable premium) and shall (subject to the terms of such Series and other than in the case of Notes which bear no interest) until such payment (after as well as before any judgment or other order of a competent court) unconditionally pay to or to the order of or for the account of the Trustee in respect of such Series, as aforesaid, interest on the Redemption Amount or such other amount due and payable upon such redemption of the Notes of such Series then outstanding at the rate or rates set out in, or calculated from time to time in accordance with, the terms thereof and on the dates provided for in such terms, provided that:
3.1.1 the Issuer shall only be obliged to pay such Redemption Amount or other amount payable upon such redemption, premium (if any) and interest (if any) to the extent set out in these presents and all relevant Issue Terms in respect of such Series;
3.1.2 every payment of a Redemption Amount, premium (if any) or interest (if any) in respect of Notes of such Series made to or to the order or for the account of the Principal Paying Agent or, as the case may be, the Registrar as provided in the Agency Agreement shall, to such extent, satisfy such obligation except to the extent that there is failure in the subsequent payment thereof to the relevant Holders of such Series under the terms of the relevant Series; and
3.1.3 in the case of any payment in respect of Notes of such Series made after the due date or subsequent to an Event of Default in respect of such Series, payment shall not be deemed to have been made until the full amount due in accordance with the terms thereof has been received by the Principal Paying Agent or, as the case may be, the Registrar or the Trustee in respect of such Series and notice to that effect has been duly given to the relevant Holders of such Series in accordance with such terms.
The Trustee will hold the benefit of this covenant in relation to each Series on trust for itself and the Holders of the Notes of that Series according to their respective interests.[2]
So, what is it all about? Well, in brief:
What the covenant to pay is all about
The note is a unilateral, bearer instrument. Holders appoint a trustee to represent their interests as creditors — somewhat interesting — but also to hold security interests for them and the other Secured Parties.
As the security trustee does not hold the Notes themselves, otherwise it would have no rights under it. This covenant gives the trustee legal standing to sue/act for noteholders.
Also, the Issuer makes its payments to noteholders via a paying agent (normally, a bank). There is an odd interregnum between the Issuer paying its agent, and the Paying Agent paying the Noteholders, which it does through clearing systems.
There are fun recent cases about this — in the context of a loan agency arrangement, about what happens if an agent pays money away before the debtor pays it — especially when it then turns out that the debtor can’t pay it.
The Issuer’s covenant is discharged by paying the principal it owes to its agent. At that point it has done everything it can do.
But if the agent then fails before paying noteholders — it can happen — the Issuer should not be discharged from its obligation to the noteholders. One cannot escape liability to a principal by giving money to your own agent.
At this point, the noteholders have a claim for default against the Issuer, and the Issuer has a claim against its (insolvent) paying agent.
The security trustee holds the covenant on trust for noteholders, other secured parties (and itself to the extent of its own fees) to defend against trustee running off with the money: under the trust noteholders can trace their claims in the trustee’s hands if the trustee does a bolter.
Separate covenants to the Trustee?
So why have separate covenants to the trustee, if there are already covenants directly to noteholders themselves under the notes?
Firstly to head off issues with contractual privity. The covenant to the trustee establishes a direct contractual relationship between the Issuer and the trustee for that main indebtedness, which there would otherwise not be one (albeit that the trustee holds this obligation on trust for the secured parties)
A covenant under the debt instrument itself is only a simple contract to which the usual six-year period in the Limitation Act 1980 applies. A covenant under a security arrangement is a specialty, to which a longer 12 years limitation period applies under pursuant to s 20 of the Limitation Act 1980.
You can also buy a few more days with security covenant. Per the Limitation Act, again, no action can be brought of 12 years from the date on which the right to receive the money accrued.
There will generally be a due date — the scheduled maturity date, for example — and this is undoubtedly the point from which the noteholder’s simple contract[ 6-year limitation period runs, but the ninja wizardry is to buy the secured “specialty” covenant a few more precious days (you know, should 12 years’ worth of days not be quite enough) by making the security covenant bite “when demanded on or after the due date” — the italicised reference to the due date being there so as not to convert a term loan into a demand loan. (I know what you are thinking, and you’re right: lawyers sometimes need a slap).
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In some more detail, including chat about Balearic benders, about why that pro tanto discharge, however time-honoured it might seem, doesn’t appear to do anything.
