Opinion ID: 387913
Heading Depth: 2
Heading Rank: 1

Heading: The Nature of the Contract

Text: 38 Because the construction of the Indenture is basically a question of contract law, it is perhaps worthwhile to discuss briefly the way in which this type of contract operates, and the reasons why such contracts must be so long and detailed. Convertible debentures represent one of many means through which business enterprises obtain capital from investors for long periods of time. Most such means can be classified as either debt securities or equity securities, but convertible debentures are something of a hybrid basically a debt security, but with equity features. 39 In part because of the differing treatment of debt and equity securities both by statute and at common law, debt securities are, to a much larger degree than is true of equity securities, creatures of contract law. 10 As a result, the written contracts that govern the rights and obligations of debt securities are often long and complex, for those contracts attempt to anticipate and deal with in advance all possible contingencies that might call into question the operation of those rights and obligations. In the case of debentures, those contractual rights are set forth in a document that is separate from the debt instrument itself. That document, whose terms are incorporated by reference on the face of the debt instrument, is commonly called an indenture. 11 40 The debt represented by the debenture is typically not secured by specific assets of the issuer, 12 and is frequently subordinated to senior indebtedness of the issuer. It is usually the case that the debentures of a given issue are held by a great number of parties, and for this reason it was found desirable, as the modern concept of debentures developed, that the indenture designate a corporate trustee to protect the rights of the many holders of the debentures and to perform certain ministerial tasks connected with the normal operation of the debentures. Thus, although the debts created by the debentures run directly from the issuer to the holders, the contractual rights conferred by the indenture run from the issuer to the trustee for the benefit of the holders of the debentures. 13 In today's usage, then, a security is generally termed a debenture when it is a long-term unsecured debt security, issued pursuant to an indenture and with an indenture trustee. 41 Not all debentures are straight debt securities. The Debentures at issue in this case are examples of convertible debentures, which exhibit characteristics of both debt and equity securities: 42 A convertible debenture is one which gives the holder the right to exchange his debenture for other securities of the (issuing) Company, usually for shares of common stock and usually without payment of further consideration. The conversion right, although set forth in the debenture and in the indenture, is separate and distinct from the debt evidenced by the debenture. As a separate right it has its own ascertainable value. 43 American Bar Foundation, Commentaries on Indentures 522-23 (1971) (footnotes omitted) (hereinafter cited as Commentaries). The fact that a debenture is convertible into equity securities is an important feature, and therefore the terms under which the debenture may be converted are usually summarized on the face of the debenture itself. All convertible debentures, however, purport only to summarize the salient provisions of the conversion terms on the face of the instrument; as is the case with the other complicated provisions that govern the duties of the issuer and trustee, the terms of redemption, and so forth, many of the details concerning the debenture's convertibility must be set forth instead in the governing indenture. 44 The indenture will specify a rate at which the debentures can be converted into equity securities (usually common stock). This is often expressed in terms of a conversion price, which may be conceptualized as the price at which a share of stock may be purchased by the holder of the debenture in exchange for the surrender of indebtedness under the debenture. For example, if the conversion price for a debenture in the principal amount of $1000 is $50, the holder of the debenture is entitled to convert his $1000 debenture into a total of 20 shares of common stock. 45 The discussion above only briefly describes the manner in which convertible debentures function. Given this, 46 it is not surprising that corporate indentures are lengthy and complex. There is much that much be covered by the contract set forth in the indenture. But it is also true that much of what has to be covered is, or could be, virtually the same for all indentures. These are the provisions that are commonly referred to as boiler-plate, e. g., provisions regulating the issuance, authentication, transfer and exchange of securities; provisions establishing the procedures for collective action by the securityholders; and provisions prescribing the duties of the trustee. These, and certain others, are provisions which have been stated in many different ways in various indentures. Since there is seldom any difference in the intended meaning, such provisions are susceptible of standardized expression. The use of standardized language can result in a better and quicker understanding of those provisions and a substantial saving of time not only for the draftsmen but also for the parties and all others who must comply with or refer to the indenture, including governmental bodies whose approval of authorization or the issuance of the securities is required by law. 47 Commentaries at 3. Not least among the parties who must comply with or refer to the indenture are the members of the investing public and their investment advisors. A large degree of uniformity in the language of debenture indentures is essential to the effective functioning of the financial markets: uniformity of the indentures that govern competing debenture issues is what makes it possible meaningfully to compare one debenture issue with another, focusing only on the business provisions of the issue (such as the interest rate, the maturity date, the redemption and sinking fund provisions and the conversion rate) and the economic conditions of the issuer, without being misled by peculiarities in the underlying instruments. 48