§ 518. The Usual Forms of Trust Agreements

The trustee is appointed by virtue of the trust agreement; all the powers exercised by the trustee are derived from this agreement; and all of the duties are fully set forth in it. There are a great variety of trust agreements. In fact it may be said that no two such agreements are alike in detail, although in a general sense there are many similarities. Some of the more commonly known classifications and titles by which different trust agreements are generally designated are: first mortgage, general mortgage, collateral mortgage, and so on ad infinitum.

In order to understand how the trustee acts and what its duties are, it is necessary to know what the more common of these classifications imply.

A first mortgage bond is a first lien on whatever property is the subject of the mortgage, such as, in the case of a railroad, the right of way. As one would readily imagine, a first mortgage means that the lien is prior to all other liens. It is, therefore, a very safe kind of investment and if the debtor corporation is even passably good, these bonds will ordinarily sell at a premium. The yield will naturally be comparatively low. Often other wording is added in the name of the bond, as, for example, "First Mortgage Gold Bonds." These additional words really add nothing to the security and are used solely as a means of attraction to the buying public. This is a case where there is something in a name.

A refunding mortgage is issued to take up some expiring obligation and may be good or not depending upon the soundness of the issuing corporation and the obligation which it replaces.

A general mortgage is usually a pretty fair kind of investment because it is a lien on all the property belonging to the corporation. However, there may be any number of liens against specific property which would be prior obligations. In

this case, the general mortgage would probably not be an absolutely safe investment.

A collateral mortgage is a mortgage, the security for which would be the securities of another or the same corporation. If the securities were of the same corporation, they would, of course, be of a different issue. The securities thus pledged might be either stock or bonds. If they were bonds, the safety from an investment standpoint would ordinarily be greater.

A debenture bond is merely a promise to pay and is not secured by a lien on any special property. It is safer than preferred stock because it is a legal debt of the corporation, and its interest is not conditioned on profits.

An income bond is somewhat like a debenture in that it is a mere promise to pay, but it differs in that interest is payable only if and when earned. It, therefore, has some of the characteristics of preferred stock. Preferred stock is often cumulative, while, as a rule, income bonds are not cumulative, nor are they very desirable.

An equipment trust is usually in the form of a note issue. The security behind an equipment trust is, as the name implies, some part of the equipment of the corporation issuing the obligation. This kind of security is used by railroad corporations in the majority of cases, and the equipment pledged consists of the cars or locomotives. The holders of these obligations are in an advantageous position in the case of a default either on the notes themselves or on any other obligation because they can say that unless their interest is paid, they will foreclose and take the equipment. The cars or locomotives must be identified. For this reason the trustee causes the fact of his own legal ownership to be painted or stenciled on the property.

A terminal mortgage is a mortgage on the terminals of the railroad, if the issuing corporation happens to be a railroad.

§ 519. The Legal Effect of Trust Agreements

It should be remembered that stock is an evidence of ownership and is never due or payable by the corporation until the corporation is dissolved. One cannot, therefore, foreclose on stock. A bond is a promise to pay at a future time, either fixed or determinable. Therefore, at some future time the corporation will have to meet its obligation. Of course, there are many more kinds of corporate obligations; but for our purposes those herein described will serve to give the reader a general idea of the subject.

The instrument by which these different kinds of issues are created and by which the trustee is appointed is known by different names. When real property is mortgaged, the instrument is called a "deed of trust." When personal property is pledged, the instrument is known as a "trust agreement." If the issue is a debenture or an income bond, the instrument is called an "indenture" or a "trust indenture." In general, however, these instruments are similar. The main object in each case is practically the same; namely, the creation of a legal relation between the corporation, the trustee, and the purchasers of the obligations. The legal obligation in each case is that the corporation agrees to pay the holder of its bonds or notes the face amount thereof at the time named therein and interest at a certain rate. The agreement also sets forth the duties of the trustee, including what the trustee is to do in the case of a default by the corporation in any of its obligations or promises. It also sets forth any provisions with regard to the creation of any sinking fund or means of retiring any of its bonds before maturity.

The instrument is an important document and a difficult one to draw. Only a lawyer familiar with corporation law should be entrusted with the work of preparing these agreements. The trust officers of banks and trust companies should familiarize themselves as fully as possible with corporate trust

agreements in general. Where an institution is appointed a trustee under an agreement, the provisions of the particular agreement should be carefully studied so that the officers may be familiar with the duties the bank or trust company has assumed. An analysis should be made and preserved for future reference so that when a question is raised the information will be at hand.

§ 520. Investigation of the Offering

Of course, the first thing is to secure an application from the prospective customer. This having been accomplished either by solicitation or otherwise, the whole matter must be investigated very carefully, for it is the duty of every trust officer to see to it that his bank does not represent an organization whose membership is not thoroughly reputable, nor one whose only object is to unload its securities on the public. Hardly a day passes in the history of a large bank or trust company without its receiving an application to act as trustee for some concern which no institution desirous of maintaining a high reputation in the community could afford to represent. Even with the greatest care it is easy to err, either by being too lenient or by being overcautious. Of the two dangers, it is better to err by being overcautious. Each application should, therefore, be considered on its own merits. The elements which are most important are:

1. What is the personnel of the board of directors and officers and their credit standing?

2. Is the enterprise practicable? What has been the previous history of similar enterprises?

3. Are those who are to manage the enterprise skilled business men or is this their first experience?

4. Is the proposition legal?

5. What are the plans for selling the issue? Who are the brokers going to be? What equipment have they for putting

the issue out? Are their methods approved? What is their standing?

At this time the following papers are to be filed with the institution which is asked to act as trustee :

1. A copy of the certificate of incorporation, certified to by the secretary of state where the corporation was incorporated.

2. A copy of the by-laws of the corporation, certified to by the secretary of the corporation.

3. A certified copy of the minutes of the first meeting of the stockholders, to prove that the corporation has actually commenced business.

4. A certified copy of the minutes at which the issue was authorized and the appointment as trustee was made. 5. Specimen signatures of the officers of the corporation authorized to sign the issue.

6. Certified copies of the form of bond or certificate which is to be issued.

If the certificate of incorporation or the by-laws have been amended at any time, copies of the amendments should also be filed. The agreement by which the issue is created and by which the trustee was appointed should be carefully examined, not only by the trust officers, but also by counsel for the institution.

After the trust committee of the proposed fiduciary is fully satisfied as to the soundness and desirability of the application, it is in a position to make arrangements with the applicant as to what the fees for trustees' services will be. § 525.)

§ 521. Examination of Property and Securities

(See

The foregoing section outlines the preliminary work of the trust officer. After all these things have been satisfactorily