2. Dividends not to be declared which will decrease the surplus below the amount existing at the time the loan was made.
3. All necessary repairs, renewals and replace ments to be made by subsidiary companies out of their own earnings, and before any dividends are declared.
4. Limitations upon the right to lease out the prop erty of the companies whose securities are held as collateral.
5. Restrictions upon the sale of the property of the borrower, or of the companies whose securities are held as collateral, unless the proceeds are used to re tire a part of the bonds or deposited with the trustee for the purchase, with the consent of the bondholders, of additional property at least as valuable as the prop erty sold.
6. Limitations upon the power to incur debt, ex cept for the purpose of improving or extending the property of the company in order to increase its pro ductive capacity.
In the case of bond collateral, the principal safe guard consists in a prohibition against the issue of other bonds of prior or equal rank which would tend to weaken the lien of the existing bonds, or the issue of junior obligations for unproductive purposes. To in sure against this, the borrowing company, if it owns the stock of the subsidiary company, whose bonds are deposited as collateral, may be required also to deposit with the trustee a controlling interest in this stock. By his controlling vote, the trustee can then prevent any further borrowing that would weaken the lien of the outstanding bonds or the earning power of the com pany. Another object of this precaution is to pre vent the parent company from exploiting its subsidia ries to secure funds for some temporary expenditure that might jeopardize the solvency of the company and the security of the bond holders.
6. Substitution of mortgage bonds, the trust deed, in the case of collateral trust bonds, usually does not provide for the substitu tion of collateral. The reason for this is found in the nature of the security. Real estate is more substan tial and its value to the borrowing company more eas ily determined than in the case of stocks and bonds. Accordingly, substitution is accomplished more easily and with less risk to the bondholders, in the case of real estate.
Some collateral trust obligations, however, are drawn subject to the substitution of collateral to a limited extent. In such case, the kinds of collateral which may be substituted are usually stated in a gen eral way, and the substitution is made on the basis of the market values of the securities. The judg
ment of the trustee may govern the transaction, or, if the company and the trustee cannot agree, a corn mitte of appraisers may be provided to evaluate the securities offered in exchange. The deed of trust under the Oregon Short Line fours, Of 1904, provides that the trustee may appoint one appraiser, the rail road company another, and these two a third, and that the judgment of the majority of these appraisers shall be final as to the value of the security offered for substitution.
7. Purpose of collateral trust bonds.—Companies whose only property consists of the stocks and bonds of other companies are practically limited to the collateral trust bond. Such companies are strictly holding companies and are illustrated best by the large industrial combinations which have become so powerful within the past twenty years. In such cases, it is usual for the trust deed to convey to the trustee all the stocks and bonds of subsidiaries owned by the holding company. The advances made by the hold ing company to its subsidiaries, out of the proceeds of the bond sale, are evidenced by additional securities given by the subsidiary to the holding company and turned over by the latter to the trustee. If prior lien obligations of subsidiaries are outstanding, provision is often made for refunding them by a bond reserve, so that the collateral trust bonds will eventually be secured by first liens upon all the properties of the subsidiary companies.
As a rule, industrial companies cannot borrow much upon first mortgage bonds, because their earn ings fluctuate widely and their properties are of specialized and uncertain value. Consequently, their collateral trust obligations are secured largely by the stocks of subsidiaries and depend mainly upon their surplus earnings for repayment. It is plain, how ever, that the existence of any prior lien against the property of subsidiaries, or any discretion retained by the debtor company to create such additional prior liens, or liens equal in rank to the new issue, would jeopardize the security of the collateral trust bonds. This explains why all the securities usually are re quired to be deposited with the trustee, leaving him in position not only to prevent the creation of future prior liens, and the dissipation of the company's as sets, but also to control the company for the benefit of bondholders in the event of default, without the necessity of foreclosing on a mortgage to get posses sion.