3. Classification according to security.—Classifica tion of bonds according to security is more complex. Security is the fundamental requirement of bond holders, who sacrifice income for safety. The reader should note carefully the distinction between secu rity and collateral. A mere promise to pay is se curity, and there is no such thing an unsecured bond, altho that term is frequently used to indicate a bond having no pledge of specific assets behind it. A mere signature is called personal security, and depends upon the personal honor or ability of the signer, whether he be the direct obligor, guarantor, or indorser. We shall see later that guarantee secur ity may be either weak or strong, according to the wording of the guarantee.
There are good and bad securities of all types and this "quality of mercy" therefore has nothing to do with any classification.
A reinforced obligation is merely one which has security additional to the signature of the original obligor. It may be of real or personal property. This classification is therefore valuable as indicating to the investor the character of the assets which protect him. The term "sinking fund bonds," for instance, implies that, in addition to the signature of the ob ligor, personal property in the form of a sinking fund has been or will be set aside to insure the payment of the obligation. Equipment bonds, whether called by that name or car-trust certificates or car-trust bonds, indicate that personal property in the form of equip ment of some kind has been pledged.
The most usual form of bonds reinforced by lien upon personal property, however, is the collateral trust bond, which name indicates that certain paper instruments evidencing property rights have been de posited as specific collateral to strengthen the promise of the obligor. These will be discussed in more detail later, the principal purpose of this chapter being to describe mortgage bonds, secured by a lien on real estate.
4. Mortgage bands.—Personal property may be moved, lost, stolen, destroyed or consumed. Real estate, however, is quite permanent. The working capital of a corporation is constantly changing; whereas, the real estate, consisting of land, buildings and fixed equipment, changes but slowly and does not frequently pass from one owner to another. More over, the supply of land is limited, and it is of fairly stable value. Real estate, therefore, is considered the best ultimate security.
Real estate is pledged by means of an indenture known as a mortgage. In form this is a deed from the borrower to the lender, or to a trustee representing the lenders, containing a proviso that the instrument shall become null and void if a certain sum, the amount borrowed, is repaid with interest within a stated time. The borrower, however, retains the possession and use of the property, and never loses control of it if his obligations are promptly met, so that in effect the mortgage is considered a lien, rather than a deed. A
lien is a conditional deed or transfer of property.
With such a mortgage in hand, the bond holder may, in case of default, by the legal process known as foreclosure, take possession of the real estate, in whole or partial satisfaction of his claim. Usually certain days of grace, notice and other elements of protection are extended to the mortgagor by law and by the terms of the mortgage itself.
The corporate mortgage differs in no essential par ticular from the instrument given by the individual borrower who gives a mortgage upon his home. The individual gives his mortgage directly to the lender, probably accompanied by a bond for twice the amount. The corporation, however, may have its bonds dis tributed among many holders, and it would not be convenient or practicable to divide the mortgage lien between them individually. This necessitates the intervention of a trustee fo hold the mortgage in the interests of all the bondholders and to see that the pro tection accorded by it is exercised for their equal benefit. This is accomplished by mortgaging the property to certain individuals, or to a trust company, as trustee, who assumes his duty under a contract, called a deed of trust.
5. Deed of trust.—A deed of trust is, in effect, a contract between two or more parties, by which certain individuals or a trust company are appointed trustees to hold certain property which is conveyed in the instrument to them, and to conduct certain business stated in the contract. From this fact, the instrument receives its name—deed of trust. The trust agreement and the deed may be separated, but are usually one indenture.
In the case of corporate bonds secured by lien on real estate, this deed takes the form of a mortgage, included in the same indenture as the declaration of trust. Since the trustee is a third party, acting be tween the mortgagor and the bondholders, the con tract becomes a three-cornered one. The company is interested in retaining the undisturbed use of its property and securing a reconveyance of it upon pay ment of the bond. The bondholders in turn are in terested in having the property held subject to the satisfaction of their lien, and free from loss or depre ciation meanwhile. The trustee personally is inter ested in the faithful discharge of his trust, the avoid ance of any personal liability, and the receipt of rea sonable compensation for his services. The deed of trust must contain provisions which will accomplish all these purposes. Its form and contents will be considered in greater detail in the following chapter.