6. After-acquired property clause.—T hat portion of the deed of trust which constitutes a mortgage for the protection of bondholders, must contain cer tain provisions beyond those merely creating the lien upon the property. Bonds are usually for long term; property itself is subject to constant change in value, and neither the bondholders nor their chosen trustees can closely watch the security.
Moreover, the company may desire from time to time to extend its plant, or to dispose of certain por tions of it, and a way must be left open for doing this. If the proceeds of the bond sale are invested in new property which does not come under the mortgage, instead of in extending, improving or maintaining the mortgaged property, the margin of safety to bond holders will decrease with time.
In order to safeguard the bondholders and at the same time leave the company sufficient freedom of action, a clause is often inserted in the trust deed pro viding that all the property stipulated, as well as any property thereafter acquired by the company, shall be subject to the lien of the mortgage. This is known as the "after-acquired property clause." We shall see later that it often embarrasses future financing, and is frequently evaded by interposing a lease or a subsidiary company, under which new property is acquired without subjecting it to the mortgage. Here is a typical after-acquired property clause: Together with all the structures . . . (description of mortgaged property inserted) . . . and generally all and singular the estate real and personal of the said Com pany, whatsoever, now owned, or hereafter to be acquired by it.
7. Open mortgages.—When a corporation is grow ing rapidly, and needs constantly to enlarge its capi tal by borrowing, the fact that its best assets are sub j ect to the lien of a mortgage may render it dif ficult to borrow further on favorable terms. This is particularly true when the presence of the above clause prevents the new extensions or improvements themselves from being pledged under a new mortgage to secure additional funds. It is therefore customary, in financing railroads, and occasionally others com panies, either to provide a bond reserve or to execute an open mortgage, under which additional bonds may, from time to time, be issued to meet new capital re quirements.
When the property is valuable enough to sustain a mortgage beyond the immediate amount required, the company frequently mortgages the whole property and authorizes upon this security, an issue of bonds much larger than is immediately needed. These un issued bonds, available for sale at any time for new capital, or for pledge as collateral for temporary loans, constitute a bond reserve for financing future extensions.
however, the property is not adequate to create a satisfactory bond reserve, or future exten sions are contemplated beyond the amount of such reserve, and cannot be financed on separate mortgage because of the after-acquired property clause, it is customary to employ an open mortgage. A closed mortgage is one under which a fixed amount of bonds may be issued and which carries no lien protection beyond that amount. An open mortgage is one which does not fix in advance the exact extent of the lien or the amount of the bonds that may be issued under it.
The open mortgage always restricts the bonds is sued under it by requiring the maintenance of an adequate margin of safety in the value of the prop erty above the par value of the bonds outstanding. The trustee is instructed not to permit the issue of additional bonds, unless this margin of safety is main tained, and certain definite requirements are imposed to insure this being done. The following are the more customary safeguards surrounding the open mortgage and usually several of them are found in the trust deed : (a) Investment of the entire proceed from the sale of bonds in the productive property or equipment covered by the mortgage, or to retire maturing prior liens thereon.
( b) No additional bonds to be issued while the floating debt exceeds a certain amount or a .certain proportion of the total liabilities.
(c) No additional bonds to be issued unless the earnings available for fixed charges have averaged for a certain period of time a certain excess above the interest requirements, including interest upon the contemplated new issue.