Termination of the rights and interests of the bondholders under an Indenture or Bond Resolution/Ordinance and the release of the liens on the security for the repayment of the Bonds evidenced by the same, which occurs either upon final payment of all Debt Service on the Bonds or by depositing in an irrevocable Escrow Fund sufficient funds or investments to guarantee timely payment of Principal and Interest due on the Bonds at the earlier of Redemption or final maturity. This mechanism is usually used in connection with a Refunding, when proceeds of the Refunding Bonds are used to establish the Escrow Fund to refund the Refunded Bonds.

When Bonds are not yet subject to Optional Redemption, an Issuer might choose to defease them. This means that the Issuer or Conduit Borrower provides (typically through an Escrow or other segregated fund) the money or investments necessary to repay the Bonds (or redeem the Bonds, if they are subject to Optional Redemption and become callable) through the Date of Maturity or Redemption, as applicable. A Defeasance is a concept of contract law and must be expressly permitted in the underlying documents pursuant to which the Bonds were issued. Typically, a Defeasance will relieve the Issuer of many of its repayment obligations and, in some cases, other obligations, with respect to the defeased Bonds (e.g., Pledge of collateral and Security, covenants, etc.). In exchange for the Defeasance, typically the Issuer (or Conduit Borrower) enters into an Escrow Deposit Agreement with an Escrow Agent. Pursuant to the Escrow Deposit Agreement, the Issuer (or Conduit Borrower) typically grants to the Escrow Agent, for the benefit of the bondholders, an irrevocable Pledge of cash and/or Securities as collateral and Security for the Bonds and irrevocable instructions to redeem the Bonds at the first available Optional Redemption date. In other words, the bondholders now look to the money and Securities set aside by the Issuer or the Conduit Borrower (including the investment earnings) for the repayment of the Bonds instead of the original source of repayment. This is known as a legal Defeasance. Generally, for Bonds to be legally defeased, verification of the sufficiency of the amounts deposited into the Escrow Fund is required (and will be done by a Verification Agent), as well as an opinion that there has been a  legal Defeasance of the Bonds. Once Bonds are legally defeased, they are generally considered no longer outstanding from the Issuer’s perspective.

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See Also

Redemption

The repayment of bonds prior to their maturity date.

Refunding

A transaction in which refunding bonds are issued and their proceeds are used to pay off outstanding bonds.

Escrow Fund

Trust account established in the escrow deposit agreement that holds cash, investments, usually obligations of the federal government or, sometimes, federal agencies, or both, all of which are pledged to the payment of the debt service of the refunded bonds.