Adjustment Bond - Explained
What is an Adjustment Bond?
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Table of ContentsWhat is an Adjustment Bond?How Does an Adjustment Bond Work?Academics Research on Adjustment Bonds
What is an Adjustment Bond?
Corporations issue adjustment bonds when it recapitalizes its debts during financial difficulties and bankruptcy proceedings. These bonds are issued against the outstanding bonds to the existing bondholders. When a corporation meets with bankruptcy and is unable to make payments on its previous bonds, it issues adjustment bonds with the permission of the bondholders.
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How Does an Adjustment Bond Work?
Adjustment bonds help a company avoid bankruptcy. Against such bonds, interest is paid only when the business has earnings. In this way, the company does not have to face a default for unmade payments. The company adjusts the terms of its bonds in terms of interest rates and dates of maturity. Thus, the company gets a better chance to meet its obligation without facing bankruptcy. The bondholders approve the issuance of adjustment bonds because exchanging the existing bonds with adjustment bonds are often better for them than the other alternative which is bankruptcy. It is beneficial for them in the long term, as an adjustment bond would allow them to earn more than the earning from the company's liquidation. During the Chapter 11 bankruptcy proceeding, all the assets of the company are liquidated to pay back its creditors. However, this liquidation often pays only a fraction of what the company owes to its creditor. Adjustment bonds provide an opportunity for the company to restructure its debts and continue its operations. In this way, the bondholders stand a better chance to get their dues in the long term. While a company faces financial difficulties, the company representatives meet the creditors that include it, bondholders, to find an alternative arrangement that is beneficial for both the company and its creditors. In these meetings, they negotiate the terms to make it a better alternative than bankruptcy. Usually, the provisions of adjustment bonds allow the company to pay interests only when it has a positive earning. It depends on the specific terms of the adjustment bond whether the bondholders will get the missed interest payment in full, in parts or nothing at all. It also helps the company to avoid default on its debt as they do not have to pay any interest in case of negative earning. Any interest paid against adjustment bonds is a tax-deductible expense. However, often the creditors are required to wait for a long time to be repaid against an adjustment bond. The company needs to recover from its financial difficulties before it can pay its creditor.