Defeasance Agreement

Defeasance Agreement

A Defeasance Agreement is a legal contract commonly used in finance and real estate transactions that allows a borrower to satisfy or discharge a debt by substituting a portfolio of securities, typically government bonds, for the collateral that secures the debt. This agreement effectively releases the borrower from their obligation while ensuring that the lender receives equivalent security for the debt.

In a typical scenario, a borrower may enter into a Defeasance Agreement when they wish to pay off a loan secured by real estate without making a cash payment. Instead, the borrower will purchase a set of government securities that generate sufficient cash flow to cover the remaining debt payments. Once the securities are properly structured and set aside, the borrower notifies the lender, who then releases the lien on the property.

For example, if a company has a commercial mortgage with a remaining balance of $500,000, it could enter into a Defeasance Agreement by purchasing U.S. Treasury bonds that will provide enough interest income to make the remaining mortgage payments. Upon executing the agreement, the lender is required to release its claim on the property, and the borrower continues to make payments from the income generated by the securities.

Defeasance Agreements are particularly beneficial in situations where borrowers wish to sell the property or refinance without incurring prepayment penalties associated with traditional loans. They offer a strategic financial solution that can enhance liquidity and financial maneuverability while ensuring that lenders are secured against default.