No sinking fund: Overview, definition, and example
What is no sinking fund?
No sinking fund refers to a contractual provision stating that the issuing company is not required to set aside funds for the repayment of a debt or financial obligation before its maturity date. This means that the company does not have to make periodic contributions to a reserve fund to retire bonds, loans, or other financial liabilities.
For example, if a corporation issues bonds without a sinking fund provision, it is not obligated to gradually set aside money for repayment. Instead, the full repayment is due at the bond's maturity.
Why is no sinking fund important?
A no sinking fund provision gives the issuing company greater financial flexibility, as it does not have to allocate cash for debt repayment before it is due. This allows the company to use its available funds for other business operations, investments, or growth initiatives.
However, for investors and creditors, a no sinking fund provision may introduce higher risk, as there is no guarantee that funds will be available when the debt matures. This can lead to higher interest rates or stricter loan terms to compensate for the increased risk.
Understanding no sinking fund through an example
A company issues corporate bonds with a 10-year maturity but does not include a sinking fund provision. This means the company is not required to make periodic payments toward the principal and will need to pay the full amount at the end of the 10-year term. Investors accept this risk in exchange for potentially higher returns.
In another example, a real estate development firm secures a loan to finance a construction project. The loan agreement includes a no sinking fund clause, meaning the company does not have to set aside money for early repayments. Instead, the entire loan is due at the end of the term, allowing the firm to use its cash flow for development rather than debt servicing.
Example of a no sinking fund clause
Here’s how a no sinking fund clause might appear in a contract:
“The Borrower shall not be required to establish or maintain a sinking fund for the repayment of any obligations under this Agreement. All payments shall be made in accordance with the repayment schedule set forth herein.”
Conclusion
A no sinking fund provision allows a company to avoid setting aside funds for debt repayment before maturity, providing greater financial flexibility. While this benefits businesses by allowing them to use cash for operations and growth, it may increase risk for lenders and investors. Including a clear no sinking fund clause in agreements ensures transparency in financial obligations and repayment terms.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.