What is the definition of Defeasance in finance?

Defeasance in finance refers to the legal process of setting aside funds specifically to pay off a debt, thereby effectively removing the liability from the issuer's balance sheet. This often involves placing assets in a trust or escrow account that will generate enough cash flow to meet future debt obligations, which allows the original borrower's outstanding debt to be regarded as satisfied.

This mechanism is particularly relevant in the context of bonds or other loans, where an issuer can ensure that investors will be paid back through dedicated and secured funds. By doing this, the issuer can eliminate the risks associated with their existing debt, often allowing for improved financial management and potentially enhanced credit ratings.

Understanding defeasance is crucial because it impacts how financial statements are presented and how obligations are viewed by investors. It involves strategic financial planning, often implemented when managing large-scale projects or significant financial changes within an organization.