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Bankruptcy Law Reform on Asset-backed Securitization
To give safe harbour to asset backed securitization transactions, the US congress has passed an amendment to Title 11 of the US Code which is contained in section 912 of the Bankrupcy Reform Act of 2001. It reads as under:
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Text of the Bankruptcy Reform Act section 912 SEC. 912. ASSET-BACKED SECURITIZATIONS. Section 541 of title 11, United States Code, is amended-- (1) in subsection (b), by inserting after paragraph (7), as added by this Act, the following: `(8) any eligible asset (or proceeds thereof), to the extent that such eligible asset was transferred by the debtor, before the date of commencement of the case, to an eligible entity in connection with an asset-backed securitization, except to the extent such asset (or proceeds or value thereof) may be recovered by the trustee under section 550 by virtue of avoidance under section 548(a);'; and (2) by adding at the end the following new subsection: `(f) For purposes of this section-- `(1) the term `asset-backed securitization' means a transaction in which eligible assets transferred to an eligible entity are used as the source of payment on securities, including, without limitation, all securities issued by governmental units, at least one class or tranche of which was rated investment grade by one or more nationally recognized securities rating organizations, when the securities were initially issued by an issuer; `(2) the term `eligible asset' means-- `(A) financial assets (including interests therein and proceeds thereof), either fixed or revolving, whether or not the same are in existence as of the date of the transfer, including residential and commercial mortgage loans, consumer receivables, trade receivables, assets of governmental units, including payment obligations relating to taxes, receipts, fines, tickets, and other sources of revenue, and lease receivables, that, by their terms, convert into cash within a finite time period, plus any residual interest in property subject to receivables included in such financial assets plus any rights or other assets designed to assure the servicing or timely distribution of proceeds to security holders; `(B) cash; and `(C) securities, including without limitation, all securities issued by governmental units; `(3) the term `eligible entity' means-- `(A) an issuer; or `(B) a trust, corporation, partnership, governmental unit, limited liability company (including a single member limited liability company), or other entity engaged exclusively in the business of acquiring and transferring eligible assets directly or indirectly to an issuer and taking actions ancillary thereto; `(4) the term `issuer' means a trust, corporation, partnership, governmental unit, limited liability company (including a single member limited liability company), or other entity engaged exclusively in the business of acquiring and holding eligible assets, issuing securities backed by eligible assets, and taking actions ancillary thereto; and `(5) the term `transferred' means the debtor, under a written agreement, represented and warranted that eligible assets were sold, contributed, or otherwise conveyed with the intention of removing them from the estate of the debtor pursuant to subsection (b)(8) (whether or not reference is made to this title or any section hereof), irrespective and without limitation of-- `(A) whether the debtor directly or indirectly obtained or held an interest in the issuer or in any securities issued by the issuer; `(B) whether the debtor had an obligation to repurchase or to service or supervise the servicing of all or any portion of such eligible assets; or `(C) the characterization of such sale, contribution, or other conveyance for tax, accounting, regulatory reporting, or other purposes.'. |
As is evident from the definition of "transferred" in the proposed amendment, if the seller has represented and warranted that the eligible assets are being transferred, the transfer will be automatically a true sale and the sale thereof cannot be questioned. Such true sale will take place even if the sale in question is a fractional transfer, or the seller has a buyback obligation, or the characterisation of the sale for accounting or tax purposes. Clearly this is a significant safe harbour provision.
The legal academia are perturbed about the potential misuse of this section by potentially bankrupt companies to hive off their assets - see the controversy in this regard covered on our news page here.
In legal interpretation, whether a document, manifestly reading like a transfer agreement, has the true effect of transferring an asset or merely leading to a disguised funding transaction, is always a matter of dispute before Courts. A number of so-called sales are really garbed funding transactions, in which case a Court may recharacterise such transactions are funding transactions. If recharacterised, a securitization, which seeks to attribute identified assets solely for the benefit of securitization investors, will rank at par with unsecured lenders.
In a number of cases, securitization transactions have been recharacterised, or attempted to be recharacterised, by Courts. LTV Steel was one such case. The bankruptcy reforms amendment above seeks to give a safe harbour to securitization transactions, so that what is promised as a sale of assets today is not questioned as a funding transaction in bankruptcy.
True sale, a critical question from bankruptcy viewpoint, would become largely irrelevant if this amendment is carried.