Asset Securitization: The Unsecured Creditor's Perspective

Lois R. Lupica* Introduction When a corporation needs funds for working capital, inventory, or general operations, it can take one of two financing approaches: right hand side (RHS) balance sheet funding or left hand side (LHS) balance sheet funding. RHS funding methods include a firm's issuance of traditional debt (secured and unsecured) and equity obligations, which are backed by the general credit of the issuer. In contrast, when a firm uses an LHS funding approach, it raises capital based upon a specific asset pool's cash flow and value. Examples of LHS funding approaches include asset leasing,1 project finance,2 factoring,3 and the most recent financial innovation, the securitization of financial assets.4 Quite a few articles have appeared in the legal and financial journals on the subject of securitization,5 and implicit in much of this literature is the message that securitization transactions are efficient. This literature has invariably viewed these transactions from the perspective of the originator and the other transaction participants; its conclusion with respect to the efficiency of securitization is hardly surprising. The literature has not adequately considered the perspective of third parties-specifically, the perspective of the originators' unsecured creditors. Viewing these transactions from an unsecured creditor's perspective is important because unsecured creditors are harmed when an originator sells its most valuable assets. In the event of bankruptcy, the originator's residual estate, available for pro rata distribution to unsecured creditors, likely will not include the securitized assets.6 If the originator has used or spent the consideration it received from the sale of the securitized assets, its unsecured creditors will receive no benefit from the value of these assets.7 Predictably, bankruptcy trustees will use aggressive and creative techniques to try to recapture previously transferred assets.8 As an increasing number of financially marginal firms securitize an increasingly exotic array of assets and subsequently enter bankruptcy,9 courts may be persuaded by trustees' legal, economic, and equitable arguments to unwind the securitization transaction and preserve the assets for the benefit of the bankruptcy underdogs-the unsecured creditors. Although neither trustees nor bankruptcy courts have the power or authority to unwind a transaction in the absence of adequate grounds, if the transaction results in significant harm to a firm's unsecured creditors at a time when the firm is in a precarious financial position, bankruptcy judges, in the exercise of their equitable discretion, will rely on existing equitable doctrines and may expansively interpret these doctrines to support their decisions to invalidate these transactions. 10 When this occurs, there will be a drastic adjustive reaction in the market for asset-backed securities. This Article identifies the possible challenges to the claim of structured finance's efficiency and examines the potential equitable bases for a court's avoidance of these transactions. Part II defines structured finance and describes the nature of the current market for asset-backed securities. Part III outlines the benefits that securitization provides to originators and other transaction participants. Part IV outlines and discusses the debate on the efficiency of secured transactions, applies the substance of this debate to structured finance transactions, and then examines the equitable challenges that may be made to avoid securitized asset transfers. Finally Part V illustrates how the rapid expansion of the securitization market has subjected transaction participants and third parties to mounting uncertainty. This Article begins a discussion of these issues-it provides no definitive answers. This Article predicts, however, that further research will support the conclusion that securitization is an inefficient transaction. …