The Impact of Bankruptcy Reform on “True Sale” Determination in Securitization Transactions

THE IMPACT OF BANKRUPTCY REFORM ON "TRUE SALE" DETERMINATION IN SECURITIZATION TRANSACTIONS* I. INTRODUCTION Both Houses of Congress have passed similar bankruptcy reform bills,1 and President Bush has signaled he would sign such a bill ("Reform Act") once Congress reconciles the differences between the House and Senate versions.2 Among other things, the Reform Act would create, for the first time, a legislative "safe harbor" regarding what constitutes a bankruptcy true sale3 in securitization transactions.4 Because both bills include identical forms of this safe harbor provision, it is expected that the Reform Act will include the safe harbor provision unchanged. Because of the attacks against our country on September 11, 2001 and the resulting economic downturn, it is uncertain when, and indeed whether, Congress will enact the Reform Act.5 At the time of this writing, there was some indication that the Reform Act would be placed back on track.6 Even if the Reform Act is not ultimately enacted in full, it is possible that the provisions that are identical in both House and Senate versions - such as the aforesaid securitization safe harbor - may be enacted separately. II. BACKGROUND Securitization is reputed to be by far the most rapidly growing segment of the U.S. credit markets,7 and its use is rapidly expanding worldwide.8 In a typical transaction, a company usually called the "originator" transfers rights to payment from incomeproducing assets such as accounts receivable,9 loans, or lease rentals (collectively, "receivables" or "financial assets") - or frequently undivided interests in such rights - to a special purpose vehicle ("SPV").10 The SPV, in turn, issues securities to capital market investors and uses the proceeds of the issuance to pay for the receivables. The investors, who are repaid from collections of the receivables, buy the securities based on their assessments of the value of the receivables. Perhaps the most important issue in a securitization is whether the SPV's investors will continue to be repaid in the event of the originator's bankruptcy. If the SPV owns the receivables, its investors will continue to be repaid; if not, their right to be repaid will be suspended and subject to possible impairment. The SPV will own the receivables only if the transfer of those receivables from the originator to the SPV constitutes a sale under applicable bankruptcy law - usually referred to as a "true sale."11 This issue, and the concerns that surround it, are illustrated by the recent bankruptcy case of LTV Steel Company, Inc. ("LTV").12 LTV challenged its pre-bankruptcy securitization facilities, arguing that the transfers to the SPVs were not true sales, and therefore, LTV should be able to use the collections of receivables as "cash collateral" by giving adequate protection under bankruptcy law.13 LTV's rationale was that, without such use, it might have to cease its operations, thereby jeopardizing employee jobs and retiree benefits and adversely affecting the local economy.14 The Bankruptcy Court permitted LTV to use these collections pending resolution of the true sale issue.15 However, LTV should have little importance as a legal precedent because, prior to such resolution, the parties reached a settlement that included a summary finding that the transfers were true sales.16 Nonetheless, to some extent, this use has shaken financial market confidence in securitization. III. THE REFORM ACT The Reform Act provides an explicit "true sale" safe harbor for most transfers of receivables in securitization transactions. It does this by amending (sec) 541 of the Bankruptcy Code,17 which defines property of the debtor's estate, to exclude from that estate any "eligible asset" transferred to an "eligible entity" in connection with an "asset-backed securitization."18 Because these terms are expansively defined, the exclusion is broad. The term "eligible asset," for example, means any existing or future-arising financial asset, including interests therein and proceeds thereof, that by their terms convert into cash within a finite period of time. …