Securitisation Case Law
[ In this section, we would be putting up a compilation of legal cases on securitization from various countries. If you are aware of any legal ruling that deals with any aspect of securitization, you are welcome to contribute - your contribution will be acknowledged with thanks. ]
One of the major US rulings on whether assignment of receivables in a securitization transaction is a true sale or mere financing is Major's
Furniture, Inc. v. Castle Credit Corp., 602 F.2d 538 (3d Cir. 1979). In this ruling, the Court held the assignment of receivables by the furniture seller to the factoring company a case of financing and not assignment, as the factor had full recourse on the seller and the factor only paid a part of the total debt factored by him.
In this case too, [ ENDICO POTATOES, INC., and others vs. CIT GROUP/FACTORING, INC., SECOND CIRCUIT Nos. 1751, 1961 Decided: October 2, 1995] dealing with a factoring transaction, the Court had occasion to consider whether the agreement amounted to financing or true sale. The case relied, among others, upon Major' Furniture and Evergreen Valley. The decision between financing and true sale, in the court's opinion, hinges on the assumption of risk. See excerpts below:
"Resolution of whether the "contemporaneous transfer," as CIT describes Merberg's assignment of accounts receivable to CIT and CIT's loan advances to Merberg, constitutes a purchase for value or whether the exchange provides CIT with no more than a security interest, depends on the substance of the relationship between CIT and Merberg, and not simply the label attached to the transaction. In determining the substance of the transaction, the Court may look to a number of factors, including the right of the creditor to recover from the debtor any deficiency if the assets assigned are not sufficient to satisfy the debt, the effect on the creditor's right to the assets assigned if the debtor were to pay the debt from independent funds, whether the debtor has a right to any funds recovered from the sale of assets above that necessary to satisfy the debt, and whether the assignment itself reduces the debt.Major's Furniture Mart, Inc. v. Castle Credit Corp. , 602 F.2d 538, 543-46 (3d Cir. 1979); Levin v. City Trust Co. , 482 F.2d 937, 940 (2d Cir. 1973); Hassett v. Sprague Electric Co., 30 B.R. 642, 647-48 (Bankr. S.D.N.Y. 1983); In re Evergreen Valley Resort, Inc. , 23 B.R. 659, 660-61 (Bankr. D. Me. 1982).The root of all of these factors is the transfer of risk. Where the lender has purchased the accounts receivable, the borrower's debt is extinguished and the lender's risk with regard to the performance of the accounts is direct, that is, the lender and not the borrower bears the risk of non-performance by the account debtor. If the lender holds only a security interest, however, the lender's risk is derivative or secondary, that is, the borrower remains liable for the debt and bears the risk of non-payment by the account debtor, while the lender only bears the risk that the account debtor's non-payment will leave the borrower unable to satisfy the loan.
"The first sentence of the financing agreement belies the contention that CIT purchased the accounts receivable. As the agreement states, CIT is "pleased to confirm the terms and conditions under which we shall make loans and advances to you upon the security of your accounts receivable." Just as important, the terms of the agreement make clear that what CIT held was no more than a security interest. Merberg's assignment of accounts receivable had no effect on the outstanding balance of Merberg's indebtedness. Instead, Merberg's loan balance was reduced only upon receipt of payment, whether such payments arose from the accounts receivable or from any other source. Moreover, CIT could demand payment directly from Merberg at any time for the entire outstanding loan balance notwithstanding that CIT held what it termed an assignment of Merberg's accounts receivable. Finally, in the event that Merberg paid all outstanding obligations to CIT, CIT would no longer hold an interest in Merberg's outstanding accounts receivable. Each of these provisions indicates that the primary risk of a customer's non-payment remained at all times with Merberg and that the assignment alone did not reduce Merberg's obligations to CIT. CIT also asserts that even if it does not hold the accounts receivable as a bona fide purchaser, it should benefit from the protections of Section 304(2)(c) of the Restatement. Section 304 provides three limited exceptions to the general rule that a transfer of trust property to satisfy an antecedent debt does not constitute a transfer for value. Restatement (Second) of Trusts § 304(2). CIT, however, did not receive the accounts receivable "in consideration of the extinguishment in whole or in part of a pre-existing debt." Id. § 304(2). To the contrary, the loan agreement provides expressly that Merberg's outstanding loan balance is decreased only upon receipt of funds from Merberg or Merberg's customers. "
Links For more on true sale, see our page here
In a pass through transaction, the investor buys a fractional, undivided share in the pool of underlying receivables. It may be an interesting question to examine as to whether the investors' interest in such a case is akin to a financial transaction, or a capital market security, or does the investment take its character from the underlying transaction. For example, if the underlying transaction is a mortgage, is the investor who buys a pass-through derived from the mortgage (a) a financier as in a loan transaction, or (b) an investor as in a capital market security investment; or (c) a mortgage lender as in a direct mortgage transaction?
The case of STEPHEN A. GOLDBERG v REMSEN PRT LTD, a case before Court of Appeals of Columbia circuit (dated March 26, 1999) is a queer case on facts. Here, a person advising an originator on securitization of mortgage receivables was treated as a mortgage broker, and hence, was held as caught under Brokerage Act of Columbia. Click here for a full text of the case
The issue concerned transfer of low quality and non-performing loans to SPEs. See here for the full text of the order.
In a very significant ruling, and the first of its kind, the Court of Appeal in UK has discussed the rights of trustees in a securitisation transaction. Click for the Court of Appeal ruling. The original order of the Cancery
court is here.