True sale is at the very heart of legal issues in securitization. If securitization is a true sale, the investors get a legal right over the receivables. If it is not a true sale, investors may be either at par with unsecured lenders, or even worse.
The true sale question is also the foundation of off-balance-sheet accounting treatment, regulatory relief, etc.
The genesis of securitization lies in giving the investors rights over specific assets of the originator, such that the investors are not affected by the performance, or bankruptcy of the originator. This would obviously necessitate that the investors, or the SPV which is a conduit on behalf of the investors, has legally acquired the assets.
Here are the important questions regarding true sale:
Why is a true sale required?
To allow investors an unqualified right over the assets being securitized. True sale forms the very line of distinction between securitization and collateralised lending.
What needs to be done to achieve true sale?
The requirements for true sale may:
- be laid down by the law of land
- be laid down by Courts
- be implied from judicial history/ legal tradition
- be inferred from international practice of securitization industry.
Several countries have enacted specific laws on securitization which also define "true sale".
There are several common law rules that establish a true sale. For example, the rulings from both USA and UK – for some of these rulings, see our section on securitisation cases.
What if a transfer is not a true sale?
If the transfer of assets for the benefits of investors is not a true sale, it might mean:
- the investors are unsecured lenders
- the transfer is regarded as creating security interest in favour of investors; so the investors are secured lenders (whether such security interest is perfected or not will depend on the procedure relating to perfection of security interests)
- worst of all, since the transaction would not have been backed by loan documentation, the investors may not be regarded as lenders as well – meaning, they might only have an equitable right to recover their money but would not stand as unsecured lenders.
Hence, the consequences of the transfer not being a true sale could be really disastrous.
What kind of receivables can be subject of a true sale?
This again is a question to be answered with reference to local law. Normally, the receivables should be existing and identifiable. Sale of future receivables may take place as a promise to sell in future. Sale of unidentifiable receivables might only create an interest in a pool of receivable, not transfer the receivables.
The truth of true sales in the subprime crisis:
The subprime crisis might explode several of the assumptions on which securitization has been built. This is not unique as it is only a crisis that provides a real test to the robustness of an instrument.
Justice Boyko in an Ohio Federal Court ruling refused Deutsche Bank as trustee to go ahead with foreclosure action on mortgages as their ownership was not properly established. What the Judge expected was what the securitization industry was ignoring over the years.
The true sale will come under severe attack also for another reason: the myth of independence of SPVs seems exploded as most originators have adopted numerous measures, including buyback of assets, increase of enhancement levels etc to prevent their transactions from defaulting. Hence, bankruptcy remoteness by hiving off assets seems merely a device and not a reality.
For an interesting series of blogs on this issue, see here: http://iamfacingforeclosure.com/blog/2007/11/16/true-sale-false-securitizations/
- Treatment of Securitized Transactions in Bankruptcy: A very methodical treatment of the true sale question in securitization and possible ways out including the recent bankruptcy laws, article by Kensington & Ressler LLC –click here.
- Case law on true sale – our section on securitization case law
- Recently US steel maker LTV filed for banruptcy and sought consolidation of its securitisation subsidiary. Read about the case, and an editorial comment.
- Articles by Prof. Steven Schwarcz on this site.
- Structural and Legal Issues In Commercial Mortgage Securitization Transactions by Patrick C. Sargent – a highly readable article with details on true sale issues – http://www.andrewskurth.com/
- CORPORATE LOAN SECURITIZATION: SELECTED LEGAL AND REGULATORY ISSUES by THOMAS W. ALBRECHT AND SARAH J. SMITH – http://djcil.law.duke.edu/
- A recent ruling of the Hong Kong High Court has gone by the language of the agreement between the parties, thereby giving supremacy to form over substance, and held the transaction to be a sale even though the elements of sale were absent. See Soma Bagaria's article analysing the same here.
- PPT on true sale, a lecture delivered by Vinod Kothari at Hong Kong University – click here
- For a thought provoking write up on why are true sales required at all, see a report on the news page here.
- A recent ruling by a Canadian court in BC Tel's case gave a positive ruling on true sale, though most of the negatives earlier found by Courts to be destructive of true sale were present in this case. See our news item on this case here.
- An interesting analysis of the ruling in BC Tel's case by Matthew Burgoyne – click here
- The bankruptcy reforms legislation in the USA intends to provide a safe harbour in bankruptcy as far as the true sale issue is concerned. See our page here.