Asset Securitization and Insolvency

Asset securitisation and the effect of insolvency on special purpose vehicles Mayer Brown LLP

Asset securitisation and the effect of insolvency on special purposevehicles under US bankruptcy lawThomas S Kiriakos, partner

David S Curry, partner

Mayer Brown LLP

Asset securitisations are transaction structures whereby assets areconveyed by the originator to an entity that then issues securities (either

publicly or privately) secured by the transferred assets or obtains a loan fromone or more financial institutions secured by such assets. In the United States,this entity – commonly referred to as a special purpose vehicle (SPV) or aspecial purpose entity – is often a subsidiary or other legal entity owned orcontrolled by the originator, and its business purpose and operations arelimited to issuing the securitisation securities or debt and to owning andconducting business with respect to the transferred assets. The SPV conveysthe proceeds of such securities issuance or loan to the originator, either inpayment for the transferred assets, where the transfer is structured as a sale,or as an equity distribution on account of the originator’s equity interest,where the transfer is structured as a contribution to the equity of the SPV. TheSPV then operates its business – which is limited to the ownership of thetransferred assets – through contracting with another party, usually theoriginator itself in the first instance, for the servicing of the transferred assets.

In pursuing a securitisation transaction, the parties have usually madethe judgement that the transferred assets are generally expected to performbetter than the general credit rating of the originator would otherwiseindicate. The business purpose of an asset securitisation is to unlock thehigher relative value or strength of those assets for the benefit of theoriginator through isolating the assets to be securitised from the claims of thecreditors of the originator, including from the insolvency risk of theoriginator. Where the originator enters into a conventional loan secured bythe subject assets (instead of financing those assets in a securitisationtransaction) and then becomes a US bankruptcy debtor, the lender is exposedto a number of risks:• the lender that has a lien on such assets is automatically stayed from

proceeding to liquidate such assets;• the originator, under certain circumstances and over the objection of the

lender, can continue to use the proceeds of such assets in the operation ofits business;

• the bankruptcy court has the power to grant other (even superior) lienson such assets to other lenders or authorise the substitution of other(more illiquid) property as the lender’s collateral in order to facilitatecontinued lending to the originator while it is in bankruptcy; and

• a Chapter 11 plan of reorganisation that re-writes the tenor, interest rateand other terms of the lender’s claim ultimately can be approved overthe lender’s objection in certain circumstances.

By attempting through a securitisation transaction to isolate the assetsfrom these and other risks inherent in a bankruptcy of the originator, theassets can be financed on a standalone basis, and because the assets areconsidered to be stronger than the originator’s general credit rating, thatfinancing is expected to be materially less expensive than financing generally

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Mayer Brown LLP Asset securitisation and the effect of insolvency on special purpose vehicles

available directly to the originator. Thus, throughan asset securitisation the originator is expected toobtain lower-cost financing than it would otherwisebe able to obtain, which redounds to the benefit ofthe originator and its stakeholders. The utility ofsuch a lower-cost funding structure has led to theemergence and exponential growth over the last 20years of the securitisation market in developedcountries. In the United States alone, securitisationis widely considered to have been a $865 billionmarket in 2007.

Securitisation in the United States: bankruptcyfundamentals

Bankruptcy is a federal statute

Under the Constitution, government powers areexercised through the federal government, as wellas by the states. In general, where the Constitutionhas empowered the federal government to act in anarea, its laws take precedence. While many stateshave various types of insolvency law, bankruptcy isthe domain of the federal government andsecuritisation market participants are principallyconcerned with the effect of the US BankruptcyCode (11 USC Sections 101 and following) on SPVsin securitisation transactions.

However, only persons or entities that reside orhave a domicile (which includes incorporation),place of business or property in the United Statesmay be debtors under Section 109(a) of the code.While the code contains provisions providing fordifferent types of relief, certain types of debtor areeligible only for certain types of relief – forexample, a railroad is ineligible to be liquidatedunder Chapter 7 and can be subject only to its ownspecial provisions under Chapter 11, and astockbroker or commodity broker is ineligible forChapter 11 relief and can be liquidated only underits own special provisions of Chapter 7. Others areineligible for any type of relief under the code – forexample, a domestic insurance company, adomestic bank, a foreign insurance companyengaged in such business in the United States or aforeign bank that has a branch or agency (asdefined in Section 1(b) of the International BankingAct of 1978) is ineligible for any relief under thecode (11 USC Section 109(b), (d)). Such entities areineligible for bankruptcy relief as they are allregulated under state and/or federal regulatoryschemes which contain their own provisions andprocedures for dealing with such entities whenthey are in financial distress. Parties entering into

securitisation transactions with these types oforiginator should become conversant with howthese regulatory schemes may affect thetransactions should their originators becomefinancially distressed.

However, the bulk of US securitisationstructures do involve originators and SPVs that areeligible to be debtors under Chapter 7 or Chapter 11of the code.

Bankruptcy fundamentals of a typical USsecuritisation transaction

Securitisation transactions are not governed by anexpress provision of the code. Specifically, there isno statutory safe harbour that prescribes the stepsthat, if followed by market participants, will ensurethat the desired goal of the isolation of thesecuritised assets from the credit (includingbankruptcy) risks of the originator (known as‘bankruptcy remoteness’) will be achieved.

Instead, the legal foundation of securitisation inthe United States is premised on the ability of aperson or legal entity (originally a corporation andnow including entities such as partnerships, limitedliability companies and business trusts) to conveyassets to a separate legal entity, wholly or partlyowned by the transferor, in a true sale or a truecontribution transaction, that extinguishes anyremaining property interest of the transferor in theassets themselves, such that in any subsequentbankruptcy of the transferor, the transferred assetsthemselves are not part of the transferor’sbankruptcy estate, but instead belong to thetransferee. In such a subsequent bankruptcy of thetransferor, only the transferor’s equity interest inthe transferee (and not the assets themselves) ispart of the transferor’s bankruptcy estate; thetransferred assets belong to the transferee and arenot generally subject to the claims of thetransferor’s creditors.

In short, the legal foundation of securitisation isthe recognised ability to create standalone limitedliability entities. The twin legal concepts related tothat foundation are true sale or true contributionand the doctrine of substantive consolidation. Theformer governs whether the originator, inpurporting to transfer such assets to the SPV, hassufficiently parted with ownership of the assetssuch that they would be considered underapplicable law to belong no longer to the originator(including in any subsequent bankruptcy), butinstead to the SPV.

Notwithstanding that bankruptcy is a species

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of federal law, non-bankruptcy law – usually statelaw – governs whether a particular transfer is a truesale or a true contribution. While the code generallyincludes in the bankruptcy estate “all legal orequitable interests of the debtor in property as ofthe commencement of the [bankruptcy] case” (11USC Section 541(a)(1)), courts have consistentlyheld that applicable non-bankruptcy law governsand defines the substantive parameters of thoselegal or equitable interests (see Travelers Cas &Surety Co v Pacific Gas & Elec Co, 127 S Ct 1199, 1205(2007)). Although some states have sought toaddress the question through statute, thesubstantive law governing true sale and truecontribution decisions is primarily comprised ofjudicial decisions or case law applying generalprinciples. The state law governing true sale andtrue contribution determinations is similar to thepoint that it can be accurately stated that there aregenerally recognised true sale and true contributionprinciples. However, the ultimate determinationwill be governed by the law of a particular state.While the parties generally expressly choose aparticular state’s law to govern the issue, whethersuch a choice itself will be respected will depend ona court’s application of governing choice of lawprinciples.

The substantive consolidation doctrine is abankruptcy doctrine. Notwithstanding the generalrule that each legal entity (including its assets andliabilities) is separate and distinct from other (evenrelated) legal entities and must be treated as such inbankruptcy, the doctrine permits a bankruptcyjudge to combine or consolidate the assets andliabilities of two or more related entities so thatthere will be a common pool of assets from whichthe liabilities against all such entities are to besatisfied. The doctrine is equitable in nature andcase law consistently states that it is to be usedsparingly. There is no express statutory provision inthe code setting forth the doctrine or its applicablestandards; it is a creature of case law. The SupremeCourt has not articulated the governing legalstandard for the application of the doctrine, but oneof the best-known federal appellate court decisionssummarises the considerations underlying theapplication of the substantive consolidationdoctrine as “merely being variants on two criticalfactors: (i) whether creditors dealt with the entitiesas a single economic unit and ‘did not rely on theirseparate identity in extending credit,’…; or (ii)whether the affairs of the debtors are so entangledthat consolidation will benefit all creditors …[in thesense that] untangling is either impossible or so

costly as to consume all assets” (Union Sav Bank vAugie/Restivo Baking Co (In re Augie/Restivo BakingCo), 860 F 2d 515, 518-519 (2d Cir 1988)).

Thus, the true sale or contribution andsubstantive consolidation concepts are concernedwith the same thing – isolating the transferredassets from the credit (including bankruptcy) riskof the originator – but from different perspectives.The true sale or contribution inquiry is concernedwith the efficacy of the transfer of the assets itself:did the transfer by the originator to the SPV satisfythe governing legal standards such that theoriginator can be said to have parted with itsownership of the assets? The substantiveconsolidation inquiry is concerned with theviability of the SPV itself and its relationship to(including any continuing business relationshipswith) the originator: will the SPV be created,maintained and operated, particularly in relation tothe originator, in a manner that ensures that itsassets and liabilities will be recognised in anysubsequent bankruptcy as being separate anddistinct from those of the originator, or instead isthe manner of the creation, maintenance oroperation of the SPV likely to result in a bankruptcyjudge being entitled, upon the request of a trustee,creditor or other party in interest, to exercise his orher discretion in any subsequent bankruptcy of theoriginator to consolidate the assets and liabilities ofboth the originator and the SPV and treat them as ifthey were a combined entity, vitiating the utility ofany true sale characterisation of the originaltransfer of the securitised assets?

Thus, a US securitisation transaction isstructured against the backdrop of this legalframework as the parties seek to obtain anacceptable level of bankruptcy remoteness. Thetransfer documents address true sale andcontribution issues, such as the level of recourse bythe SPV against the originator relating to the assetsto be securitised. With a view towards bothunderscoring the reasonableness of the reliance bythe securitisation creditors of the SPV on theseparate legal existence of the SPV and avoiding animpermissible entangling of the affairs of theoriginator and the SPV, the transfer and organicdocuments address and impose limitations andother requirements on the creation andmaintenance of the separate legal existence of theSPV, as well as on its future operation, including itsrelationship with the originator, such as requiringthe SPV to:• comply with all corporate formalities;• maintain and account for its assets and



liabilities separately (including imposinglimitations regarding the extent to which itsassets may be commingled with those of theoriginator); and

• maintain any business dealings with theoriginator on arm’s-length terms.

It is standard practice in US securitisationtransactions that a reasoned legal opinionaddressing these legal issues be delivered, usuallyby counsel for the originator, as a condition to theclosing of the transaction.

Of course, these issues do not constitute theuniverse of legal and business issues addressed inany typical US securitisation transaction. Forexample, subsidiary issues relating to true sale andnon-consolidation concepts are routinelyconsidered, such as the sufficiency of considerationinvolved in the transfer (or whether the transferinstead can be attacked as having constituted afraudulent conveyance against the originator’screditors). In addition, the state law doctrines of‘piercing the corporate veil’, ‘alter ego’ and‘corporate instrumentality’ are similar to, butconceptually distinct from, the substantiveconsolidation doctrine (although a consideration ofthese doctrines is generally subsumed as a practicalmatter in the treatment of the substantiveconsolidation issues in US securitisationtransactions). There are also federal statutes (eg, taxand pension statutes) that purport to imposecorporate group liability in certain circumstancesand whose possible application is routinelyconsidered when structuring US securitisationtransactions. In addition, a myriad of independenttax, accounting, regulatory and other issues areroutinely considered in such transactions.

Moreover, even with respect to the question ofbankruptcy remoteness, the concern is not limitedto the legal framework alone. Parties to USsecuritisation transactions are also concerned withcreating a transaction that makes the bankruptcy ofthe SPV remote as a practical matter as well as alegal matter, and certain standard bankruptcyremoteness provisions, such as the limitations onthe scope and nature of the SPV’s business, areconcerned more with these practical considerationsthan with legal principles.

The major ratings agencies have publishedcriteria relating to their own requirementsregarding bankruptcy remoteness as they considerratings for proposed transactions (eg, see Standard& Poor’s Legal Criteria for US Structured FinanceTransactions (October 2006)).

Securitisations in US bankruptcy cases

Where transactions have been structured andmaintained in a manner that is free from fraud andotherwise consistent with generally recognised truesale and non-consolidation principles,securitisation structures have been respected andtreated in the US bankruptcy cases of originatorsaccording to the general expectations underlyingthe design of the structures (see Securitization ofFinancial Assets, Jason HP Kravitt ed, 2d ed 1996 &Supp 2007), Section 5.05[M], pp 5-248 to 5-260). Forexample, where the securitisation structure hasbeen the source of ongoing funding for theoriginator and the securitised assets havecontinued to function in a manner consistent withoriginal underwriting assumptions, it has been acommon experience for the securitisationtransaction either to be continued with the consentof the SPV securitisation parties as a form of court-approved debtor-in-possession financing in theoriginator’s Chapter 11 case (see Imperial Sugar,discussed in id, Section 5.05[M][12]) or to beunwound and paid off in full shortly after thecommencement of the originator’s bankruptcy withthe proceeds of a new post-bankruptcysecuritisation transaction (see Carter Hawley HalesStores, discussed in id, Section 5.05 [M][3]) or atraditional debtor-in-possession financing facility(see National Gypsum Co., discussed in id, Section5.05 [M][4]).

Following cases such as Days Inn and LTV SteelCompany, there was some market reluctance overtransactions that involve the securitisation of bothnon-financial assets (eg, inventory) and financialassets or that otherwise involve the core assets ofthe originators, even though such cases haveresulted in either a consensual resolution or thepayment in full of the securitisation transactionsrelatively shortly after the commencement of theoriginators’ bankruptcy cases (see id, Sections5.05[M][6] and 5.05[11] for a discussion of Days Innand LTV Steel Company, respectively). One mightraise analogous issues for whole businesssecuritisations, but most such transactions, if wellstructured, will be designed to have the securitisedbusiness function independently from theremaining operations of the originator. While thisarea continues to evolve, US securitisationtransactions involving such assets are likely tocontinue to be viewed and considered by marketparticipants on a transaction-by-transaction basis(eg, see Standard & Poor’s, Corporate SecuritizationRatings: Reaching New Frontiers (February 2007)).



In re Owens Corning – an important non-consolidation decision

Designing a US securitisation transaction tominimise the risks that the assets and liabilities ofthe SPV will be substantively consolidated (orcombined and treated as a single pool) with thoseof the originator in any subsequent bankruptcy isone of the twin pillars of the isolation principleunderlying US securitisation transactions.Substantive consolidation is a judge-made doctrinewith no definitive standard for its application,having yet to be articulated by the Supreme Court.

One of the better-known federal appellate courtdecisions articulating a substantive consolidationstandard is the Augie/Restivo decision. Augie/Restivois significant not only because it articulates arigorous standard doctrine that must be met beforeconsolidation can be ordered, but also because, as aSecond Circuit decision, it is binding authority onNew York bankruptcy courts, where many largeChapter 11 cases are filed.

However, other federal court decisions havebeen depicted as representing a more liberal trendin substantive consolidation case law. The bestknown of these is Drabkin v Midland-Ross Corp (In reAuto-Train Corp, Inc) (810 F 2d 270 (DC Cir 1987)),which articulated a “balancing test” requiring abankruptcy court to determine first whether thereexists a “substantial identity between the entities tobe consolidated”, and only after making such adetermination to determine whether the proponentof the substantive consolidation has carried itsburden to demonstrate “that consolidation isnecessary to avoid some harm or realize somebenefit”. If an opponent of the requestedconsolidation after such a showing candemonstrate “that it relied on the separate credit ofone of the entities and that it will be prejudiced bythe consolidation”, the court may still orderconsolidation, but “only if it determines that thedemonstrated benefits of consolidation ‘heavily’outweigh the harm” (810 F 2d at 276).

Counsel delivering reasoned opinion letters inUS securitisation transactions routinely opine thatthe Auto-Train balancing test would not warrant,based on the factual assumptions and subject to thelimitations set forth in such opinion, thesubstantive consolidation of the assets andliabilities of the originator with those of the SPV inany subsequent bankruptcy. However, it is a lessrigorous standard than the Augie/Restivo test.

In Re Owens Corning involved not asecuritisation transaction, but another common

transaction structure: a syndicate of lenders makingloans to a parent corporation that were thenguaranteed by the parent corporation’s subsidiaries(419 F 3d 195, 199 (3d Circuit 2005)). In the ensuingbankruptcy cases of the parent corporation and thesubsidiary guarantors, the debtors moved forsubstantive consolidation of the assets andliabilities of the debtors in anticipation of proposinga plan of reorganisation for the debtors (id). The neteffect of the requested substantive consolidationwas the elimination of the lenders’ subsidiaryguarantees (id). Over the lenders’ objection, thelower court granted the motion (id at 202). Thelenders then appealed the decision to the ThirdCircuit.

In reversing the lower court’s decision, theThird Circuit essentially adopted a more robustversion of Augie/Restivo’s two-prong test, holdingthat substantive consolidation is appropriate, in acontested setting, only where either pre-bankruptcy, the subject entities “disregardedseparateness so significantly [that] their creditorsrelied on the breakdown of entity borders andtreated them as one legal entity, or [post-bankruptcy,] their assets and liabilities are soscrambled that separating them is prohibitive andhurts all creditors” (id at 211 (footnotes omitted)).Specifically, with respect to the first (reliance)prong, the Third Circuit went beyond Augie/Restivoand held that even if the proponents of substantiveconsolidation could prove that creditors “actuallyand reasonably relied” on the entities as if theywere a combined entity, substantive consolidationstill had to be denied as to the opponents of theconsolidation if such opponents could prove thatthey relied on the separate existence of one or moreof such entities and would be “adversely affected”by the requested consolidation (id at 212).

Significantly, the Third Circuit flatly rejectedthe more relaxed standard of Auto-Train: “The Auto-Train approach… adopts, we presume, one of theAugie/Restivo touchstones for substantiveconsolidation while adding the low bar of avoidingsome harm or discerning some benefit byconsolidation. To us this fails to capture completelythe few times substantive consolidation may beconsidered and then, when it does hit one chord, itallows a threshold not sufficiently egregious andtoo imprecise for easy measure. For example, wedisagree that ‘[i]f a creditor makes [a showing ofreliance on separateness], the court may orderconsolidation … if it determines that thedemonstrated benefits of consolidation ‘heavily’outweigh the harm.’ [Auto-Train], at 276 (citation



omitted); … If an objecting creditor relied on theseparateness of the entities, consolidation cannot bejustified vis-à-vis the claims of that creditor.” (419 F3d at 210.)

Owens Corning is significant for parties to USsecuritisation transactions for several reasons. Itrepresents a recent federal appellate decision thatflatly rejects the more relaxed Auto-Train standard.It also embraces a more rigorous test for theapplication of the doctrine. In particular, itunderscores that creditor reliance on theseparateness of the entities – which is a touchstoneof US securitisation structure where the SPV’screditors are in fact relying on the separateness ofthe SPV – should bar consolidation as to the claimsof those creditors. It was also decided by the federalappellate court whose decisions are bindingprecedent on the US Bankruptcy Court for theDistrict of Delaware which – like the USBankruptcy Court for the Southern District of NewYork – is the court in which many large Chapter 11cases are filed.

The decision is also interesting for the ThirdCircuit’s sensitivity to the widespread use of aparticular transaction structure in the marketplace:“To begin, the Banks did the ‘deal world’equivalent of ‘Lending 101.’ They loaned $2 billionto [the parent corporation] and enhanced the creditof that unsecured loan indirectly by subsidiaryguarantees covering less than half the initial debt.What the Banks got in lending lingo was ‘structuralseniority’ – a direct claim against the guarantors(and thus against their assets levied on once ajudgment is obtained) that other creditors of [theparent corporation] did not have. This kind oflending occurs every business day. To undo thisbargain is a demanding task.” (419 F 3d at 212.)

The same can easily be said of participants inUS securitisation transactions.

Bankruptcy and servicing

In US securitisation transactions the SPV usuallydoes not operate its own business, which throughthe limitations imposed by the transactiondocuments and its organic documents is to belimited solely to the ownership and operation of thetransferred assets. Instead, the SPV contracts suchservicing out to another party, usually theoriginator itself in the first instance. When theservicing agreement has not been properlyterminated (or expired by its terms) prior to thecommencement of the originator’s bankruptcy, theoriginator’s rights and interests under the servicing

agreement do constitute property of theoriginator’s bankruptcy estate. Indeed, as has beenthe recent experience for the mortgage lendingcompanies that have become debtors in USbankruptcy cases, the originator’s servicing rightsmay be the only ongoing property right of anyvalue that the originator still owns in such cases.

Servicing as a valuable asset in an originator’sbankruptcy

When the servicing agreement has not beenterminated prior to the commencement of theoriginator’s bankruptcy case, it is likely to beviewed as an executory contract. The BankruptcyCode has several different provisions intended topermit bankruptcy debtors to continue to obtainthe benefits of profitable contracts, through theassumption or assumption and assignment ofprofitable executory contracts, and to relievethemselves of the burdens of unprofitable contractsthrough the repudiation of such agreements (see 11USC Section 365).

A debtor’s ability to continue to obtain thebenefits of a profitable executory contract is afundamental part of the Bankruptcy Code. Indeed,as a general rule the statute expressly nullifies andrenders ineffective contractual provisionsprohibiting the assignment of a debtor’s rightsunder an executory contract, as well as provisions(commonly referred to as ipso facto clauses)permitting the non-debtor party to terminate theservicing agreement based on the bankruptcy (orfinancial condition) of the debtor (11 USC Section365(e), (f)). While there are certain types ofexecutory contract that the debtor is statutorilyprohibited from being able to assume, such asexecutory contracts to make loans to the debtor (11USC Section 365(c)(2)), bankruptcy courts havetreated servicing agreements as executory contractsand have permitted the assumption andassignment of servicing agreements in bankruptcycases of originators/servicers.

However, the Bankruptcy Code nonethelessimposes statutory requirements that must besatisfied before a servicing agreement may beassumed or assumed and assigned in anoriginator’s bankruptcy case. These include curing(or providing a mechanism for curing) all non-ipsofacto defaults (if any) under the servicingagreement, compensating (or providing amechanism to compensate) the non-debtor partyfor any damages relating to any such defaults andproviding “adequate assurance” of the debtor’s (or,



where the servicing agreement is to be assigned, theassignee’s) ability to render future performanceunder the agreement (11 USC Section 365(b), (f)).

The Bankruptcy Code is likely to accord anoriginator in a Chapter 11 case a significant lengthof time (up to the confirmation of a plan ofreorganisation) to decide whether to assume orreject a servicing agreement (11 USC Section365(d)). It is possible for a non-debtor party toobtain an order from the bankruptcy courtscompelling the originator to make such a decisionpromptly or even permitting the non-debtor partyto terminate the servicing agreement based onperformance-based defaults. However, conventionalwisdom among US bankruptcy practitioners is thatit will be difficult to do so without first proving thatthe originator is unable to continue to service thesecuritised assets at an acceptable performancelevel (as determined by the bankruptcy court).

Modifying servicing agreement for the benefit ofthe originator or servicer

The Bankruptcy Code renders unenforceable any‘anti-assignment’ and ipso facto clauses contained inservicing agreements. However, the statutorynullification of those provisions generallyconstitutes the extent of the bankruptcy court’sability to rewrite the material provisions of thecontract. Where the bankrupt servicer is unhappywith material provisions such as the amount of theservicing fee or where such servicing fee is paid inthe securitisation waterfall, the bankruptcy court isgenerally powerless to rewrite those provisions atthe originator’s unilateral urging (see In re FlemingCos, 499 F 3d 300, 306 (3d Cir 2007) – a bankruptcycourt may not modify a contract term if the term isintegral to the bargain struck between the partiesand non-performance of that term would deny theparty the full benefit of its bargain). However, thebankruptcy court can approve a consensualmodification of the material provisions of aservicing agreement, and in one very well-knownoriginator/servicer bankruptcy that is exactly whathappened.

At the time of its bankruptcy filing in 2002Conseco Finance Corp was the largest originatorand servicer of manufactured housing loans in theUnited States. However, at the time of thebankruptcy filing the compensation terms underthe standard servicing agreement for Consecosecuritisations were unprofitable, in terms of boththe amount of the fee and its payment priority inthe securitisation waterfalls. In addition, the

consensus among the key securitisation parties wasthat if the securitisation trusts were forced underexigent circumstances to transfer servicing toanother servicing platform, the pertinentsecuritisation trusts would suffer significant losses.To avoid such losses, the parties effectively reacheda consensual resolution whereby the servicingcompensation provisions were modified, in bothamount and payment position in the securitisationwaterfalls, and as a result of such modificationConseco’s modified servicing rights and itsservicing platform could be sold as a going concernon a more orderly basis (see In re Conseco, Inc, CaseNo 02-B-49672 (Bankr, ND Ill Mar 14 2003).

Rejection of servicing agreement by originator

As a general rule, where it is not in the originator’sbusiness interest to continue to service the assets,the bankruptcy judge will permit the originator toreject the servicing agreement, although the non-debtor parties can seek to prevent or at least delaysuch a rejection for a definite time period whilethey try to make replacement servicerarrangements.

Where the originator cannot satisfy thestatutory requirements for assumption orassumption and assignment (and the non-debtorparties will not waive or modify thoserequirements), such a rejection eventually will bemandated. In either situation, the ability of the non-debtor parties to find and arrange an orderlytransition to an acceptable replacement servicer islikely to become a paramount concern to the othersecuritisation parties.

Bankruptcy of the SPV: key issues

The bankruptcy remoteness of the SPV is anintended feature of a US securitisation transaction.However, there is a difference between bankruptcyremote and bankruptcy proof. Parties to USsecuritisations do not expect that SPVs will notbecome bankruptcy debtors under any set ofcircumstances, and the legal opinions delivered inconnection with US securitisation transactionsusually opine as to the true sale and non-consolidation issues based on the assumption thatboth the originator and the SPV will have becomedebtors in a US bankruptcy case.

A general overview of the other possiblebankruptcy issues that may rise in connection witha SPV bankruptcy filing is outside the scope of thischapter. However, this part briefly discusses two



such issues in the context where, notwithstandingthe assumption and underwriting regarding thestrength of those assets at the inception of thetransaction, the securitised assets do not perform asexpected or, for whatever reason, the SPV itselfotherwise becomes financially distressed.

Commencement of a US bankruptcy case for the SPV

In US securitisation transactions, it is common tomandate, as part of the SPV’s governing organicdocuments, that the SPV have an independentfiduciary (eg, an independent director where theSPV is a corporation), and that the vote of thatindependent fiduciary be required for significantSPV decisions, including before the SPV can beproperly authorised to commence a voluntarybankruptcy case. One of the notions underlyingthese independent director provisions is theintended benefit to the SPV and its creditors ofhaving an independent fiduciary consider majordecisions from the SPV’s perspective and thus be ina position to prevent the SPV from taking actions atthe direction of the originator that may harm theSPV and its creditors.

However, where the SPV is itself in financialdistress, the independent fiduciary may wellbelieve that the commencement of a bankruptcy ofthe SPV is in the best interests of the SPV and itsconstituencies, including its creditors (eg, see In reKingston Square Associates, 214 BR 713, 734, 736(Bankr SDNY 1997), observing that an independentdirector of the general partner of each SPV, whorefused to vote for the voluntary bankruptcy of 11financially distressed securitisation SPVs,“abdicated his fiduciary role to the Debtors,creditors, and limited partners in favor of theinterests of [the secured creditors]”). In addition,even where such an independent fiduciary refusesto cast such an affirmative vote, the SPV and itscreditors may challenge the enforceability of theaffirmative vote requirement on estoppel or othergrounds (eg, see In re American Globus Corp, 195 BR263, 265-266 (Bankr SDNY 1996), refusing todismiss a bankruptcy case for failure to obtainrequired 100 per cent shareholder vote becausedismissal would frustrate Bankruptcy Codeobjectives, as well as based on estoppel principles).Finally, any such requirement for the propercorporate law authorisation of a voluntary filingwould not prevent an involuntary bankruptcypetition from being filed against a financiallydistressed SPV (see 11 USC Section 303; In KingstonSquare Associates, 214 BR at 734, 736, refusing to

dismiss involuntary bankruptcy petitions againstSPVs even though such filings had beenorchestrated by the SPVs themselves in order tocircumvent the independent director provisions).

Non-US SPV and ancillary proceeding underChapter 15 of the Bankruptcy Code

It is not uncommon for an SPV in a securitisationtransaction to be a non-US entity (eg, a CaymanIslands limited liability company), but tononetheless issue securities and have assets in theUnited States. If such an SPV were to becomefinancially distressed, it could in theory be eligibleto be a debtor in an insolvency proceeding in itshome jurisdiction or in a US bankruptcy case. Itcould also become subject to insolvencyproceedings in both jurisdictions. In such asituation, the Bankruptcy Code containsprovisions, set forth in Chapter 15 (the US-enactedversion of the United Nations Commission onInternational Trade Law Model Law on Cross-Border Insolvency), that permit the non-USproceeding to be considered the main proceedingand the US proceeding the ancillary proceeding. Insuch a situation, the non-US proceeding would bethe dominant proceeding, with the expectation thatactions taken in the US ancillary proceeding wouldbe limited to and focused on facilitating andfurthering the objectives of and results in the non-US proceeding, subject to certain substantive limitsimposed by Chapter 15 on the bankruptcy judge’spower (see 11 USC Sections 1519, 1521).

However, explicit statutory standards inChapter 15 govern the recognition of non-USproceedings as the foreign main proceeding, or as aforeign non-main proceeding. If such statutoryrequirements cannot be satisfied, the non-USproceeding cannot be recognised. Two recentdecisions involving Cayman Island hedge fundshave refused to grant recognition to non-USproceedings, even in the absence of any objection tosuch recognition by any interested parties (see In reBear Stearns High-Grade Structural Credit StrategiesMaster Fund, Ltd, 374 BR 122 (Bankr SDNY 2007),Cayman Islands proceedings of ‘letterbox’company that did not conduct any business in theCayman Islands, but whose business wasconducted (and whose liquid assets were locatedprincipally) in New York could not be recognised asa foreign main or foreign non-main proceedingunder Chapter 15, and the only US bankruptcyrelief open to it was a voluntary or involuntaryproceeding under Chapter 7 or 11 of the



Bankruptcy Code; In re Basis Yield Alpha Fund(Master), 381 BR 37 (Bankr SDNY 2008), refusing togrant summary judgment on similar set of facts).

Where a financially distressed non-USsecuritisation SPV similarly has the centre of itsbusiness operations, particularly the bulk of itsassets, in the United States, these two decisions

indicate that there may be some question as towhether any non-US insolvency proceedings forsuch SPV will be able to be recognised underChapter 15 of the Bankruptcy Code and that instead,the only US bankruptcy avenue available to such anon-US SPV may be its own proceeding underChapter 11 or Chapter 7 of the Bankruptcy Code.


Economy & Finance

Asset Securitization and Insolvency