Bankruptcy remoteness of an SPV in a securitization. A selected choice of law issues

Term Paper 2015 41 Pages

Law - European and International Law, Intellectual Properties



List of Abbreviations

1 Introduction

2 Process of Securitization

3 Selected Choice of Law Issues
3.1 ’’Consolidation of the SPV with the Originator”
3.2 Transfer of Assets
3.3 Clawbacks


A Securitization

’’Title of Research Paper”[1]: Bankruptcy

Remoteness of an SPV in a Securitization -

Selected Choice of Law Issues
Number of words: 5673

List of Abbreviations

illustration not visible in this excerpt

1 Introduction

Securitization is the process of pooling assets (e.g. residential or commercial mortgages, consumer and student loans, auto loans, credit card debts, etc.)[2] and separate risk into tradable securities[3]. It is globally considered to be a very, if not the most innovative development in the modern financial markets[4] whereas the goal is to raise cash at a lower rate compared to other financing alternatives such as corporate bonds or bank loans[5].

Prior to the financial crisis that hit the world globally, securitization was booming and the issuance volume peaked in 2006 at around approximately USD 4 trillion[6]. Following the crisis, this number slumped to about USD 500 billion in 2015[7].

One of the peculiarities of securitization is its cross-border connection where multiple jurisdictions are involved for the designing, planning and implementation of the whole transaction[8] and therefore, securitization tends to be a complex undertaking that requires not only a significant amount of legal and economical due diligence but also negotiation and legal work in form of analysis and document drafting[9]. Additionally, to further complicate this issue, only a few countries have enacted specific laws for securitization[10].

As a result, the choice of law aspects for securitization are manifold and need to be carefully investigated.

The first part of this paper provides a general introduction to the process of securitization via an SPV. The second part of this paper addresses the bankruptcy remoteness of an SPV from a choice of law perspective by focusing on consolidation (see tab 13 et seqq. below), transfer of assets (see tab 23 et seqq. below) and clawback (see tab 42 et seqq. below).

2 Process of Securitization

The process of securitization is best described at an example which shall be done with a fictitious international car manufacturer called ’’Hotcars”[11]. Currently, more and more cars are leased and not bought by customers[12], which is also true for Hotcars. Hotcars, while leasing its cars to customers, remains the owner of the car[13] and receives regular payments from its cus­tomers. In the chart (see Figure 1 in Appendix A), Hotcars would represent the Originator and the customer who leases the car would represent the Bor­rower.

Since the business of car leasing is booming, Hotcars, in a short amount of time, will have a lot of customers who do not buy cars but lease them. This may result in the situation that Hotcars is running short in liquidity as it still has the full costs to produce the cars but will only get the full payment in the future. As a result, if Hotcars whishes to expand its business, it will be required to raise capital. Instead of issuing bonds, shares or getting a bank loan, Hotcars may securitize its receivables originating from its car leasings[14].

In a first step, Hotcars would be required to ”deconstruct[s] itself by separating” its car leasing contracts, including the cars, from its general business[15]. To achieve this goal, Hotcars would be required to set up a separate legal entity in a foreign jurisdiction known as an SPV to which the assets in form of the car leasing contracts and the cars will be sold[16].

In a securitization, the SPV usually has special characteristics compared to an operating company such as:[17]

- thin capitalization;
- ”no independent management or employees”;
- external management of the SVP's assets; and
- bankruptcy remoteness.

The SPV will finance the acquisition of the assets by issuing securities to investors (”privatly or publicly”[18] )[19]. Such securities can have many different names, depending on their specific characteristics such as ABB, ABN, ABO, ABS, CBOs, CDO, CLN, CLO, CMBS, CMOs, CRE, MBS, RMBS, often in combination with terms like ’’senior notes, junior notes, floating rate notes, etc”[20]. With the sale of the assets to the SPV, the customers of Hotcars will make their payments in the future to the SPV[21]. The SPV will use the proceeds received from the obligor to pay interests and|or principal to the investors[22].

3 Selected Choice of Law Issues

As has been mentioned above (see tab 8), one of the primary goals of securitization is bankruptcy remoteness which should give the investor an undis- putable claim on the assets that serve as collateral for the securities bought[23].

There are several strategies that may lead to a bankruptcy remoteness but naturally, many aspects need to be considered. Generally, it is required that the assets from the Originator are transferred to the SPV in the form of a ’’true sale”[24] which is defined as ”a sale that is sufficient under bankruptcy law to remove the assets from the orgininator’s bankruptcy estate”[25]. Additionally, the SPV should be ’’demonstrably distinct”[26] from the Originator which basically means that it has to be an independent legal entity that in effect excludes the aggregation of its assets with the Originator[27]. The legal form of an SPV depends on the respective jurisdiction, but is most commonly incorporated as a corporation limited by shares, a trust, a partnership, or a limited liability company[28]. However, specifically in common law jurisdic­tions, the SPV usually is set-up as a trust[29]. According to Underhill, a trust is:

”...an equitable obligation binding a person (who is called a trustee) to deal with property over which he has control (which is called the trust property) for the benefit of persons (who are called ben­eficiaries or cestui que trust) of whom he himself may be one and any of whom may enforce the obligation”[30]

Last but not least, even tough the transfer was perfected and the SPV is recognized as a separate legal entity, creditors of the Originator may still have a clawback claim against the SPV in the case of the insolvency of the Originator[31]. Therefore, the following three issues regarding the bankruptcy remoteness of an SPV shall be elaborated from a choice of law perspective:

- ’’Consolidation of the SPV with the Originator”[32] [33] ;
- Transfer of Assets; and
- Clawbacks.

3.1 ’’Consolidation of the SPV with the Originator”

[33] It is widely recognized in corporate laws around the world that corporations are separate legal entities which have a legal personality and legal capacity[34]. This basically means that the company alone is responsible for its debts and that its shareholders, besides paying the share price, bear no further liability towards the company[35].

One of the key goals of securitization is the separation of the assets from the Originator which, in a first step, is achieved by setting-up a separate legal entity called ”SPV”[36]. The goal of this structure is to make sure that in the case of a bankruptcy of the Originator, its creditors only have access to the assets of the Originator but not to the assets of the SPV[37].

However, there may be circumstances where the concept of separate legal entities of SPV’s may be disregarded by courts[38]. The result of such a decision would be devastating for the structure of the SPV as the Investors would not be protected from the insolvency of the Originator.

Most legal systems have rules or at least a practice as to when a separate legal entity may be disregarded[39]. However, this is usually only possible ’’un­der exceptional circumstances”[40] and is called consolidation or alternatively lifting or piercing of the corporate veil (herein called Consolidation)[41]. To make things from a substantive law even more complicated, the rules for Consolidation may not be found in statutory provisions but may have been developed by court practice and legal scholars as is the case in Switzerland where the basis is considered to be the principle of good faith[42]. Swiss courts, similar to the U.S.[43] may order a Consolidation if one of the following cir­cumstances, are met, however, such cases are extremely rare[44]:

- commingling of the Originator’s assets with the SPV’s assets[45]
- inadequate capitalisation of the SPV[46] ; or • for trust created in the cases where the SPV as a separate legal entity has completely been ignored in public by the Originator[47].

The applicable laws most at hand regarding a Consolidation are: (1) the law of the place of incorporation of the SPV and (2) the law of the place of incorporation of the Originator as the place where the transaction occured[48]. By determining the applicable law, the nature of the case has to be analysed and classified. The question as to whether a legal entity can be Consolidated affects the basic principle of the non-liability of the shareholder for the company's debts and therefore is, in most cases, a core principle of the applicable company law in the respective jurisdiction. The question is not about a general claim or an obligation, although this often forms the basis, it is more about the nature of the company itself and whether the respective company law, legal doctrine or legal practice allows Consolidation. Since this question focuses on the core principal of the applicable company law, the place of incorporation of the company should be the applicable law. This is also the approach chosen by most jurisdictions[49].

Consolidation is also frequently described as a matter of the ’’internal affairs of a corporation”[50] and therefore, should be governed by the law of the place of incorporation[51]. This seems to be the logical explanation when considering that the company in question has its place of business or its main shareholders in the same jurisdiction as the place of incorporation[52]. In the case of an SPV, at least the latter is rarely the case. Whether the SPV has its primarily business at the place of incorporation may be interpreted in different ways with valid arguments. Usually, besides holding the assets that originally belonged to the Originator, an SPV does not have any businesses and also no employees. This argumentation may open the doors to a different applicable law which may be the place of incorporation of the Originator as this is the place where not only the underlying contracts were originated but also the securitization itself[53]. This is also described as being the jurisdiction with ”the most significant contact”[54].

Additionally, countries may have enacted specific laws for the protection of their creditors which declare that the applicable law is the place of the Creditor[55]. Even not found in the materials consulted for this paper, it also cannot be fully excluded that a country may not apply the law of the underlying obligation.

As a result, based on this analysis, a creditor, depending on the specific circumstance, may have the choice of the following laws:

- Law of the place of incorporation of the SPV;
- Law of the place of incorporation of the Originator;


[1] all quotation marks provided herein and the first two pages are based on the require­ments of the HKU as published on moodle or sent to me by email. The wording has not been changed unless specifically asked.

[2] Encyclopedia [21]; Skadden [65].

[3] Academike [1], N 1.

[4] Cerrato et al. [11], page 1; Schwarcz [61], page 133; Academike [1], N 1.

[5] Schwarcz [61], page 133; Janger [37], page 305; Hu [33], page 3 with further expla­nation regarding credit risk.

[6] Blommestein, Keskinler, and Lucas [8], page 4.

[7] Kiffmeister [40].

[8] Arca [4], page 21, cited after Frankel [23], page 1; Frankel [23], page 1.

[9] Davidson et al. [15], page 524; Kothari [44], page 571.

[10] KoTHARi [44], page 571 and 592; Markets [49], page 6, cited after Frankel [23], page 278.

[11] A more comprehensive explanation of the securitization process of car leasing contracts can be found in DBRS [17] and IBCA [34]. The idea of explaining securitization with an example was inspired by Fabozzi and Kothari [22], page 8 et seqq.

[12] Phillips [56].

[13] This is usually the case, see as an example Honsell [30], page 25.

[14] see Arnold [6], page 369 et seqq which also discusses further alternatives.

[15] ScHWARCZ [61], page 134.

[16] Gorton and Souleles [27], page 1; Janger [37], page 301.

[17] Gorton and Souleles [27], page 2.

[18] Slaughter and May [66], page 7.

[19] Schwarcz [61], page 136.

[20] Kothari [44], page 11, 39-58.

[21] Institute [36].

[22] Desai and Kably [18], page 2; Köhn [43], page 103.

[23] Kothari [44], page 571.

[24] Kothari [44], page 577 et seqq.

[25] ScHWARCZ [61], page 135 with reference to U.S. law and ScHWAROZ [60], page 35-36; see also KoTHARl [44], page 577 et seqq.

[26] Gorton and SouLELES [27], page 10.

[27] Kothari [44], page 632.

[28] Gorton and Souleles [27], page 7.

[29] Gorton and Souleles [27], page 7.

[30] Oerton [55], page 1, cited after Ramjohn [57], page 11.

[31] Lenoir [46], et passim; II and Lipin [35], page 223 et seqq.

[32] KoTHARi [44], page 636.

[33] KoTHARi [44], page 636.

[34] see MacDonald [47]; Mäntysaari [48], page 65; see as an example CC 52 and 53 as well as CCL 3 and 4.

[35] Hopkins [31]; Easterbook [19], page 89-90; Horn [32], page 934; see as an example CO 680 and CCL 3; for German law see Schiessl [59], page 1.

[36] Consultant [12].

[37] Consultant [12].

[38] see as an example II and Lipin [35], page 181.

[39] Schiessl [59], page 481.

[40] Horn [32], page 934.

[41] Kothari [44], page 632; Slaughter and May [66], page 6 and 7.

[42] BGE 102 III 165; Kobierski [42], page 36, cited after Hans Caspar von der Crone [28], page 449; Honsell [29], Article 2, N 52.

[43] Karagjozi [38], page 8.

[44] Sethe [64], N 25.

[45] Sethe [64], N 24; Karagjozi [38], page 8.

[46] Sethe [64], N 24; Karagjozi [38], page 8.

[47] Sethe [64], N 26; Karagjozi [38], page 8; BGE 120 II 331.

[48] Ketenci [39], E.

[49] Cavitch [10], 120.07, citet after Crespi [13], page 6 with various other sources and examples; Matheson [51], page 1096 with references to court cases.

[50] Crespi [13], page 11; Ketenci [39], E.2.

[51] Ketenci [39], E.2.

[52] Ketenci [39], E.2.

[53] indicative Thompson [70], page 1053 et seq. with references to California and New York law; Ketenci [39], E.2; Martin-Nagle et al. [50], page 6 with case law example.

[54] Martin-Nagle et al. [50], page 6 with reference to 18 F.3d 1384, 1387 (7th Cir. 1994).

[55] Thompson [70], page 1054 with further references; Martin-Nagle et al. [50], page 7.


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Title: Bankruptcy remoteness of an SPV in a securitization. A selected choice of law issues