Monday, February 23, 2009

Securitization: ‘True Sale’ of Receivables

In order to make a securitization transaction bankruptcy-proof with respect to the originator (seller) of receivables, it is necessary that there is a ‘true sale’ of the receivables to the assignee (purchaser). Failing this, the transaction could be recharacterized as a secured loan, thereby altering the rights and obligations of the parties under law (sometimes contrary to their original commercial intent). This issue is often critical in securitization transactions even in the Indian context.

An article True Sale of Receivables: A Purposive Analysis posted on SSRN by Kenneth Kettering elaborates on this issue. Although the article essentially relates to the U.S. law position (Article 9 of the Uniform Commercial Code), several of the general principles discussed therein have universal applicability, and hence may bear relevance in the Indian context as well. The abstract is as follows:

“An enormous market exists in securitized debt backed by receivables. For the product to achieve its intended purpose, it is essential that the receivables be conveyed by the beneficiary of the financing to its securitization vehicle in a "true sale" - that is, a conveyance that courts will respect as being a sale, in accordance with its form, and not recharacterize as a loan secured by the receivables. Article 9 of the Uniform Commercial Code declines to provide guidance on the proper conditions for recharacterization, and cases have been incoherent. This paper analyzes the purposes of the recharacterization doctrine, inside and outside of bankruptcy, and the conditions for recharacterization that follow from those purposes. Different conditions for recharacterization may apply in different legal settings. The paper concludes that cases have been more aggressive in recharacterizing sales under Article 9 than is justified by the purpose of the doctrine. By contrast, the true sale status for bankruptcy purposes of the conveyance of receivables made in a typical securitization transaction is inherently doubtful under current law. Assurance that the typical securitization structure would survive legal challenge in bankruptcy therefore rests largely upon nondoctrinal factors.”

2 comments:

Anonymous said...

Interesting article... I wonder how far the argument will be relevant in India? Is the understanding of true sale same in India as well as the US?

Umakanth Varottil said...

Thanks for the comment. Although the specifics of 'true sale' may be different in the U.S. and in India, some of the general principles are likely to be universally applicable across common law countries. To that extent, securitisation transactions in the Indian context may be susceptible to recharacterisation if not properly structured. However, the relevant law in India seems quite scattered (across Transfer of Property Act - Sec. 130, bankruptcy/corporate insolvency provisions in the Companies Act and relevant RBI guidance on 'true sale' for banking companies, etc.) and case law is yet to acquire some level of robustness.