Guernsey

Author: | Published: 10 Oct 2001
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INTRODUCTION

This paper seeks to deal with the establishment of financing vehicles in Guernsey as exempted or international companies under the relevant provisions of the Companies (Guernsey) Laws of 1994 to 1996 ('the Companies Law'). They will be termed 'SPVs' for the purpose of this memorandum. It does not analyse in detail all the considerations which may lead to the inclusion of an offshore structure in a financing transaction. The material considerations tend to vary on a transaction by transaction basis, but, in a normal course of events are driven by on-shore securities law, fiscal and accounting considerations.

'Securitization' is a commercial rather than a clearly defined legal term and can be used to describe a variety of transactions. Typically, a securitization transaction involves the establishment of a special purpose company ('SPV') which will issue notes, bonds or other debt instruments, the sale proceeds from which will be applied to the acquisition of a specified class of underlying securities designed to provide the cashflow necessary to meet the payments of interest and principal on the debt securities issued by the SPV. In a simple case, the underlying securities might, for example, comprise a fixed rate debt instrument coupled with a fixed to floating rate swap. This, effectively, allows the promoter of the SPV to convert fixed rate securities to floating rate securities. Variations on this theme are endless. Another common use of a securitization vehicle is to permit the convenient marketing and sale of the stream of future income, for example, the royalties paid to a musician or the stream of income and capital payable on a mortgage portfolio. The relevant property is transferred into the SPV by the owner thereof in exchange for a price which is funded out of the issue of debt instruments secured on and payable by reference to the underlying income stream. Again, there are numerous variations on this particular theme.

THE BAILIWICK OF GUERNSEY

Constitution

The Bailiwick comprises three jurisdictions: Guernsey, Alderney and Sark. Some legislation covers the whole of the Bailiwick, in particular financial services legislation. Guernsey and Alderney have their own separate and different Companies Laws and there is no Companies Law in Sark. Alderney and Sark are dependencies of Guernsey but have certain legislative powers of their own. Guernsey is governed by the States of Deliberation which is its legislature. Bills are known as 'projets' and following approval by the States are sent to the Privy Council for assent. The States may provide enabling provisions within a projet permitting further legislation to be passed by the States by way of Ordinance without the necessity for the assent of the Privy Council. The executive business of the States is conducted through a Committee System, the senior committee being the Advisory and Finance Committee. This Committee is primarily responsible for, inter alia, the Financial Services Sector, but in 1987 the Guernsey Financial Service Commission ('GFSC') was established and the GFSC has received delegated authority for the regulation of Financial Services in the Bailiwick.

Legal System

Although Guernsey has an interesting Norman French legal history, in company and commercial matters, the basic common law principles are, by and large, subject to specific statutory differences, applicable in Guernsey and the basic legal framework in this area will be recognisable to the English practitioner, albeit supplemented in certain areas by Guernsey customary laws.

Relationship with United Kingdom and European Union

Guernsey is not part of the United Kingdom. It was a possession of the Duke of Normandy, having been retained after the Duchy of Normandy was lost to the French King in 1204. As such Guernsey owes allegiance to the Crown, but the role of the UK Parliament in its affairs is limited. The Kilbrandon Report in 1973 established that the United Kingdom Parliament (in which the Island is not represented) does not legislate for Guernsey in domestic matters without the consent of the States of Guernsey and that taxation is a domestic matter.

Guernsey's relationship with the European Union is dealt with in Protocol III to the Treaty of Accession 1973. Guernsey is not a member of the European Union but enjoys the benefit of the free movement of goods and persons. Accordingly, there are no tariff barriers between Guernsey and the EU and persons (other than those with purely Channel Islands connections) are free to move between the two. However, the Housing Laws in Guernsey restrict the occupation of all but 1800 houses (known as 'open market' dwellings) to those persons who are either Guernsey in origin or have a Housing Licence for essential or other purposes. (Guernsey is only 24 sq. miles with a population of around 60,000 persons).

OECD

The OECD Convention applies to Guernsey by virtue of an extension of the Convention as it applies to the UK. This is considered desirable in locating an SPV in the context of structures involving certain European jurisdictions.

Establishment in Guernsey

The reasons for establishing a securitization vehicle offshore vary, usually according to the tax and regulatory regimes applicable in the home jurisdiction. It is usually critical to the establishment of any successful securitization structure that (i) the SPV itself does not attract material corporation tax; (ii) payments of interest and principal can be made by the SPV without deduction of withholding tax; and (iii) stamp duty and taxes of a like nature should not be payable on the issue or transfer of the debt instruments issued by the SPV.

In the UK, for example, difficult questions can arise as to whether, for UK tax purposes, a corporate SPV will be treated as a 'trading' company or an 'investment' company and in terms of the deductibility of payments on credit derivatives. With some securitization structures, there can be difficulties with withholding tax requirements and UK legislation on 'manufactured payments'. There can also be difficulties with 'potential distribution treatment' whereby interest payable by the SPV can be treated for UK tax purposes as a dividend and hence cease to be tax deductible, in particular, where, as is common in securitization arrangements, the coupon on securities issued is dependent upon the return on underlying securities. Given these areas of difficulty, it is often desirable to establish an SPV offshore. Other jurisdictions, typically, have similar considerations which lead to the same conclusion.

Having decided to establish the SPV offshore, it is then necessary to establish a jurisdiction with certain key features and, in this regard, Guernsey, as a general rule, proves to be eminently suitable given the features described below, in particular:-

  • flexible Companies Law including "Protected Cell" companies;
  • authorisation and regulation as a Collective Investment Scheme is not required for debt issuing vehicles;
  • availability of tax exempt status;
  • suitable trust laws to permit the establishment of 'orphaned' vehicles;
  • specific recognition of foreign law security arrangements;
  • specific statutory recognition of set-off and subordination arrangements;
  • arrangements may be made for listing on the Channel Islands Stock Exchange, where appropriate.

Recent Developments in Guernsey

The basic legal infrastructure for the establishment of SPVs in Guernsey was largely settled with the Companies (Guernsey) Laws 1994 to 1996, the Security Interests (Guernsey) Law, 1993 and the Trust Laws of 1989 and 1990.

A recent innovation has been the introduction of Protected Cell Companies and the extension of their use to securitization vehicles during the course of this year. The Ordinance, which is described below, permits a multi-series vehicle to issue separate tranches of bonds through "Cells"; a mechanism that can be used instead of or as well as the more traditional limited recourse arrangements. The Protected Cell legislation was, in fact, pioneered with an eye to the Guernsey insurance industry but, as has become apparent, the concept is equally useful in multi-series securitization structures as well as in the context of umbrella mutual funds.

The establishment of the Channel Islands Stock Exchange in St Peter Port in the fourth quarter of 1998 has also proved something of a magnet for those who seek a primary or secondary listing for the SPVs securities. Listings on the Exchange have now reached 220. The special, simplified rules for debt listings have proved attractive to the promoters of debt issuing SPVs.

THE PRINCIPAL STRUCTURES

On Balance Sheet Finance Vehicle

Typically, where the SPV is established by a bank or international group for fund raising purposes it will be established under the Companies Laws (for which see below) as a wholly-owned subsidiary within the group and, in the normal course of events, will be used to issue euro-bonds or notes, usually unsecured but, often, guaranteed by the parent. Such debt securities may be convertible into shares of the parents. They may be subordinated. Occasionally they may be secured, possibly limited recourse (for which see below).

Off-Balance Sheet Securitization Vehicle / Use of Charitable Trust Structure

Where, usually for accounting or fiscal reasons, it is required that the SPV should not be consolidated in the balance sheet of the lender, borrower or promoter, the SPV may be established on the basis that its issued share capital (usually in the vicinity of £1,000 or US$1,000; there is no definitive, statutory figure) is registered in the name of a local trust company ('the charitable trustee') as trustee of a charitable trust established pursuant to a declaration of trust by the trustee.

Typically, the declaration of trust would restrict any disposition of the shares of the SPV or its winding up prior to the termination of the transaction or whilst any notes or bonds of the SPV remain outstanding. Alternatively, there may be provisions prohibiting the trustee from undertaking certain actions without the consent of, for example, the promoter or, perhaps, the security trustee. However, the promoter should not be so aggressive in its demands to control the SPV that it risks the SPV being regarded as its nominee or agent and disregarded as a separate legal entity or in such a way as to cause it to fall within controlled foreign company legislation in the UK or within equivalent legislation in other jurisdictions or to require consolidation under applicable GAAP.

In terms of funding the establishment of the charitable trust, in addition to providing sufficient funds to capitalise the SPV in an appropriate amount, it may be desirable to include additional capitalisation at the trust level to cover the trustee's fees and disbursements for the anticipated life of the transaction. Alternatively, the trustee may waive its fee and settle for its administration fee under the administration agreement described below. Another possible arrangement would be for the security documentation to require the security trustee to settle the fees of the charitable trustee as trustee and/or as administrator of the SPV.

Following the termination of the transaction, the trust will terminate and the trust property, (which, in the normal course of events, will comprise the capital of the SPV and any transaction fees paid to the SPV net of its expenses), will be distributed by the trustee to such one or more charities as the declaration of trust requires.

The SPV will enter into an administration or management agreement usually with the trustee acting as administrator. This agreement will set out the services to be provided by the administrator to the SPV. The services will include the provision of directors and officers, maintenance of the registered office, attending to applicable filings and annual returns and other filings under Guernsey law and, if applicable, liaising with auditors in the preparation of the SPVs audited financial statements. Depending on the circumstances it may (or may not) be desirable to include the promoter (or, possibly, the security trustee) as an additional party to this agreement to take covenants from the administrator in respect of the business and management of the SPV which the promoter or security trustee, as the case may be, may then enforce directly.

If there is no cash flow or other provision in the transaction documentation to meet the SPVs ongoing fees and expenses, the promoter or another person (e.g. the trustee of the bonds) may be included as an additional party to the administration agreement to undertake to meet these costs.

There are a significant number of affiliates of major international banking institutions competent to provide trustee and administrative services in the Bailiwick of Guernsey as well as a number of reputable local companies.

Security/'Bankruptcy Remote'

A typical securitization transaction entered into by a Guernsey SPV will include all or some of the following elements:-

  1. The SPV will secure notes or bonds, usually secured on a holding of underlying securities and, possibly, a swap or other income enhancement transaction.
  2. The assets comprising the security will be held by a trustee of the notes or bonds ('the security trustee') (not to be confused with the charitable trustee described above) for the benefit of the holders thereof.
  3. The SPV will be established on a 'bankruptcy remote' basis. This aspect usually involves two elements:-
    1. the Memorandum and Articles of the SPV and/or the charitable trust deed and/or the note issue documentation will prohibit the SPV from entering into any commercial transactions other than those specifically contemplated at the outset and matters strictly incidental thereto;
    2. the obligations of the SPV in respect of the notes or bonds it issues will be expressed to be limited in recourse to the underlying security held by the security trustee and that, after exhaustion of these assets, the debts of the SPV represented by the notes and bonds, will be extinguished and no person will have any right to petition to wind-up the SPV in respect of such balance. The point of this is, having secured due performance of the notes or bonds issued by the SPV with all of its material assets, there is little point of leaving the charitable trustee or the directors of the SPV exposed by an insolvent liquidation of the SPV (and see 'Limited Recourse and Commercial Benefit' below). A further consideration is that, if the SPV is to be used to issue a series of notes or bonds, each secured on a separate portfolio of assets, then it is critical that each issue should, so far as possible, be 'isolated' from each other. Effective limited recourse wording is critical in achieving that end unless a Protected Cell Company is used (for which see below).
  4. The security trustee may also take security over the issued share capital of the SPV which would give it the ability to take control of the SPV on a default. The security instrument granted by the charitable trustee will differ in some respects from the security granted by a parent in respect of its on-balance subsidiaries. These differences reflect the fact that, in this case, the charitable trustee's role is that of a service provider rather than a commercial transaction party. In particular, it would usually be appropriate to make provision for the security trustee to bear all costs of enforcement out of the secured assets. Clearly, it would be inappropriate to place on the charitable trustee any obligation, whether as primary obligor or as guarantor, in respect of the SPVs payment obligations. Where security is to be taken over the SPVs issued share capital, the charitable trust arrangements in respect of the issued capital of the SPV will need to accommodate the security either by express permissive provisions on the charitable trust deed or by the 'flawed asset' approach, (i.e. providing that the shares are settled on the trust, subject to the security). As an alternative to a security interest in the SPVs issued share capital, the security trustee may consider a call option arrangement, requiring the charitable trustee to transfer the shares to the security trustee on request and usually on payment of par value.

Protected Cell Companies

The use of Protected Cell Companies, initially covered by the Protected Cell Companies Ordinance, 1997 to 1998 has now been extended from mutual funds and certain insurance vehicles to other financial services companies including, specifically, securitization vehicles. The principal purpose of a PCC is to permit the segregation of assets and liabilities of a single company into separate, distinct 'Cells'. The Ordinance provides for the isolation of an insolvent Cell so that the assets of the other Cells are protected from contagion by the liabilities of the impaired Cell. PCC structures are, therefore, a convenient tool in the structuring of multi-issue securitization vehicles (as well as multi-class umbrella mutual funds). In the context of securitization vehicles, a PCC structure may be used as a supplement to or, in certain cases, in lieu of the traditional contractual limited recourse wording.

Limited Recourse and Commercial Benefit

The SPV is a corporate entity and its directors will be subject to the typical common law duties of care and skill and to fiduciary duties. Of primary relevance here is the duty of a director to act in that which he believes to be his company's commercial interests.

In determining the level of benefit or fee payable to the SPV the directors may be expected to undertake the usual risk-reward analysis: that is, the directors will want to satisfy themselves that the profit opportunity or fee payable to the SPV is commensurate with the perceived risk assumed.

The importance of directors' duties for the other transaction parties is well established in common law jurisdictions by the English decision of Rolled Steel Products (Holdings) Ltd v British Steel Corp. The theoretical risk is that other transaction parties, if fixed with actual or constructive knowledge of such breach of duties, may find themselves unable to enforce their contractual rights as against the SPV if challenged by a liquidator or third party creditor. There is also the risk of personal liability on the part of the directors of the SPV.

The solution, which avoids either a breach of duty or the payment of significant transaction fees to the SPV to balance the commercial risk of the assumption of open-ended loan repayment obligations, is to limit those obligations both in amount and recourse to the value of the security granted by the SPV. As the SPV will grant security over all its material assets, the lender is not being deprived of recourse against any significant asset. As the potential or theoretical downside to the SPV is limited to the loss of assets it would not have had it not participated in the transaction and with no prospect of insolvency, the directors typically take the view that a modest transaction or profit fee would be appropriate.

Equipment Financing Transactions

The arrangements described above are, in principle, suitable for the financing by commercial airlines and shipping lines of their fleet acquisitions; also the acquisition of power generation facilities and, indeed, in principle, any other assets or equipment.

The attraction of an 'orphaned' SPV structure from the lender's perspective is that for example, in the context of aircraft financing, ownership of the aircraft does not rest with the airline, but with an SPV owned and controlled by a trust company which holds title in an off-balance sheet capacity. Ownership therefore vests in an entity which is unlikely to be hostile to the lender in a default scenario when the lender seeks to enforce its security. From the lender's perspective, this ownership arrangement may provide the lender with advantages that are close to those that would come with retaining title to the aircraft itself whilst avoiding the consolidation of the aircraft on its own balance sheet. The assignment by the SPV of its rights under the lease with the airline will also give the lender effective control of the enforcement of rights of the SPV as against the airline under the lease. In the event of default, if the lender seeks de-registration in the airline's jurisdiction, the lender should be able to count on the exercise of the de-registration rights, rather than having to rely solely on a mortgagee's rights. Certain jurisdictions do not recognise the mortgagee's right to de-register and may otherwise limit the mortgagee's remedies, thus making exclusive reliance on a mortgagee's rights, potentially unsatisfactory for the lender.

In addition to legal certainty, ownership of the aircraft or other relevant asset will be in a jurisdiction with political, economic and social stability which may give comfort to a lender in cases where the 'borrower' is based in a jurisdiction where there is perceived risk.

Ownership of the asset will vest in a bankruptcy-remote structure which should not be directly affected by the bankruptcy of the borrower, thus avoiding the significant difficulties that could arise if title vested in the borrower or in a special purpose subsidiary or affiliate established by it.

VALIDITY OF SECURITY GRANTED BY A GUERNSEY COMPANY

Where the SPV, incorporated in Guernsey, has entered into security arrangements, it would be important to establish that they are valid and binding on the SPV under the laws of Guernsey, being the jurisdiction of incorporation. Conflicts of law issues can be complex. Typically, for example, in respect of a secured bond or note issue, the issue and security documentation will be governed by the laws of a foreign jurisdiction, usually English law or New York law; the security trustee will, typically, be in London, New York or Luxembourg and the underlying securities may well be documented under the laws of various jurisdictions. Under Guernsey law, there is statutory recognition of such security arrangements under Section 10 of the Security Interests (Guernsey) Law, 1993.

In circumstances where the share capital of the SPV itself is to be charged, then, in the normal course of events, this will be documented under Guernsey law in accordance with section 2 of the Security Interests (Guernsey) Law on the basis that Guernsey law would be most appropriate as the chose in action to be charged is both sited in and governed by the laws of Guernsey.

It follows that, in the normal course of events, appropriate, satisfactory opinions as to the validity of the security arrangements under the laws of Guernsey can be given.

SET-OFF AND SUBORDINATION

The Security Interests (Guernsey) Law also gives statutory recognition of set-off arrangements and the Companies Law recognises subordination arrangements, thus clarifying by statute uncertainties which might otherwise be a concern under, for example, English law. Subordination will be relevant, in particular, where credit enhancement is to be achieved by the creation of a Senior / Junior Notes structure.

THE CHANNEL ISLANDS STOCK EXCHANGE

The Channel Islands Stock Exchange was established in Guernsey with its principal office in St Peter Port on 27th October 1998. The CISX provides for the listing of investment funds, debts securities and trading companies. Debt securities of local and international issuers may be listed, including issues by SPVs. The CISX is a Member of the European Securitization Forum, an initiative sponsored by the US Bond Market Association to promote the continued growth and development of securitizations throughout Europe and to represent the interests of European securitization market participants. It is also a corresponding member of the Paris based International Federation of Stock Exchanges and an associate member of the International Securities Market Association.

RATING

In certain cases, the rating of Bonds issued by an SPV may be important. Indeed, certain transactions are structured by the use of credit enhancement or swap arrangements, effectively, with a view to 'converting' debt with one rating into debt issued by an SPV, suitably enhanced, with a higher rating. In the normal course of events, an SPV structure can be established in Guernsey with appropriate security and 'bankruptcy remote' arrangements so that the best possible rating can be achieved consistent with the quality of the underlying assets.

INCOME TAX STATUS

For the purposes of Guernsey Income Tax, a distinction is drawn between three types of Guernsey registered company:-

Guernsey Resident Company - All Guernsey registered companies will automatically be regarded as resident for Guernsey Income Tax unless they qualify and apply for 'exempt' status. A Guernsey resident company is subject to tax on its trading profits at the standard Guernsey rate of 20 per cent. Although an SPV establish under the Guernsey Companies Law will not usually have resident status, in fact, in some cases, such status would not be problematic in that pre-clearance may be established with the Income Tax Authority as to the deductibility of the SPV's outgoings. With full deductibility established, in the normal course of events, the SPV's taxable profits will be nominal in any event and, in principle, the 20% income tax rate will apply only to that nominal profit.

Exempt Status - In the normal course of events, a Guernsey SPV established for Guernsey securitization purposes will qualify for exempt company status under one of the headings of the Income Tax (Exempt Bodies) (Guernsey) Ordinances, 1989 to 1996. The headings are too complex to set out in an article of this length. Suffice it to say, most securitizations will fall within them. It should also be noted that under Guernsey tax regulations, the directors of the SPV may be resident in Guernsey and board meetings may be held within Guernsey without affecting the SPV's status for tax purposes.

International Status - A company may qualify as an international body if it is resident or carries on business in Guernsey but derives no income from trading with persons resident in Guernsey. It may not be owned wholly or in part by any persons resident in Guernsey. An international body pays Guernsey tax at a rate agreed between it and the Income Tax Authority of more than zero but not exceeding thirty per cent upon its world wide income. It may thereby benefit under favourable tax legislation or concessions in other jurisdictions.

Typically a special purpose financing vehicle will be established with either exempt status or with international status.

OTHER TAXES

There are no capital gains taxes, inheritance taxes, gift taxes or estate duties (other than small probate charges) in Guernsey. An exempt company will not be subject to withholding tax on interest paid. There are no transfer duties or taxes applicable to notes or bonds issued by a Guernsey company.

GUERNSEY FINANCIAL SERVICES COMMISSION

In the normal course of events, a debt issuing SPV will not constitute a Collective Investment Scheme and so will not require authorisation or be subject to regulation under Guernsey's Protection of Investor Laws. The establishment of the SPV will require consent under the Control of Borrowing (Bailiwick of Guernsey) Ordinances, 1959-1989. The Guernsey Financial Services Commission do not pass comment upon the terms of any particular securities issue in detail. The point is to deter lower grade business from establishing itself in the Bailiwick. There are no fees involved. Local counsel will file a final or near final draft of the information memorandum and, based upon this, subject to any questions arising, the approval-in-principle is normally forthcoming within ten business days although, by special arrangement on the presentation of well prepared documentation, this can be telescoped into a shorter period. For a multi-issue vehicle the consent would usually be to the programme as a whole; not for each issue. Guernsey Financial Services Commission consent is also required to the establishment of Protected Cell Companies. In the normal course of events, the application for such consent would form part and parcel of any application for the COBO consent referred to above. The Guernsey Financial Services Commission will require the appointment of a local administrator/representative competent to administer such a structure.

CONCLUSION

To conclude, the Bailiwick of Guernsey has proved to be a very suitable jurisdiction for the establishment of offshore financing and securitization vehicles Its express statutory provisions with regard to security, set-off and subordination cut through what would otherwise be an uncertain area. The limited, non-intrusive levels of regulation and the availability of exempt tax status in a well established jurisdiction with a reputation for competence and integrity in a stable 'English style' legal environment are of considerable benefit. The availability of listing facilities on the CISX may also be convenient in respect of certain secured note issues. A full range of accounting, legal, banking and administrative services are available.

12 October 2001

Contacts:
John F Dyke
MA Cantab
Consultant
Ozannes
Tel: +44 1481 723 466
Fax: +44 1481 714 653
E-mail: j.dyke@ozannes.com

William P Simpson
Advocate
Tel: +44 1481 727045
Fax: +44 1481 727 964
E-mail: w.simpson@ozannes.com


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