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United States

The Business Bankruptcy Reform Act, S.1914, was introduced into the US Senate on April 2 1998. S.1914 proposes to amend the Bankruptcy Code to make it clear that assets transferred in a securitization are not property of the estate in a bankruptcy filed by the transferor. If passed, this amendment may well remove the legal uncertainties as to whether the bankruptcy trustee may reach financial assets previously transferred to a special purpose entity that has issued debt or equity backed by those assets. Other sections of S.1914 would amend the Bankruptcy Code to broaden the category of transactions that qualify as swaps or repurchase agreements and for the first time permit cross-netting pursuant to master agreements of amounts due and owing under forwards, swaps, repurchase agreements, commodities and securities contracts.

Section 215 of S.1914 would also add a new subsection (b)(5) to Section 541 of the Bankruptcy Code to clarify that property of the estate does not include "any eligible asset (or proceeds thereof), to the extent that such eligible asset was transferred by the debtor, before the date of commencement of the action, to an eligible entity in connection with an asset-backed securitization." The definitions applicable to this section are rather all-inclusive and should cover a wide variety of securitizations:

  • "asset-backed securitization" means a transaction in which eligible assets transferred to an eligible entity are used as collateral for securities issued by an issuer, the most senior of which are rated investment grade by a nationally recognized securities rating organization;
  • "eligible asset" means financial assets either fixed or revolving, includingresidential and commercial mortgage loans, consumer receivables, trade receivables and lease receivables that by their terms convert into cash within a finite time period;
  • "eligible entity" means (1) an issuer or (2) a trust, corporation, partnership or other entity exclusively engaged in the business of acquiring and transferring eligible assets, directly or indirectly, to an issuer;
  • "issuer" means a trust, corporation, partnership or other entity exclusively engaged in acquiring and holding eligible assets and in issuing securities backed by eligible assets;
  • "transferred" in this section means that the debtor, pursuant to a written agreement, represented and warranted that eligible assets were sold, contributed, or otherwise conveyed with the intention of removing them from its estate pursuant to subsection (b)(5) irrespective of: (i) whether the debtor, directly or indirectly, holds or obtains an interest in the issuer or in any securities issued by the the issuer; (ii) whether the debtor had an obligation to purchase, service or supervise the servicing of the eligible assets; or (iii) the characterization of such sale for tax, accounting, regulatory reporting or other purposes.

If enacted, Section 215 would establish a safe harbour that would protect asset-backed deals from the reach of the bankruptcy trustee. At present such protection turns on whether the conveyance of the asset qualifies as a true sale, which is a fact-specific determination made under state law. Transactions outside the reach of Section 215 would presumably continue to rely on qualified true sale opinions from law firms to provide assurances to rating agencies and lenders that a trustee would not be able to reach as property of the estate assets or proceeds thereof transferred in an asset securitization.

The remaining sections of Title II of S.1914 propose to amend the Bankruptcy Code's treatment of swaps, forwards, repurchase agreements and commodities and securities contracts both to permit cross-netting under master agreements and to broaden the definitions so that more transactions will qualify for the special termination and netting rules applicable in the event of a bankruptcy filing by a party to one of these agreements. Swaps will now include credit spreads and swaps, debt, equity and commodity options, swaps, futures, and forwards, as well as equity, debt or commodity index swaps, futures, forwards or options. Repurchase agreements will qualify for the specialized netting and termination rules as long as the subject of the repo is a certificate of deposit, a bankers' acceptance or securities; the former requirements that the securities be backed by the full faith and credit of the United States and that the repo close out within one year have been eliminated.

Perhaps the most significant of these proposed amendments is Section 207(e), that would make cross netting pursuant to the terms of a master agreement enforceable against a bankruptcy trustee. Under current law, it is doubtful whether a counterparty who has both a swap and a repo with a party that files for bankruptcy could net the amount it owed to the bankrupt on the repo against the amount due to it on the swap. This puts the counterparty at economic risk because it will have to pay the full amount owed to the bankrupt while receiving only cents on the dollar on its claim against the bankruptcy estate. A proposed new Section 561 of the Bankruptcy Code would for the first time allow cross-netting pursuant to master netting agreements so that immediately after the bankruptcy filing the non-bankrupt party can terminate all of its financial contracts with the debtor, apply any collateral it is holding, and automatically net the amounts owed to a debtor on these different categories of financial contracts against the amounts owed to it. Such cross-netting would also be exempt from preference avoidance and would not be subject to the automatic stay.

Ronald Cohen

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