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True-Sales: Quest Continues to Create a Doctrine to Guide Investors, Creditors, Courts

Ever since the securitization market began its exponential growth three decades ago, scholars and lawyers involved in structured finance have searched for a secular "holy grail"—a clear legal definition of a true-sale.1

The quest is an important one.

Despite its implosion in the aftermath of the financial crisis a decade ago, the securitization market in the U.S. remains massive and is now roaring back. Standard & Poor’s recently estimated that new private securitization issuances in the U.S. alone may reach $565 billion in 2018, a figure which represents an increase of more than 50 percent from just two years ago, and new private securitizations worldwide this year are expected to top $1 trillion.2

Scholars and securitization participants have proposed a variety of analytical approaches to create a comprehensive true-sale doctrine. However, courts continue to rely on a nonexclusive set of factors governed mostly by state law in making their true-sale decisions.

This article explores the continued vitality of the factors’ approach in determining whether a transaction represents a true-sale or a loan, and highlights some of the true-sale frameworks suggested by commentators.3

Securitization’s Tension with Bankruptcy Law

If a business decides that it needs cash immediately, two principal means are available to achieve this goal: the business may sell an asset at some discounted price, or it may borrow funds and use the asset to collateralize the loan.4 Many businesses choose the former option by selling a portfolio of receivables (e.g., credit card, loan, or accounts receivables) by means of a securitization transaction.

Important benefits may flow to a business that securitizes a portfolio of assets in a true-sale transaction, including increased liquidity and lower costs of capital. However, securitization exists in a fundamental tension with bankruptcy law because each dollar of assets sold by a business through a true-sale securitization transaction is also a dollar of assets permanently removed from that business’s balance sheet and no longer available to, among other things, satisfy the claims of creditors if the business later files for bankruptcy.5 On the other hand, assets pledged by a business as security for a loan remain its property, both prior to and during its bankruptcy case.6

Receivables Securitization Structure

Although securitization transactions take many forms and are constantly evolving, the simplest structure of a receivables securitization reflects the following:7

  • A business (originator) with a portfolio of receivables to sell establishes a special purpose vehicle (SPV), which is a separate, newly formed, bankruptcy-remote entity (i.e., an entity set up in a manner which makes its bankruptcy nearly impossible)

  • The originator sells the assets to the SPV

  • The SPV raises capital by issuing asset-backed securities to fund the purchase of the receivables (i.e., the purchased receivables are pledged as security by the SPV to the investors)

  • The SPV uses the funds from the issuance of the asset-backed securities to pay the originator for the purchase of the receivables

  • The SPV uses the revenues generated over time by the receivables to make payments to the investors holding the asset-backed securities

In deciding whether to participate in this transaction, investors rely on the continued existence of a predictable and uninterrupted stream of cash flow expected to be produced by the receivables.8 Thus, the key concept from a bankruptcy perspective is that the originator has transferred ownership of the receivables to the SPV.9

If the transaction passes muster as a true-sale, a future bankruptcy of the originator should have no impact whatsoever on the SPV’s right and ability to collect the cash flow produced by the receivables and to make the payments to the investors.10 On the other hand, if the transaction is viewed as a disguised loan from the SPV to the originator, then the receivables do become the property of the originator’s bankruptcy estate and are subject to the many protections afforded to debtors and creditors under bankruptcy law.11

A variety of interested parties involved in the bankruptcy case of the originator may seek to recharacterize a purported true-sale as a loan. For example, the unsecured creditors—whose claims exist at the bottom of the distribution priority “waterfall” and are likely to receive distributions representing a small fraction of the face value of their claims—have a strong incentive to seek to have the Bankruptcy Court recharacterize an alleged true-sale transaction as a loan so that the assets are subject to the originator’s bankruptcy case and are potentially reachable to satisfy their unsecured claims.12 Alternatively, the business-debtor itself (or a trustee appointed in its case) might pursue recharacterization of the transaction as a loan so that the cash flow generated by the receivables is available to the estate for a variety of purposes, including financing the bankruptcy case.

The Factors

So, what is a true-sale? The answer is often not an easy one.

The Bankruptcy Code does not define “true-sale,” nor does it provide other rules for determining whether a debtor’s rights with respect to property constitute a security interest or another type of interest.13 Similarly, Article 9 of the Uniform Commercial Code explicitly covers both the sale of receivables and the grant of a security interest in receivables, but provides no guidance in distinguishing between a sale or a grant of a security interest in the public record.14

Rather, courts tasked with evaluating whether a transaction is, in reality, either a true-sale or a loan generally describe their analysis as an attempt to determine the intent of the parties in light of all the facts and circumstances underlying the transaction.15 In making this determination, courts generally rely upon a nonexclusive set of factors governed mostly by state law.16

The following list reflects factors which courts and commentators have mentioned as being relevant to the true-sale analysis. Each factor is described in a particular manner so that answering “yes” in response to the description indicates an increased likelihood of the transaction being characterized as a true-sale, whereas a “no” response signals that the transaction has features that more resemble a loan:17

  • Adequacy of consideration: The transaction is at arm’s length for adequate consideration (i.e., full market value) received by the originator.
     
  • Recourse to the originator (aka benefits and burdens of ownership or transfer of risk): The risk of loss (i.e., the risk of performance by the underlying account obligors) is transferred from the originator to the SPV. The transaction documents could reflect this by including any of the following provisions:
     
    • The transfer of the assets is made without any credit recourse between the originator and the SPV
       
    • The SPV assumes the risk of the return on the transferred assets (i.e., if the transaction does not generate as much value as anticipated, the originator is not be liable to the SPV for the shortfall)
       
    • The absence of evidence that the originator retains any economic benefits in the assets transferred
       
    • Any indemnification by the originator in favor of the SPV is limited to the originator’s obligations under the transaction documents and not for any credit losses incurred by the SPV
       
    • The absence of a representation or warranty by the originator guaranteeing a minimum return to the SPV on the assets transferred
       
    • The absence of a right by the SPV to reserve a part of the purchase price, which would be released to the originator only as the SPV receives from the originator the cash flow generated by the transferred assets
       
    • The absence of a requirement on the part of the originator to purchase an insurance policy payable to the SPV in the event that any of the underlying account obligors fail to perform

  • Repurchase option: The originator does not retain the option to repurchase the transferred assets.

  • Post-transfer control over the assets and administrative activities: The originator has limited or no control over the transferred assets and related administrative activities. The transaction documents could reflect this by including any of the following provisions:

    • The originator must follow the directions of the SPV with respect to the transferred assets

    • Any limitation on the SPV’s autonomy with respect to the transferred assets does not arise from the originator, but rather from third parties (e.g., an underlying account obligor pays off the balance due on a credit card, and the related receivable had been sold to the SPV)

    • The originator does not serve or collect the assets transferred to the SPV, but if the originator does so (e.g., acts as the servicer), the originator may be removed by the SPV if the originator defaults on its duties

    • The originator and the SPV agree to use commercially reasonable efforts, and to take the necessary actions, to elevate the SPV’s position as the owner of the assets transferred (e.g., filing UCCs)

    • The originator is forbidden from commingling any cash flow obtained from the underlying account obligors with its general operating funds

  • Accounting treatment: The transfer is treated as an absolute sale and purchase, respectively, on the books and records of the originator and the SPV.

  • Modifications to transaction: The originator and the SPV must mutually agree on any modifications to the terms of the transaction (i.e., neither party has the unilateral right to change the terms of the transaction).

  • Investigation rights: The SPV has a full and independent right to investigate the assets transferred to it by the originator (i.e., investigate the creditworthiness of each of the underlying account obligors) before, during, and after the transfer, and there is evidence that the SPV has done so.

  • Excess collections: The SPV has the right to keep excess collections on assets transferred to it by the originator over the predetermined amount of collections.

  • Express intent of the parties: The documents and conduct of the originator and the SPV reflect an explicit intent by the parties for a sale of the assets transferred from the originator to the SPV. The transaction documents could reflect this approach by including any of the following provisions:

    • The parties intend the transaction to constitute an absolute and irrevocable sale

    • The absence of post-closing price adjustments

    • The assets transferred no longer constitute property of the originator and have become the property of the SPV

    • The SPV is entitled to grant security interests in the assets transferred

    • The absence of any liens granted by the originator to the SPV

    • The absence of any interest rate, maturity date, or schedule of payments of principal or interest to be made by the originator to the SPV

Although the presence or absence of one factor alone rarely dictates the outcome of a true-sale determination, scholars and securitization market participants often indicate that two of the factors—price and recourse—have particular importance in the analysis.18

Two additional points should be made regarding recourse. First, commentators point out that some type of recourse alone, without other factors suggesting a loan, does not preclude true-sale treatment, but best practices discourage including recourse to the originator as a part of the transaction.19

Second, a few commentators seek to make a distinction between “collectability recourse” and “credit recourse.”20 Collectability recourse is said to exist when an originator guarantees the performance of the receivables sold to the SPV and agrees to repurchase the receivables of any particular account for which the underlying obligor defaults.21 These commentators analogize collectability recourse to a warranty of quality, and they argue that this type of recourse is consistent with a true-sale characterization.22

On the other hand, credit recourse is defined as a situation in which an originator guarantees a particular level of return to the SPV on its purchase price, which commentators assert reflects a transaction more akin to a loan.23

Analytical Frameworks

Scholars and securitization participants have criticized the current factors-based court decisions in the true-sale context as being unsettled, confusing, inconsistent, and sometimes incoherent. They contend that the unpredictability of judicial outcomes involving true-sale disputes materially increases the cost of securitization transactions for originators (i.e., sellers), SPVs (i.e., buyers), and investors.24

They have proposed a variety of analytical frameworks that they believe bring clarity and predictability to the issue of whether a transaction should be characterized as either a true-sale or a loan.25 A sample of their approaches follows.

Aicher/Fellerhoff (1991). What would an informed and willing buyer pay a willing seller for a transfer of the entire bundle of risks and benefits embodied in the cash flow represented by the receivables? If the ultimate price that the transferee pays, taking into account the presence of any direct and indirect recourse provisions, is notably less than this amount, a court should conclude that the transaction is a secured loan.26

Plank (1991). If the documents evidencing the transaction and the actions of the parties unambiguously characterize a particular transaction as a sale, a court should not disregard this characterization if the buyer paid fair value for the property, unless the seller retains substantially all of the benefits and burdens of ownership. If the buyer assumes some burdens or benefits, or if the transfer is one in which the burdens and benefits of a loan or a sale transaction are hard to distinguish, a court should respect the characterization that the documents and other conduct of the parties give to the transaction. In other words, if the buyer pays fair value, any doubts are resolved in favor of the characterization that the parties chose.27

Lubben (2004). Instead of vague multifactor tests derived from other marginally relevant areas of the law, both Chapter 11 policy and the parties to securitizations would be better served by a more functional test that considers the reasons for inclusion or exclusion of an asset in a debtor’s estate. Specifically, an asset should be included in an estate when its removal from the debtor’s balance sheet was done in a way that triggers concerns about misrepresentation of the firm’s overall financial situation or the transfer of the asset is of the kind that no reasonable creditor would have agreed to allow after the fact. If a reasonably sophisticated unsecured creditor would have been misled by the failure to include a particular transaction on the balance sheet, the securitization is inherently suspect.28

Harris and Mooney (2014). A transaction should be recharacterized as a transfer of a security interest in a loan if the interest transferred to the purported buyer is in fact not the functional and economic equivalent of ownership but rather the functional and economic equivalent of a security interest that secures an obligation.29

Despite their worthy efforts, none of these approaches to date has been explicitly adopted by any court.30 Rather, the few instances in which courts have cited these articles generally have entailed discussions of an aspect of the factors’ approach in evaluating the true-sale issue.

However, a theoretical approach that may have a good chance of eventually resulting in a practical true-sale doctrine to guide investors, creditors, and the courts is the one offered by Heather Hughes, a professor at American University’s Washington College of Law. She argues that current approaches to the true-sale doctrine do not squarely address the actual scope of the property interest the doctrine determines.31

Among other things, Professor Hughes suggests that successful rules for deciding whether a transaction is a true-sale or a loan must be grounded in a conception of property that can explain and justify the rights of exclusion by an SPV’s investors against an originator’s unsecured creditors.32Stated differently, the ability to create a functional true-sale legal doctrine lies in understanding the inherent tension between, on the one hand, the expectations and rights of the investors involved in true-sale securitization transactions and, on the other, the unsecured creditors which hold claims located at the bottom of the claims distribution priority waterfall in a bankruptcy case of an originator. Within this context, she encourages scholars to undertake “substantive vetting” of the true-sale doctrine.33

Until a comprehensive true-sale doctrine is developed and adopted by the courts, the current quest of securitization participants is to be familiar with, and guided by, the indefatigable factors.

The views expressed in this article are those of the author and do not reflect the views of Richards Kibbe & Orbe LLP.


  1. Heather Hughes, “Property and the True-Sale Doctrine,” 19 U. Pa. J. Bus. L. 870, 871 (2017); Kenneth C. Kettering, “True Sale of Receivables: A Purposeful Analysis,” 16 Am. Bankr. Inst. L. Rev. 511, 511-512 (2008); Peter V. Pantaleo et al., “Rethinking the Role of Recourse in the Sale of Financial Assets,” 52 Bus. Law. 159, 159 (1996).
  2. “Global Securitization on Pace for $1 Trillion in 2018,” Standard & Poor’s Financial Services LLC (July 24, 2018), spglobal.com/ratingsdirect; see also “US ABS Issuance and Outstanding,” Securities Industry and Financial Markets Association (July 25, 2018), sifma.org/resources/research/us-abs-issuance-and-outstanding/; “US Mortgage-Related Issuance and Outstanding,” Securities Industry and Financial Markets Association (July 25, 2018), sifma.org/resources/research/us-mortgage-related-issuance-and-outstanding/.
  3. This article provides a brief overview of legal true-sale issues only. It does not discuss the accounting rules, such as those promulgated by the Financial Accounting Standards Board, for determining when securitized assets belong off the balance sheet of an originator (defined herein).
  4. In re Dryden Advisory Group, LLC, 534 B.R. 612, 620 (Bankr. M.D. Pa. 2015); Steven L. Harris and Charles W. Mooney Jr., “When Is a Dog’s Tail Not a Leg?: A Property-Based Methodology for Distinguishing Sales of Receivables from Security Interests That Secure an Obligation” (2014), Paper 1013 1029-1030, scholarship.law.upenn.edu/faculty_scholarship/1013; Thomas J. Gordon, “Securitization of Executory Future Flows as Bankruptcy-Remote True Sales,” 67 U. Chi. L. Rev. 1317, 1317-1319 (2000); Robert D. Aicher and William J. Fellerhoff, “Characterization of a Transfer of Receivables as a Sale or a Secured Loan Upon Bankruptcy of the Transferor,” 65 Am. Bankr. L.J. 181, 181 (1991).
  5. Hughes at 876, 883-885; Harris and Mooney at 1029-1031; “A Practitioner’s Guide to Trends in True Sale and Other Structured Finance Options,” presented by the Securitization and Structured Finance Committee, Federal Regulation of Securities Committee, Law and Accounting Committee, and Legal Opinions Committee, ABA Fall Meeting (2013) (Practitioner’s Guide), Attachment 2, Steven L Schwarcz, “The Parts are Greater Than the Whole: How Securitization of Divisible Interests Can Revolutionize Structured Finance and Open the Capital Markets to Middle-Market Companies,” 140 Columbia Business Law Review 139 (1993)” (Schwarcz) at 140-142; Kettering at 555-560; Stephen J. Lubben, “Beyond True Sales: Securitization and Chapter 11,” 1 N.Y.U, J. L. & Bus. 89, 90-92 (2004); Gordon at 1317-1318; Pantaleo at 160, 182; Thomas E. Plank, “The True Sale of Loans and the Role of Recourse,” 14 Geo. Mason U. L. Rev. 287, 307-308 (1991); Aicher and Fellerhoff at 181-182.
  6. Id.
  7. Hughes at 880-882; Harris and Mooney at 1032-1034; “Not So Remote After All: Bankruptcies of So-Called 'Bankruptcy Remote' Special Purpose Entities and Other Structured Vehicles,” ABI NYC Bankruptcy Conference (May 9, 2012) at 473-475; Kettering at 555; Lubben at 92-93; Gordon at 1321-1323; Pantaleo at 162 n.8 (describing a FINCO, two-tier structure); Aicher and Fellerhoff at 181-182.
  8. Practitioner’s Guide (“IV. Treatise on True Sale Factors”) at 17 and Schwarcz at 143-144; Aicher and Fellerhoff at 181.
  9. Hughes at 875 n.19; Harris and Mooney at 1032-1033; Kettering at 555-557; Gordon at 1325, 1345; Aicher and Fellerhoff at 181-182.
  10. Id.
  11. Id.
  12. Harris and Mooney at 1030; Pantaleo at 159-161; Aicher and Fellerhoff at 308.
  13. 11 U.S.C. §§ 101 et seq.; Practitioner’s Guide (“IV. Treatise on True Sale Factors”) at 17.
  14. Hughes at 898-899; Harris and Mooney at 1031, 1034-1040; Kettering at 515, 533; Michael Gaddis, “When is a Dog Really a Duck? The True-Sale Problem in Securities Law,” 87 Tex. L. Rev. 487, 493 (2008); Gordon at 1331; Pantaleo at 160; Aicher and Fellerhoff at 184-185.
  15. In re Commercial Money Center, Inc., 350 B.R. 465, 481 (B.A.P. 9th Cir. 2006); In re Burm, 554 B.R. 5, 17 (Bankr. D. Mass 2016); Dryden Advisory Group, 534 B.R. at 620; In re Sterling Optical Corp., 371 B.R. 680, 686-687 (Bankr. S.D.N.Y. 2007); Practitioner’s Guide, Attachment 4, John Arnholz and Edward E. Gainor (eds.), “‘True Sale’: Exclusion of Securitized Assets from the Bankruptcy Estate,” Offerings of Asset-Backed Securities (2013) (Arnholz and Gainor) at 18.
  16. In re Doctors Hosp. of Hyde Park, Inc., 507 B.R. 558, 708-719 (Bankr. N.D. Ill. 2013) (citing Butner v. United States, 440 U.S. 48, 59 (1979)); Hughes at 876, 899-901, 908; Harris and Mooney at 1031, 1040-1049; Practitioner’s Guide, Schwarcz at 145-149; Kettering at 516, 533, 556-557; Gaddis at 493; Lubben at 96, 109; Gordon at 1331-1336; Pantaleo at 160, 163-164, 182-189; Plank at 290-291; Aicher and Fellerhoff at 184-194.
  17. See, e.g., Fireman’s Fund Inc. Cos. v. Grover (In re The Woodson Co.), 813 F.2d 266, 270-273 (9 Cir. 1987); Major’s Furniture Mart, Inc. v. Castle Credit Corp., Inc., 602 F.2d 538, 544-547 (3d Cir. 1979) (note: Although this decision remains the law in the 3rd Circuit, it has been criticized significantly by a number of the commentators cited in this article); In re Qualia Clinical Services, Inc., 441 B.R. 325, 329-331 (B.A.P. 8th Cir. 2011); Commercial Money Center, 350 B.R. at 482-484; In re Lendvest Mort., Inc., 119 B.R. 199, 200-201 (B.A.P. 9th Cir. 1990); Burm, 554 B.R. at 17; Dryden Advisory Group, 534 at 620; Doctors Hosp. of Hyde Park, 507 B.R. at 708-719; In re Siskey Hauling Co., Inc., 456 B.R. 597, 606-607 (Bankr. N.D.Ga. 2011); cf. S&H Packing & Sales Co., Inc. v. Tanimura Distributing, Inc., 883 F.3d 797, 808-809 (9th Cir. 2018) (PACA); Consumer Financial Protection Bureau v. RD Legal Funding, LLC, 2018 WL 3094916 at *8 (S.D.N.Y. June 21, 2018) (CFPA); Classic Harvest LLC v. Freshworks LLC, 2017 WL 3971192 at *-11 (N.D. Ga. Sept. 7, 2017) (PACA); see also M. John Sterba, Jr. et al., “True Sale Opinions and True Lease Opinions,” Legal Opinion Letters, LOLGOL § 10.5 (Aspen Publishers, 2018); Hughes at 876, 899-905; Harris and Mooney at 1031, 1040-1049; Practitioner’s Guide (“IV. Treatise on True Sale Factors”) at 18, Schwarcz at 145-149, and Arnholz and Gainor at 18-26; John A. Pearce II and Ilya A. Lipin, “Special Purpose Vehicles in Bankruptcy Litigation,” 40 Hofstra L. Rev. 177, 197-199 (2011); Kettering at 516, 533, 556-557; Gaddis at 492-495; Lubben at 96, 109; Gordon at 1331-1336; Pantaleo at 163-179; The Committee on Bankruptcy and Corporate Reorganization of The Association of the Bar of the City of New York, “Structured Financing Techniques,” 50 Bus. Law 527, 542-543 (1995); Plank at 290-307; Aicher and Fellerhoff at 186-194.
  18. Hughes at 901; Kettering at 516, 541; Lubben at 96; Gordon at 1332-134; Pantaleo at 163-164; Plank at 339; Aicher and Fellerhoff at 186-191.
  19. Hughes at 902; Harris and Mooney at 1069; Practitioner’s Guide (“III. Risks of Forward Solvency Guaranties of Special Purpose Entities”) at 5; Gordon at 1332-1334; Plank at 339-346; Aicher and Fellerhoff at 186-191.
  20. Hughes at 902; Kettering at 542-543; Pantaleo at 163-172; Plank at 339-346; Aicher and Fellerhoff at 186-191.
  21. Id.
  22. Id.
  23. Id.
  24. Hughes at 870, 872, 875, 900; Harris and Moody at 1031, 1040; Kettering at 511-512; Gaddis at 487, 493; Lubben, at 96, 109; Gordon at 1330; Pantaleo at 163-164; Plank at 291, 313-314.
  25. Hughes at 910-914; Harris and Mooney at 1050; Lubben at 109; Gordon at 1342-1345; Pantaleo at 161, 163-182; Plank at 328-329.
  26. Aicher and Fellerhoff at 207. This article has been cited in 10 cases.
  27. Plank at 328-329. This article has been cited in just four cases, none of which discuss the author’s proposed framework.
  28. Lubben at 109. This article has been cited in just two cases, neither of which discuss the author’s proposed framework.
  29. Harris and Mooney at 1050. This article has been cited in a footnote in just one case (In re Dryden Advisory Group, LLC, 434 B.R. 612, 621 n.7) in which the court remarked that the “approach provides a coherent framework for analyzing the sale versus financing dichotomy that often has eluded courts struggling to apply varying sets of factors,” but provided no reasons in support of this statement.
  30. Based upon citations to these articles on Westlaw; see also Harris and Mooney at 1041; Gordon at 1342-1345; Pantaleo at 161, 163-182; Plank at 313, 328; Aicher and Fellerhoff at 182-211.
  31. Hughes at 914.
  32. Hughes at 870.
  33. Hughes at 926.
Christopher Andrew Jarvinen

Christopher Andrew Jarvinen

Richards Kibbe & Orbe LLP

Christopher Andrew Jarvinen is a corporate restructuring partner in the New York office of Richards Kibbe & Orbe LLP. Jarvinen is an elected fellow of the American College of Bankruptcy, the American Law Institute, and the International Insolvency Institute. He holds a law degree from Boston College Law School and additional degrees from Brown, Harvard, and Yale universities in the U.S. and the business schools of FGV-EAESP (Brazil) and the University of Oxford (U.K.).

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