Over the last two years, securitization of operating assets, such as containers, chassis, vehicles, aircraft and railcars, together with short-term leases of the equipment, have led to several billion dollars' worth of asset-backed securities being issued, primarily in Rule 144A transactions.
These transactions involve financing the cash flows from repeated short term leasing of long-lived physical assets, during a time period covering a reasonable percentage of the remaining useful life of the assets.
Unlike securitization of long-term leases, operating asset deals require the ongoing management by an operating company experienced with that kind of equipment. The final maturity of the notes is based on the anticipated decline in the fair market value of the equipment, but the actual rentals are expected to amortize the notes much sooner than that date.
The cash flow needed to repay the principal balance of, and accrued interest on, the ABS is derived from a combination of the collections on the initial pool of leases, revenues derived from the re-leasing of the assets during the life of the deal, and the ultimate sale of the assets.
Unexpected declines in asset values (determined through depreciation schedules or periodic appraisals), or in the level of cash generated by the transport assets relative to the ABS debt service requirement, or in the financial condition or operating efficiency of the manager/servicer, may also trigger a diversion of cash otherwise payable to the issuer, either to a collateral account or to prepayment of the ABS.
Revisions to UCC9
Revised UCC Article 9 assists cross-border operating asset transactions by authorizing secured parties to perfect their U.S. law security interest in the equipment, wherever located, by filing a UCC financing statement in Washington, D.C., if the debtor is located in a foreign jurisdiction that does not require a UCC-type registry for notice of security interests.
Perfecting the security interest enables the ABS holders' lien to withstand U.S. bankruptcy law challenge should the issuer become insolvent. Using this new UCC provision may be tricky, because the general rule is that a "debtor that is an organization" is located at its sole place of business or, if it has more than one place of business, at its chief executive office (another brand-new rule, deeming a debtor located at its state of registered organization, does not apply to non-U.S. entities).
But this general rule applies only if the debtor's office is located in a jurisdiction "whose law generally requires information concerning the existence of a non-possessory security interest to be made generally available in a filing, recording, or registration system as a condition or result of the security interest's obtaining priority over the rights of a lien creditor with respect to the collateral."
Unless it is clear that the law of the non-U.S. jurisdiction does or does not comply with this condition, the secured party would be wise to file in both the District of Columbia and the overseas jurisdiction.
In addition, two international treaties adopted in late 2001 are expected to have an impact on operating asset securitizations: the Unidroit Convention on International Interests in Mobile Equipment; and the United Nations Convention on the Assignment of Receivables in International Trade. Both Conventions borrow heavily from UCC Article 9 and their operation will be familiar to lawyers steeped in UCC practice.
The Unidroit Convention
The Unidroit Convention covers interests arising under a security agreement, conditional sale agreement or lease (both true leases and finance leases). Specifically covered are "airframes, aircraft engines and helicopters; railway rolling stock; and space assets," although there is a mechanism whereby the Convention can be extended to "any category of high-value mobile equipment."
In every case, both the Convention itself and a Protocol with respect to each asset class must be adopted by any nation which is home to a borrower or lessee who wants to take advantage of the Convention provisions for that asset class. A Protocol for aircraft already has been finalized and another for railway rolling stock is expected to be completed by December 2002. The Convention will "enter into force" three months after the third nation (a "Contracting State") has ratified the Convention, and will apply whenever the debtor is situated in a Contracting State which also has ratified a Protocol with respect to the asset class involved.
The Convention contains familiar rules about determining where the debtor is situated, the remedies of the secured party, conditional seller or lessor, and the relative priorities of competing claimants.
But the centerpiece of the Convention is its provision for an International Registry for giving public notice of international interests and assignment or subordination thereof. The Protocol for each asset class is to establish a Supervisory Authority which will supervise the creation and operation of an International Registry for that asset class.
In effect, for assets subject to the Convention and a related Protocol, there will be the equivalent of a UCC Article 9 filing office and the public notice of lessor and secured party interests.
U.N. Convention facilitates securitization
The United Nations Convention contains a uniform body of rules concerning (1) the assignment of international receivables (a receivable owed to an assignor located in one nation by a debtor located in another nation) and (2) international assignments of receivables (a receivable assigned by an assignor located in one nation to an assignee located in another nation).
Excluded are receivables assigned to an individual for consumer purposes or receivables arising under securities transactions, swap transactions, currency hedges, repurchase agreements, letters of credit or guaranties, among others. The U.N. Convention will "enter into force" six months after the fifth nation (a "Ratifying State") has ratified it.
The U.N. Convention covers both sales and security assignments of receivables, provided that the assignor (under an international assignment) is located in a Ratifying State or (for an international receivable) either the account debtor is located in a Ratifying State or the receivables contract is governed by the law of a Ratifying State.
Generally, the assignor must be located in a Ratifying State, but once a receivable is subject to the U.N. Convention, further assignments thereof also will be governed by the U.N. Convention rules. The assignor and assignee can elect to have a State's law selected by them govern their mutual rights and obligations.
Among other things, the U.N. Convention contains several features that facilitate the financing of receivables: it validates any waiver of defenses by a debtor; it invalidates any provision in an underlying agreement restricting an assignor's ability to assign any amounts payable under that agreement; and facilitates securitizations by recognizing assignments of future receivables, or parts of or undivided interests in receivables or bulk assignments of receivables.
An optional annex (similar to the Protocol under the Unidroit Convention) to the U.N. Convention establishes an international registry and contains priority rules based on (a) registration of data about assignments, (b) the time of assignment and (c) the time of notification of the assignment.
U.S. ratification is next step
Understandably, there is great interest surrounding these two Conventions, and the international community is awaiting ratification by the United States as a signal that these advances in international commercial law are for real. State Department sources are hopeful that ratification by the U.S. Senate can occur before Congress adjourns for the midterm elections this autumn. Because these Conventions will facilitate financing of aircraft and aircraft leases and hence aid mightily the ailing airline and aircraft manufacturing industries, public expectations are high that Senate action will be positive and timely.
For more information about student loans, call Lauris Rall at (212) 789-1408; about operating assets, bankruptcy and international conventions, call Steve Whelan (212) 789-1230 or Mike McGrath (212) 789-3549; and about credit default swaps, please call Jeffrey Stern at (212) 789-1472 or Jeffrey Koppele at (212) 789-1261.