By James Patti, partner at Mayer Brown Rowe & Maw, with a focus on emerging markets, including future flow securitizations.
U.S. market participants have for some time found ways to address the reality that the desire of debtors to securitize their receivables conflicts with the desire of creditors to impose "negative pledges" that restrict a debtor's use of its assets to support other funding programs. For example, when negotiating a new credit agreement, debtors and creditors will often include a negative pledge covenant that contains a securitization-focused exception. Numerous formulations for these exceptions have been used, and one common approach is to restrict the permitted securitizations to transactions in which there is "no recourse" to the company and/or where the initial outstanding principal amount of the securitization does not exceed the value of the assets that have been securitized.
Such approaches have worked quite well in the U.S. and other markets where "asset-backed" securitizations are common, and they ensure that both a debtor and its creditors have a common understanding as to what type of securitization is permissible. Unfortunately, the language used to permit "asset-backed" securitizations in these markets often does not work at all well for another type of securitization that is growing in popularity in a number of less-developed markets - the "future flow" securitization.
Though in some regards similar to a security interest, these transactions are structured under the appropriate governing law as present "true sales" of future assets. Other than off-balance-sheet treatment, future-flow securitizations are generally entered into with the same goals as asset-backed securitizations - lower funding costs and diversification of funding sources.
While "future flow" structures have proven to be essential in enabling strong banks and other companies in emerging markets to access the international capital markets, unfortunately these companies' creditors are often unfamiliar with the differences between a traditional asset-backed securitization and a "future flow" securitization. This unfamiliarity has unfortunately resulted either in having no securitization-friendly exception to the negative pledge or having an exception that would work perfectly well for an asset-backed securitization but would inadvertently block a "future flow" transaction. In other words, this is one of those hopefully rare situations in which the parties likely would have addressed the issue if only they had been aware that there even was an issue to be addressed.
In order to minimize future occurrences of these unintended restrictions on securitizations, it would be useful to ensure that a negative pledge either explicitly refer to securitization, but then include in the common list of exceptions an equally explicit permission for securitization so long as it satisfies certain agreed requirements. This approach provides both creditors and debtors with the confidence that a securitization would be covered by the negative pledge and be permissible in the agreed parameters.
This explicit "permitted securitization" exception would then need to be drafted broadly enough to cover not only traditional asset-backed securitizations but also "future flow" transactions. The following is one potential approach:
"Permitted Securitization" means any securitization or similar transaction in which: (a) the [Borrower] sells or similarly disposes of any property or assets (including existing and/or future revenues, accounts receivables and other payments), and (b) the repayment of the indebtedness incurred pursuant to such securitization or similar transaction is expected to be primarily made from such property or rights and recourse to the [Borrower] in respect of such indebtedness, property or rights does not extend to defaults by the obligors of such property or rights; provided that the aggregate outstanding principal amount of such indebtedness (measured at the time of the incurrence of each such principal amount, including each principal distribution/incurrence from multi-distribution/incurrence facilities and using the exchanges rates published by an independent data provider as of the date that is one month before such date of distribution/incurrence) shall not exceed [an amount equivalent to X% of the Borrower's assets.
As can be noted above, this formulation: (a) specifically refers to the sale of both existing and future receivables, (b) specifically prohibits real "recourse" but permits other "deal recourse," (c) limits the amount of obligations that may be outstanding under the securitization and (d) tests compliance with the quantitative limit agreed by the parties only at the time of each issuance using the most recent audited numbers in order to provide greater certainty as to the numbers with which this test is to be satisfied. Most importantly, it provides both the debtor and it creditors with clear guidance as to what is permitted and fairly balances the two parties' interests.
While such an approach may not be relevant or appropriate in many circumstances, if the parties to a transaction for a company that is a "future flow" securitization candidate are aware of the possibility of such a securitization, then it can be discussed and properly accommodated in the negative pledge. This would both eliminate the unintended consequences of the traditional negative pledge and would enable borrowers and their potential underwriters to retain the ability to structure a "future flow" securitization.
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