An impending overhaul of uniform state law, slated for acceptance by nearly all 50 states next month, might be a boon to securitization lawyers and issuers of CDO/CLO transactions, and may even clear up lingering doubts stemming from the LTV Steel bankruptcy case (see ASR 3/12/01), which challenged true sale treatment for ABS deals.
Securitization-friendly revisions to Uniform Commercial Code Article 9, which sets forth rules on secured transactions and security interests for certain types of collateral, have already been adopted in 35 states, and are expected to be adopted by several more on July 1, which is the effective deadline date.
Of the remaining states, however, Florida, Alabama and Mississippi have delayed the effective date until January 1, 2002, while New York is still in the process of reviewing the sweeping changes to this key article.
Essentially, the revised version of UCC Article 9 will now apply to many transactions that did not fall within the scope of the current Article 9, including "general intangibles," which opens up the regulation to a whole new range of assets eligible for true sale treatment. Besides bringing uniformity to varying state laws, the new rule will isolate new types of assets from the credit risk of the originator, and will ensure that these assets are not brought back into the originator's bankruptcy estate.
"It no longer has to be a manufacturing company, or a company selling goods, [in order to fall within the realm of Article 9]," said Cynthia Baker, a securitization attorney at Mayer, Brown & Platt who gave a presentation on the revisions last week via Credit Suisse First Boston. "The new definition of account'...allows all kinds of service fees, services rendered, insurance premiums, fees due for issuance of guarantees, creditor charge cards, lottery winnings, and healthcare receivables all to fall within the definition. Because it includes the concept of payment intangibles', ...this will reduce uncertainty and reduce transaction costs."
Most importantly, however, the wording of the new Article 9 has given some degree of comfort to market observers who were disturbed by the LTV Steel case earlier this year, which called into question basic tenets regarding true sale treatment of assets in securitizations.
Under the revised regulation, Article 9 will not prevent a true sale of assets, Baker said. Instead, the revision will overrule the landmark Octagon case which was adjudicated in the tenth circuit; that case held that a debtor's interest in an asset cannot be transferred. The judge in the Octagon case used the current version of Article 9 as one of the reasons behind the decision, since the article governs the true sale of accounts.
"To the extent that the court [in the LTV Steel case] was trying to reach the same kind of Octagon analysis, the mere fact that the [revised] Article 9 applies to this kind of transaction prevents the debtor...from completely transferring his interest," Baker said. "It definitely helps. But it still doesn't address the common-law true-sale issue of whether the transaction in question itself meets the standards for true sale."
With the revisions, a debtor that sold an account or promissory note does not retain a legal interest in the collateral sold.
Moreover, the new version of the law gives added protection against "anti-assignment clauses," which are particularly troublesome for CDO/CLO transactions. In a bankruptcy, if there is an asset that is not within the contract provisions, a security interest in this asset may not be granted under the current statute.
However, the more user-friendly version of Article 9 debuting in July overrules this, saying that the security interest still attaches, even if the SPV or secured party does not have the right to directly sue the obligor. According to Baker, lawyers must constantly scan documents for anti-assignment provisions, especially for CDO transactions.
Article 9 will now also include the true sale of promissory notes and other types of instruments as primary collateral under its definition of eligible accounts, which directly applies to CLOs and CDOs.
Among the caveats to the Article 9 revisions, Baker said that conduits, administrators, lenders, originators and servicers must now take a careful look at backoffice procedures, making sure they are compliant with the improved statute.
"Many of the people [working on this] have been doing this for twenty years, and are not lawyers, or are not highly trained or paid, and this is a fairly complex system for transition, and time and attention must be paid to that," Baker added.