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
50 Pages Posted: 22 Feb 2014 Last revised: 14 Jan 2015
Date Written: 2014
There are two principal ways in which a firm that is owed money payable in the future but needs the money now may use its rights to payment (“receivables”) to obtain the needed financing. It might sell its receivables, or it might borrow and use the receivables as collateral to secure the loan. Different legal consequences follow depending on whether the transaction is a true sale or is a security interest that secures an obligation (a “SISO”).
These legal consequences are particularly salient when the firm enters bankruptcy. If the transaction is a sale, then the buyer can collect the receivables as if no bankruptcy had ensued. If, however, the transaction is a SISO, then the receivables can be used by the firm during the bankruptcy and cannot be collected by the secured party unless the bankruptcy court orders otherwise. The bankruptcy consequences of the distinction between a true sale and a SISO form the cornerstone of securitization transactions.
If the firm enters bankruptcy, creditors have an incentive to argue that a transaction that is structured and documented as a true sale creates a SISO in substance and so should be recharacterized as a SISO and treated as such in the bankruptcy. But unless the bankruptcy court treats a securitization transaction as a true sale of the receivables, the transaction will not accomplish its intended purpose and the value of the transaction will be diminished.
Because a true sale and a SISO share many attributes, the distinction between them has proven difficult to draw in securitization and other complex transactions. The existing case law is confused and confusing, and none of the commentators has found an approach to characterization that has been wholly successful.
This Article offers a property-based methodology for determining whether a transaction is a true sale or a SISO. One must first identify the specific allocation of rights between the purported buyer and seller and then determine whether the seller has retained any meaningful economic interest in the receivables. The property-based approach builds on the analysis of the true sale issue by others and borrows directly from the existing learning, literature, case law, and codification concerning an analogous determination: whether a true lease of goods should be recharacterized as a SISO. By focusing on the essential attributes of a sale and a SISO, the property-based methodology provides a workable way in which to give effect to the policy underlying recharacterization.
Keywords: security interests, true sales, receivables, UCC, collateral, securitization, property, financing
JEL Classification: K11, K20
Suggested Citation: Suggested Citation