Over recent years, the banking profession has been confronted with two waves of damage, sovereign risks and real estate, which led them in particular to have recourse to a technique known as "defeasance", which consists generally in transferring doubtful assets to an unconsolidated entity, usually a trust. Thereby, the risks and the potential losses should be transferred to shareholders or any other third party, and accounted for with respect to general accounting principles.
The Banking Regulation Committee ("Comité de la Réglementation Bancaire") defined the accounting treatment, by the seller, of such "defeasance" transactions in its ruling 89.07, dated July 1989. This ruling specifies the conditions to respect in order to see such a transaction as a complete sale, i.e. in order to "account for profit or loss resulting from this transfer, equal to the difference between the selling price and the book value of the defeased assets:
the transfer should be realised without any repurchase or taking back agreement or ability,
the transfer should not be accompanied with a guarantee granted by the seller against the debtors' default risks."
As a result, there should be no possible recourse against the seller since the final risk on defeased assets would be completely transferred to the unconsolidated entity. No provision would therefore be necessary by the seller.
The potential contractual relationships which might be set up between the seller and the ad hoc vehicle should be carefully examined, as, for example, the granting, by the seller, of funding to the purchaser in order to enable the latter to buy the defeased assets. Thus, taking account of such relationships, this transaction could be compared to an exchange transaction, which, according to the "Plan Comptable General" (French Accounting Principles), should be valued at the fairest value of the exchanged assets, i.e. the net present value of the funding.
For more information, please contact Olivier Drion or Ghislaine Mattlinger on 33 - 1 42 91 08 16.
For further information contact Olivier Drion on +33 1 4291 0606.
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