Answers to the questions in sections 1 and 2 generally describe the rules provided by the Uniform Commercial Code ("UCC"), a model statute enacted with some variations in each state, and answers to question 4.10 and the questions in section 6 generally describe the rules provided by the U.S. Bankruptcy Code, in each case unless otherwise specified. The United States is a signatory to, but has not yet ratified, the United Nations Convention on the Assignment of Receivables in International Trade (the "UNCITRAL Convention"). It is anticipated that the United States may ratify the UNCITRAL Convention in the near future. Upon the effectiveness thereof, the UNCITRAL Convention would override the UCC and change many of the answers set forth herein.
1 RECEIVABLES CONTRACTS
1.1 Formalities. In order to create an enforceable debt obligation of the obligor to the seller, (a) is it necessary that the sales of goods or services are evidenced by a formal receivables contract; (b) are invoices alone sufficient; and (c) can a receivable "contract" be deemed to exist as a result of the behaviour of the parties?
With respect to a contract for the sale of goods for $500 or more, some writing sufficient to indicate that a contract for sale has been made is required. A contract for services is generally required to be in writing if, by its terms, it is not to be completed within one year. However, with respect to contracts for sales of goods, a formal sales contract is not required but rather a contract may be on the basis of exchanged purchase orders, general terms, and invoices, or by a combination of writings which are themselves insufficient to establish a contract coupled with the conduct by both parties which recognises the existence of a contact.
1.2 Consumer Protections. Do the USA's laws (a) limit rates of interest on consumer credit, loans or other kinds of receivables; (b) provide a statutory right to interest on late payments; (c) permit consumers to cancel receivables for a specified period of time; or (d) provide other noteworthy rights to consumers with respect to receivables owing by them?
- Each state has different limitations on the permissible rate of interest; however, U.S. federal law permits banks and some other depository institutions to use a uniform nationwide rate, determined by the law of the state where the principal office of the institution is located.
- Not to our knowledge.
- Certain jurisdictions provide consumers with a period of time to cancel certain types of transactions after entering into a contract, in some cases these rights only apply when the contract was entered into in a specified context (e.g., when a contract is entered into with a merchant other than at a merchant's regular place of business).
- Consumers benefit from a number of protections. For example, restrictions on assignment of consumer loans are generally enforceable. In addition, personally-identifiable consumer information cannot be disclosed or used other than in specified manners.
Federal and state consumer protection laws and regulations regulate the relationships among credit card members, credit card issuers and sellers of merchandise and services in transactions financed by the extension of credit under credit accounts. These laws and regulations include the Credit Card Accountability and Disclosure Act, the Federal Truth-in-Lending Act and Fair Credit Billing Act, and the provisions of the Federal Reserve Board's Regulation Z issued under each of them, the Equal Credit Opportunity Act and the provisions of the Federal Reserve Board's Regulation B issued under it, the Fair Credit Reporting Act and the Fair Debt Collection Practices Act. These statutes and regulations require credit disclosures on credit card applications and solicitations, on an initial disclosure statement required to be provided when a credit card account is first opened, and with each monthly billing statement. They also prohibit certain discriminatory practices in extending credit, impose certain limitations on the charges that may be imposed and regulate collection practices. In addition, these laws and regulations entitle card members to have payments and credits promptly applied on credit accounts and to require billing errors to be promptly resolved. The Credit Card Accountability and Disclosure Act and the provisions of the regulations that implemented it limit the ability of credit card issuers to increase the interest rates on existing credit card balances, regulate how interest is calculated for each billing cycle, and regulate how payments must be allocated to outstanding balances with different interest rates. A card member may be entitled to assert violations of certain of these consumer protection laws and, in certain cases, claims against the lender or seller, by way of set-off against his or her obligation to pay amounts owing on his account. For example, under the Federal Truth-in-Lending Act, a credit card issuer is subject to all claims, other than tort claims, and all defences arising out of transactions in which a credit card is used to purchase merchandise or services, if certain conditions are met. These conditions include requirements that the card member make a good faith attempt to obtain satisfactory resolution of the dispute from the person honouring the credit card and meet certain jurisdictional requirements. These jurisdictional requirements do not apply where the seller of the goods or services is the same party as the card issuer, or controls or is controlled by the card issuer directly or indirectly. These laws also provide that in certain cases a card member's liability may not exceed $50 with respect to charges to the credit card account that resulted from unauthorised use of the credit card. In addition, the Dodd-Frank Act became federal law in 2010 and contains numerous regulations relating to the financial industry and provides for the establishment of the Bureau of Consumer Financial Protection. It is not yet clear how implantation of the Dodd-Frank Act will affect consumer receivables.
The Servicemembers Civil Relief Act allows individuals on active duty in the military to cap the interest rate and fees on debts incurred before the call to active duty at 6%. In addition, subject to judicial discretion, any action or court proceeding in which an individual in military service is involved may be stayed if the individual's rights would be prejudiced by denial of such a stay. Currently, some accountholders with outstanding balances have been placed on active duty in the military, and more may be placed on active duty in the future.
1.3 Government Receivables. Where the receivables contract has been entered into with the government or a government agency, are there different requirements and laws that apply to the sale or collection of those receivables?
Yes, if the debtor is the U.S. government or one of its agencies or instrumentalities. In such a case the Federal Assignment of Claims Act will apply to an assignment of receivables and the right of the federal government to exercise set-off. A minority of states have similar laws that apply to obligations of the state or agencies or departments thereof and a few states extend such rules to municipalities and other local governmental entities.
2 CHOICE OF LAW – RECEIVABLES CONTRACTS
2.1 No Law Specified. If the seller and the obligor do not specify a choice of law in their receivables contract, what are the main principles in the USA that will determine the governing law of the contract?
Courts generally apply the choice of law rules of the state in which the court is located, and thus answers to choice of law questions may differ depending on the state in which the litigation is prosecuted. Under the Restatement 2nd of Conflicts of Law, the rights and duties of the parties with respect to an issue in contract are determined by the local law of the state which, with respect to that issue, has the most significant relationship to the transaction and the parties. In the absence of an effective choice of law by the parties, the contacts to be taken into account in determining the law applicable to an issue include: (a) the place of contracting; (b) the place of negotiation of the contract; (c) the place of performance; (d) the location of the subject matter of the contract; and (e) the domicile, residence, nationality, place of incorporation and place of business of the parties.
2.2 Base Case. If the seller and the obligor are both resident in the USA, and the transactions giving rise to the receivables and the payment of the receivables take place in the USA, and the seller and the obligor choose the law of the USA to govern the receivables contract, is there any reason why a court in the USA would not give effect to their choice of law?
The U.S. is a multi-jurisdictional country and the contract needs to select the law of a particular U.S. state (rather than federal law) as the governing law. The choice of the law of a particular state of the United States to govern a contract may not be given effect if it does not bear a reasonable relationship with the transaction or parties. A few states, such as New York, permit the choice of their law to govern a contract even in the absence of any contacts if the contract satisfies certain dollar thresholds; however another U.S. state may not respect this choice of law if litigated in the other U.S. state in the absence of a reasonable relationship. Of course, on the facts specified above, there is no reason that an effective choice of a U.S. state law cannot be made.
2.3 Freedom to Choose Foreign Law of Non-Resident Seller or Obligor. If the seller is resident in the USA but the obligor is not, or if the obligor is resident in the USA but the seller is not, and the seller and the obligor choose the foreign law of the obligor/seller to govern their receivables contract, will a court in the USA give effect to the choice of foreign law? Are there any limitations to the recognition of foreign law (such as public policy or mandatory principles of law) that would typically apply in commercial relationships such that between the seller and the obligor under the receivables contract?
In general, the choice of law of the parties will be given effect in the circumstances described above. However, each state has somewhat different considerations in determining whether to give effect to a choice of non-U.S. law. Typically such a choice of non-U.S. law will be given effect if: (i) the chosen law has a reasonable and substantial relationship and sufficient contacts with the contract or the transaction contemplated thereby; (ii) the chosen law does not violate or contravene, nor is contrary or offensive to, a public or fundamental policy of the U.S. state determining such issue; and
(iii) the chosen law was not induced or procured by fraud. Under the Restatement 2nd of Conflicts of Law, a court may decline to apply the law of a jurisdiction chosen by the parties to a contract (which may be another U.S. state or a foreign jurisdiction) when (1) it is necessary to protect the fundamental policies of the state, the law of which would otherwise apply, and (2) such state has a materially greater interest in the determination of a particular issue than the state of the chosen law. It is not possible to make a definitive statement of when the fundamental policy exception would apply since each U.S. state and each court will reach its own determinations on a case-by-case basis.
2.4 CISG. Is the United Nations Convention on the International Sale of Goods in effect in the USA?
Yes, it is.
3 CHOICE OF LAW – RECEIVABLES PURCHASE AGREEMENT
3.1 Base Case. Does the USA's law generally require the sale of receivables to be governed by the same law as the law governing the receivables themselves? If so, does that general rule apply irrespective of which law governs the receivables (i.e., the USA's laws or foreign laws)?
Generally, there is no reason that the law of the state governing the contract giving rise to the receivables needs to be the same as the law of the state governing the sale of the receivables. However, as noted below in response to question 3.4, the sale of the receivables will need to be perfected under the Uniform Commercial Code and the law governing perfection cannot be selected by the parties but, instead, is subject to mandatory choice of law rules.
3.2 Example 1: If (a) the seller and the obligor are located in the USA, (b) the receivable is governed by the law of the USA, (c) the seller sells the receivable to a purchaser located in a third country, (d) the seller and the purchaser choose the law of the USA to govern the receivables purchase agreement, and (e) the sale complies with the requirements of the USA, will a court in the USA recognise that sale as being effective against the seller, the obligor and other third parties (such as creditors or insolvency administrators of the seller and the obligor)?
Generally yes, subject to the same considerations referenced in the response to question 2.3 above.
3.3 Example 2: Assuming that the facts are the same as Example 1, but either the obligor or the purchaser or both are located outside the USA, will a court in the USA recognise that sale as being effective against the seller and other third parties (such as creditors or insolvency administrators of the seller), or must the requirements of the obligor's country or the purchaser's country (or both) be taken into account?
Generally yes, subject to the same considerations referenced in the response to question 2.3 above.
3.4 Example 3: If (a) the seller is located in the USA but the obligor is located in another country, (b) the receivable is governed by the law of the obligor's country, (c) the seller sells the receivable to a purchaser located in a third country, (d) the seller and the purchaser choose the law of the obligor's country to govern the receivables purchase agreement, and (e) the sale complies with the requirements of the obligor's country, will a court in the USA recognise that sale as being effective against the seller and other third parties (such as creditors or insolvency administrators of the seller) without the need to comply with the USA's own sale requirements?
Subject to the considerations discussed in the response to question 2.3 above, a court in a United States jurisdiction will generally recognise the foreign law determination of whether a "true" sale has occurred as between the parties to the transaction pursuant to which the receivables were sold. However, any transfer of receivables, whether characterised as an outright sale or as a conditional transfer for security is classified under the UCC as a "security interest" and such security interest would need to be "perfected" in order to be enforceable against other creditors of the seller and any bankruptcy trustee of the seller. The methods of perfecting this security interest are detailed in the response to question 4.3 below. However, the law governing perfection may not be selected by the parties but rather is subject to mandatory choice of law rules. Where perfection is obtained by the filing of UCC financing statements, the law of the seller's "location" generally governs perfection of a non-possessory security interest in receivables. A seller's location is determined according to a number of factors, including: (a) the type of organisation (e.g. corporation, limited partnership or general partnership); (b) whether it is formed under the laws of a foreign country; (c) the location of its chief executive office; and (d) whether the law of the jurisdiction in which its chief executive office is located provides a system of public filing of notices of non-possessory liens on personal property as a condition for having priority over a judgment lien creditor. Although there are some exceptions, for most corporations and limited liability companies that are organised under the laws of any state of the United States, their "location" for purposes of the UCC (and hence the law governing perfection by filing) will be their state of incorporation.
Where perfection is obtained by possession of the original promissory note or tangible "chattel paper" evidencing the receivable, the law of the jurisdiction where the promissory note or tangible chattel paper is physically located will govern perfection of a possessory security interest. Examples of chattel paper include leases of office equipment; retail auto leases; and many retail instalment sales contracts.
3.5 Example 4: If (a) the obligor is located in the USA but the seller is located in another country, (b) the receivable is governed by the law of the seller's country, (c) the seller and the purchaser choose the law of the seller's country to govern the receivables purchase agreement, and (d) the sale complies with the requirements of the seller's country, will a court in the USA recognise that sale as being effective against the obligor and other third parties (such as creditors or insolvency administrators of the obligor) without the need to comply with the USA's own sale requirements?
3.6 xample 5: If (a) the seller is located in the USA (irrespective of the obligor's location), (b) the receivable is governed by the law of the USA, (c) the seller sells the receivable to a purchaser located in a third country, (d) the seller and the purchaser choose the law of the purchaser's country to govern the receivables purchase agreement, and (e) the sale complies with the requirements of the purchaser's country, will a court in the USA recognise that sale as being effective against the seller and other third parties (such as creditors or insolvency administrators of the seller, any obligor located in the USA and any third party creditor or insolvency administrator of any such obligor)?
The answer to this question will generally be the same as the answer to question 3.4 above.
4 ASSET SALES
4.1 Sale Methods Generally. In the USA what are the customary methods for a seller to sell receivables to a purchaser? What is the customary terminology – is it called a sale, transfer, assignment or something else?
Sales of receivables in securitisation transactions are generally structured as outright sales of all of the seller's right, title and interest in, to and under the receivables and the related assets, and all proceeds of the foregoing. The transfer is valid and enforceable if the purchaser gives value, the seller owns or has the power to sell the accounts receivable and the sale is evidenced by an otherwise binding and enforceable contact. However, whether the transfer will be respected as a "true sale" or re-characterised as a security interest will depend on a number of factors discussed below in question 4.7. Sale terminology is customarily used to refer to these transactions, although governing documents will often use a combination of terms as a precaution.
4.2 Perfection Generally. What formalities are required generally for perfecting a sale of receivables? Are there any additional or other formalities required for the sale of receivables to be perfected against any subsequent good faith purchasers for value of the same receivables from the seller?
For sales of types of receivables not covered by the answer to question 4.3, the sale is perfected by the filing of a UCC financing statement that identifies the seller, the purchaser and the receivables being sold. The financing statement must be filed in the appropriate filing office of the jurisdiction in which the seller is "located" – determined as provided in the answer to question 3.4.
4.3 Perfection for Promissory Notes, etc. What additional or different requirements for sale and perfection apply to sales of promissory notes, mortgage loans, consumer loans or marketable debt securities?
Receivables evidenced by promissory notes or negotiable instrument, or that constitute "payment intangibles", "chattel paper", or "marketable securities", all have different perfection rules.
A sale of "promissory notes" (most residential and commercial mortgage loans are evidenced by promissory notes) is automatically perfected, and no UCC financing statement needs to be filed or other action needs to be taken to perfect the sale. However, automatic perfection would not be applicable in the event that the sale was re-characterised as a security interest rather than a true sale and, accordingly, to protect against this risk, it is customary for a buyer to either take possession of the promissory notes or file a UCC financing statement to ensure that the buyer is perfected in the event of such a re-characterisation. In addition, if the purchaser fails to take possession of promissory notes it may be possible for another party who takes possession to obtain superior rights in the promissory notes. In the United States, most mortgage loans are evidenced by promissory notes.
Mortgage loans that are not evidenced by promissory notes or other instruments are classified under the UCC as "payment intangibles" and are also automatically perfected. Again, it is customary to perfect by filing of a financing statement to protect against the risk of re-characterisation of the sale as a security interest rather than a true sale. A "payment intangible" is a type of "general intangible" under the UCC, and perfection of security interests in other types of general intangibles can be perfected only by filing a UCC financing statement.
In contrast to promissory notes and payment intangibles, a sale of chattel paper must be perfected regardless of whether characterised as a sale or a more traditional security interest. A sale of "tangible" chattel paper (i.e., evidence by traditional, hard copy writing) may be perfected either by filing a UCC financing statement or by the purchaser (or its agent) taking possession of the chattel paper. A sale of "electronic" chattel paper may be perfected either by filing a UCC financing statement or by the purchaser taking control of the chattel paper. In the case of conflicting security interests, a purchaser that gives new value and takes possession (or control in the case of electronic chattel paper) of the chattel paper in good faith, in the ordinary course of the purchaser's business, and without knowledge that doing so violates the rights of another party, will have priority over a purchaser that perfects by filing.
Marketable Debt Securities
Sales of marketable debt securities are governed by Article 8 of the UCC rather than as a "secured transaction" under Article 9 of the UCC. A purchaser that gives value and obtains "control" of the securities, without notice of any adverse claim, is a "protected purchaser" of the securities. A protected purchaser's ownership interest will be free from attack by any other person claiming a security interest or other property interest in the securities. The necessary steps to achieving "control" over marketable debt securities involve (a) in the case of certificated securities, taking possession of such securities together with a written assignment executed by the seller, (b) in the case of uncertificated securities, either (i) having the securities transferred on the books and records of the issuer into the name of the purchaser, or (ii) having the issuer agree that it will follow the purchaser's instructions regarding disposition or redemption of the securities being sold without the further consent of the seller, and (c) in the case of securities maintained in a securities account, either (i) having the securities transferred and credited to the purchaser's own securities account, or (ii) having a securities intermediary that maintains the securities account to which the securities are credited agree that it will follow the purchaser's instructions regarding disposition or redemption of the securities being sold without the further consent of the seller.
4.4 Obligor Notification or Consent. Must the seller or the purchaser notify obligors of the sale of receivables in order for the sale to be effective against the obligors and/or creditors of the seller? Must the seller or the purchaser obtain the obligors' consent to the sale of receivables in order for the sale to be an effective sale against the obligors? Does the answer to this question vary if (a) the receivables contract does not prohibit assignment but does not expressly permit assignment; or (b) the receivables contract expressly prohibits assignment? Whether or not notice is required to perfect a sale, are there any benefits to giving notice – such as cutting off obligor set-off rights and other obligor defences?
Obligor notification is not required in order for a sale of the sellers' rights in respect of the receivable to be effective as between the seller and the purchaser. However, the general rule under the UCC is that only once the obligor receives notice that the receivable has been sold: (i) can the purchaser enforce the payment obligation directly against the obligor; and (ii) must the obligor pay the purchaser in order to be relieved of its payment obligation. In addition, notifying the underlying obligor of the assignment has the advantage of preventing such obligor from exercising against the purchaser a right of set-off or defence that the obligor might have had against the seller and that accrues after the obligor receives notice of the assignment (although an obligor always retains the right of recoupment arising from the transaction that gave rise to the receivable) and, in those cases where the receivable has been fully earned by performance, prevents any amendment to the receivables contract without the consent of the purchaser. If, alternatively, the receivables are evidenced by a "negotiable instrument", a purchaser who becomes a holder in due course may enforce directly against the obligor and takes free and clear of defences arising from the seller's conduct, subject to a few exceptions under consumer protection laws. Similar rights are available to protected purchasers of debt securities.
Generally, a seller or obligor insolvency will not limit the ability of the purchaser of receivables to give notice to the obligors of the assignment of those receivables. The purpose of the notification requirement is to avoid the obligor being required to pay twice.
Unless the contract expressly requires such consent, obligor consent is generally not required under U.S. common law in order for a sale of the sellers' rights in respect of the receivable to be effective as between the seller and the purchaser. The answer to the question of whether the language of the receivables contract changes the general rule depends upon the type of receivables involved. Generally, under the UCC, a provision in a non-consumer account receivable and certain other types of receivable which prohibits or restricts its sale, or which provides that a sale may give rise to a default, breach, right of recoupment, claim, defence, termination or remedy, is ineffective. However, the UCC provides that if a receivable containing such a prohibition is evidenced by a "promissory note" or is classified under the UCC as a "payment intangible", although the sale is effective as between the purchaser and the seller the purchaser cannot enforce the receivable against the obligor and the sale does not impose any duty or obligation on the obligor.
4.5 Notice Mechanics. If notice is to be delivered to obligors, whether at the time of sale or later, are there any requirements regarding the form the notice must take or how it must be delivered? Is there any time limit beyond which notice is ineffective – for example, can a notice of sale be delivered after the sale, and can notice be delivered after insolvency proceedings against the obligor have commenced? Does the notice apply only to specific receivables or can it apply to any and all (including future) receivables? Are there any other limitations or considerations?
As noted in the response to question 4.4 above, notice to the obligor is required only to the extent of imposing certain obligations on the obligor. There is no specific form specified for delivery of notice other than that the notice must be an "authenticated record", i.e., in a signed writing or the electronic equivalent thereof. Generally, there is no time limit for the delivery of such a notice, though, as noted above, there are advantages in giving the notice sooner rather than later and a seller or obligor insolvency should not limit the ability of the purchaser of receivables to give notice to the obligors of the assignment of those receivables, so long as the assignment was fully consummated before the commencement of the insolvency proceeding. The purpose of the notification requirement is to avoid the obligor being required to pay twice. A notice to an obligor need not be limited to a specific set of receivables and can cover future receivables as long as those receivables are identifiable.
4.6 Restrictions on Assignment; Liability to Obligor. Are restrictions in receivables contracts prohibiting sale or assignment generally enforceable in the USA? Are there exceptions to this rule (e.g., for contracts between commercial entities)? If the USA recognises prohibitions on sale or assignment and the seller nevertheless sells receivables to the purchaser, will either the seller or the purchaser be liable to the obligor for breach of contract or on any other basis?
Generally, such restrictions will not be effective to prevent the granting of the security interest, though, as noted in the answer to question 4.4, in some cases such security interest will be unenforceable against the underlying obligor.
4.7 Identification. Must the sale document specifically identify each of the receivables to be sold? If so, what specific information is required (e.g., obligor name, invoice number, invoice date, payment date, etc.)? Do the receivables being sold have to share objective characteristics? Alternatively, if the seller sells all of its receivables to the purchaser, is this sufficient identification of receivables?
No, the sale document need not specifically identify each receivable to be sold, but it must nonetheless provide a means for identifying objectively receivables that have been sold. Under the UCC, a security interest can be created in a broad category of assets (such as accounts receivable). If all receivables have been sold, no further identification should be required.
4.8 Respect for Intent of Parties; Economic Effects on Sale. If the parties denominate their transaction as a sale and state their intent that it be a sale will this automatically be respected or will a court enquire into the economic characteristics of the transaction? If the latter, what economic characteristics of a sale, if any, might prevent the sale from being perfected? Among other things, to what extent may the seller retain (a) credit risk; (b) interest rate risk; and/or (c) control of collections of receivables without jeopardising perfection?
Whether a receivables transfer will be recognised as a "true sale" (and not as a secured loan), in most states it is determined by judge- made common law. As a result, judicial authority analysing transfers as true sales is not always consistent. Several courts have given presumptive weight to the intent of the parties. Other courts, seeking the "true nature" of a transaction, have regarded the parties' intent as only one attribute of a transaction and have balanced those attributes of a transaction indicative of a secured loan against those attributes indicative of a sale in order to determine whether the transaction more closely resembles a sale or a secured loan. Where commercially sophisticated parties have characterised transactions as sales, and acted consistently with that characterisation, courts have generally been unwilling to disturb that characterisation even though the transactions may also bear certain attributes of secured loans. Upon a showing by "clear and convincing evidence", however, that the transaction had the economic substance of a "disguised financing", courts may invoke their equitable power to re-characterise the transaction accordingly.
Generally, a key element to finding that a sale took place, as opposed to a loan, is that recourse to the seller is limited or nonexistent. Recourse to the seller can take several forms. Recourse for the uncollectibility of the receivables and recourse to provide a contracted rate of return are often cited in cases re-characterising transactions as loans.
4.9 Continuous Sales of Receivables. Can the seller agree in an enforceable manner (at least prior to its insolvency) to continuous sales of receivables (i.e., sales of receivables as and when they arise)?
Yes, a seller can agree to continuous sales of receivables in the U.S.; however, the bankruptcy code will generally cut-off the purchaser's interest in any receivables that are generated after the seller files for bankruptcy.
4.10 Future Receivables. Can the seller commit in an enforceable manner to sell receivables to the purchaser that come into existence after the date of the receivables purchase agreement (e.g., "future flow" securitisation)? If so, how must the sale of future receivables be structured to be valid and enforceable? Is there a distinction between future receivables that arise prior to or after the seller's insolvency?
Prior to insolvency, yes, as long as the receivables in question are sufficiently specified by the sale agreement. The effectiveness of sales of receivables arising after the bankruptcy of the seller could be uncertain. If both the seller and the purchaser have continuing duties to perform, the agreement could constitute an "executory contract" which may be rejected by the seller's bankruptcy trustee.
4.11 Related Security. Must any additional formalities be fulfilled in order for the related security to be transferred concurrently with the sale of receivables? If not all related security can be enforceably transferred, what methods are customarily adopted to provide the purchaser the benefits of such related security?
Generally, attachment and perfection of a security interest or sale of receivables in accordance with the formalities described in the answers to questions 4.1, 4.2 and 4.3 will result in automatic attachment and perfection of a security interest in a security interest securing the receivable, the related security or any letter of credit supporting payment of such receivable.
5 SECURITY ISSUES
5.1 Back-up Security. Is it customary in the USA to take a "back-up" security interest over the seller's ownership interest in the receivables and the related security, in the event that the sale is deemed by a court not to have been perfected?
Yes, it is customary.
5.2 Seller Security. If so, what are the formalities for the seller granting a security interest in receivables and related security under the laws of the USA, and for such security interest to be perfected?
As described in the answers to questions 4.2 and 4.3, the grant of a security interest in a receivable is generally perfected by the filing of a UCC financing statement. For instruments and chattel paper, possession of the original is also available as a method of perfection.
5.3 Purchaser Security. If the purchaser grants security over all of its assets (including purchased receivables) in favour of the providers of its funding, what formalities must the purchaser comply with in the USA to grant and perfect a security interest in purchased receivables governed by the laws of the USA and the related security?
The purchaser would be required to comply with the same formalities as did the seller, as provided in the answers to questions 4.2 and 4.3, although different locations of the purchaser and seller may result in the laws of a different jurisdiction being applicable to questions of perfection. Generally, if the relevant security agreement permits the filing of an "all assets" financing statement and the purchaser has appropriately filed such a statement, no additional UCC filing will be required in order for the providers of such purchaser's funding to have a security interest in such receivables.
5.4 Recognition. If the purchaser grants a security interest in receivables governed by the laws of the USA, and that security interest is valid and perfected under the laws of the purchaser's country, will it be treated as valid and perfected in the USA or must additional steps be taken in the USA?
5.5 Additional Formalities. What additional or different requirements apply to security interests in or connected to insurance policies, promissory notes, mortgage loans, consumer loans or marketable debt securities?
See the answer to question 4.3.
5.6 Trusts. Does the USA recognise trusts? If not, is there a mechanism whereby collections received by the seller in respect of sold receivables can be held or be deemed to be held separate and apart from the seller's own assets until turned over to the purchaser?
Yes, trusts of various forms are generally recognised in United States jurisdictions; however, if the transaction is classified as a security interest under the UCC (as discussed above, this includes the purchase of most receivables) then simply having the seller agree to hold the assets in trust for the purchaser will not be sufficient to avoid the perfection and other requirements of the UCC.
5.7 Bank Accounts. Does the USA recognise escrow accounts? Can security be taken over a bank account located in the USA? If so, what is the typical method? Would courts in the USA recognise a foreign-law grant of security (for example, an English law debenture) taken over a bank account located in the USA?
Generally, jurisdictions in the United States will recognise escrow accounts, although the specific elements required for an escrow account and the specific legal status of an escrow account will vary by state. Generally, security can be taken over a deposit account in United States jurisdictions. Typically this is accomplished through an account control agreement whereby the depositary bank, the obligor and the secured party agree that the bank will follow the directions of the secured party rather than the account holder upon the occurrence of certain events. A court in the United States should recognise a foreign law grant of security taken over a bank account located in the United States as long as the form of security and perfection satisfied the requirement of control under the UCC, notwithstanding the law governing the instrument of control, subject to the choice of law, consideration addressed by the answers to the questions in section 2.
6 INSOLVENCY LAWS
6.1 Stay of Action. If, after a sale of receivables that is otherwise perfected, the seller becomes subject to an insolvency proceeding, will the USA's insolvency laws automatically prohibit the purchaser from collecting, transferring or otherwise exercising ownership rights over the purchased receivables (a "stay of action")? Does the insolvency official have the ability to stay collection and enforcement actions until he determines that the sale is perfected? Would the answer be different if the purchaser is deemed to only be a secured party rather than the owner of the receivables?
If the sale of receivables was a true sale that occurred prior to the commencement of the seller's insolvency proceeding, then the receivables involved in such a sale would not constitute property of the seller's bankruptcy estate. Accordingly, the automatic stay imposed by section 362 of the Bankruptcy Code would not prohibit the purchaser from exercising ownership rights over the purchased receivables. No insolvency official (such as a debtor-in-possession, bankruptcy trustee, creditors' committee or bankruptcy court) would have the right to stay or otherwise affect the purchaser's rights regarding the receivables while that insolvency official determines whether the sale was perfected. However, the insolvency official can allege during the insolvency proceeding that the sale in fact was a secured loan, rather than a true sale.
The answer would be different if the purchaser is deemed only to be a secured party, rather than the owner of the receivables. Specifically, if either (a) the transaction was in fact a secured loan, or (b) the purchaser was still required (as of the commencement of the seller's insolvency proceeding) to take some action under the sale agreement vis-à-vis the seller before it was contractually entitled to collect the receivables, then the receivables would remain property of the seller's bankruptcy estate. Accordingly, the automatic stay would prohibit actions by the purchaser to obtain possession of, or otherwise exercise control over, the receivables. The purchaser could file a motion with the bankruptcy court for relief from the automatic stay to allow it to collect or otherwise exercise control over the receivables. However, any party in interest in the insolvency proceeding could object to the motion, and the bankruptcy court could deny the motion.
6.2 Insolvency Official's Powers. If there is no stay of action under what circumstances, if any, does the insolvency official have the power to prohibit the purchaser's exercise of rights (by means of injunction, stay order or other action)?
If the transaction was a true sale, then the insolvency official normally does not have the power to prohibit the purchaser from exercising its rights as to the receivables purchased. However, the insolvency official conceivably could still request that the bankruptcy court issue an injunction or stay order (particularly if there is a question about whether the transaction was a true sale or if there was an infirmity in the transaction), and the bankruptcy court would have discretion in determining whether or not to grant such a request. The bankruptcy court has some leeway to fashion equitable relief.
6.3 Suspect Period (Clawback). Under what facts or circumstances could the insolvency official rescind or reverse transactions that took place during a "suspect" or "preference" period before the commencement of the insolvency proceeding? What are the lengths of the "suspect" or "preference" periods in the USA for (a) transactions between unrelated parties and (b) transactions between related parties?
The debtor-in-possession, bankruptcy trustee or other party with requisite standing can avoid a transaction that took place within two years before the commencement of the insolvency proceeding, if the transaction was a fraudulent transfer pursuant to section 548 of the Bankruptcy Code. The look-back period for fraudulent transfers is two years both for transactions between unrelated parties and for transactions between related parties and, as discussed below, the look-back period for "preferences" is generally 90 days. Under section 548, a transaction constitutes a fraudulent transfer if the debtor (a) made a transfer or incurred an obligation with an actual intent to hinder, delay or defraud any entity to which the debtor was or became indebted, or (b) received less than a reasonably equivalent value in exchange for the transfer or obligation, and the debtor (i) was insolvent when the transfer was made or the obligation was incurred, or became insolvent as a result thereof, (ii) was engaged (or was about to engage) in a business or transaction for which any property remaining with the debtor was an unreasonably small capital, or (iii) intended to incur (or believed that it would incur) debts beyond its ability to pay as such debts matured. If a transaction is avoided as a fraudulent transfer, then a transferee that takes for value and in good faith would have a lien on, or may retain, any property the debtor transferred to it, but only to the extent that the transferee gave value to the debtor in exchange for the transfer.
Pursuant to section 544 of the Bankruptcy Code, the debtor-in-possession, bankruptcy trustee or other party with requisite standing can avoid a transaction under applicable non-bankruptcy law. For example, a transaction could be avoided under state fraudulent transfer law. Most state fraudulent transfer statutes are based on the Uniform Fraudulent Transfer Act, and others are based on the older Uniform Fraudulent Conveyance Act. These statutes contain elements that are similar to those set forth in section 548 of the Bankruptcy Code, though the look-back period under state fraudulent transfer statutes generally is longer than that under section 548. For example, the statute of limitations under the Uniform Fraudulent Transfer Act is four years after the transfer was made.
If the transaction is deemed to be a secured loan by the special purpose vehicle to the originator, then the debtor-in-possession, bankruptcy trustee or other party with requisite standing can avoid transfers made by the debtor-originator in connection with the transaction as preferential transfers, pursuant to section 547 of the Bankruptcy Code. Preferential transfers are those made (a) to a creditor, (b) on account of an antecedent debt owed by the debtor before the transfer was made, (c) while the debtor was insolvent and (d) that enables the creditor to receive more than it would have received in a Chapter 7 (liquidation) case. Generally, only transfers made within 90 days before the commencement of the insolvency proceeding are subject to avoidance as preferential transfers. However, transfers made to a special purpose vehicle within one year before the commencement of the insolvency proceeding may be subject to avoidance, because such transfers may be deemed to have been made to an "insider" (i.e., a related party). Courts typically recognise payments to fully-secured creditors as not being preferential. Even if the plaintiff can establish all of the elements of a preference claim, there are a number of statutory affirmative
defences available to creditors, including defences for transfers made in the ordinary course of business and transfers in which the creditors provided contemporaneous or subsequent new value to the debtor.
6.4 Substantive Consolidation. Under what facts or circumstances, if any, could the insolvency official consolidate the assets and liabilities of the purchaser with those of the seller or its affiliates in the insolvency proceeding?
Courts have the equitable power to order substantive consolidation under section 105(a) of the Bankruptcy Code. Substantive consolidation has the effect of consolidating the assets and liabilities of multiple legal entities and treating them as if the liabilities were owed by, and the assets held by, a single legal entity. Inter-company claims and guarantees by consolidated entities are disregarded. Substantive consolidation may be ordered with respect to related entities that are all the subject of an insolvency proceeding, and also may be ordered with respect to related entities where some are the subject of an insolvency proceeding and the others are not.
Courts in the United States do not apply a uniform standard in determining whether to order substantive consolidation. However, a number of influential courts have stated that substantive consolidation is an extraordinary remedy that typically is reserved for circumstances in which (a) creditors had dealt with the various legal entities as a single economic unit and did not rely on their separate identity in extending credit, or (b) the affairs of the entities were so entangled that substantive consolidation would benefit creditors. Courts are more likely to order substantive consolidation when principal parties consent.
In the past, courts have relied on a consideration of the following factors (among others) to guide their analysis of whether the relationships between multiple legal entities are so obscured that they could not be disentangled:
- the presence or absence of consolidated financial statements;
- the unity of interests and ownership between various corporate entities;
- the existence of parent and inter-corporate guarantees on loans;
- the degree of difficulty in segregating and ascertaining individual assets and liabilities;
- the transfer of assets without observance of corporate formalities;
- the commingling of assets and business functions; and
- the profitability of consolidation at a single physical location.
Recent court decisions have adopted an open-ended, equitable inquiry to determine whether to substantively consolidate multiple legal entities. These courts have focused on the need in insolvency proceedings to protect the pre-petition expectations of creditors. Both case law and policy considerations indicate that a court primarily should base its determination on whether or not substantive consolidation would be equitable to the respective creditors of the entities for which substantive consolidation is sought.
When a special purpose vehicle is used as part of a securitisation transaction, parties rely on the separate corporate existence of that special purpose vehicle. The special purpose vehicle should be monitored to ensure that (a) corporate formalities are observed, (b) the assets and liabilities of the special purpose vehicle can be readily distinguished from those of the originator, (c) the separate legal existence of the special purpose vehicle and the originator are disclosed to third parties, and (d) the special purpose vehicle is appropriately limited in its investments, indebtedness, business and ownership. If this is the case and the originator were to become a debtor in an insolvency proceeding, then it is unlikely that a court would order substantive consolidation of the originator and the special purpose vehicle if a party objects.
6.5 Effect of Proceedings on Future Receivables. What is the effect of the initiation of insolvency proceedings on (a) sales of receivables that have not yet occurred or (b) on sales of receivables that have not yet come into existence?
The commencement of an insolvency proceeding of the originator would create uncertainties as to sales of receivables that have not yet occurred and sales of receivables that have not yet come into existence.
First, many future flow securitisations are structured such that there is recourse back to the originator (which may take the form of a guarantee from the originator). The existence of such recourse could cause a court to conclude that the future flow securitisation was not a true sale, but rather was a secured loan.
Second, the receivables generated after the commencement of the originator's insolvency proceeding could be deemed to be included in the originator's bankruptcy estate, thus triggering the automatic stay as to those receivables. In addition, receivables generated after the commencement of the originator's insolvency proceeding generally would not be subject to a lien resulting from the security agreement entered into by the originator and the special purpose vehicle before the bankruptcy filing (unless such receivables are the proceeds, products, offspring or profits of assets acquired prior to the bankruptcy filing and subject to a security agreement).
Third, if the assets securitised are receivables that arise under executory contracts, there is a risk that in an insolvency proceeding involving a party to the contract, that party would "reject" the executory contract and no further receivables would be generated. The term "executory contract" is not defined in the Bankruptcy Code, but numerous courts have described it as a contract under which the obligations of both the debtor and the non-debtor are so far unperformed that the failure of either party to complete performance would constitute a material breach that excuses the performance of the other party. A debtor's decision to reject an executory contract is subject to bankruptcy court approval, and parties have an opportunity to object to a proposed rejection. However, bankruptcy courts generally will approve the rejection of executory contracts so long as the debtor demonstrates a valid business justification for its decision to reject. The rejection of an executory contract is treated as a court-authorised breach by the debtor, and gives rise only to an unsecured claim by the non-debtor party for damages.
7 SPECIAL RULES
7.1 Securitisation Law. Is there a special securitisation law (and/or special provisions in other laws) in the USA establishing a legal framework for securitisation transactions? If so, what are the basics?
Not as such.
7.2 Securitisation Entities. Does the USA have laws specifically providing for establishment of special purpose entities for securitisation? If so, what does the law provide as to: (a) requirements for establishment and management of such an entity; (b) legal attributes and benefits of the entity; and (c) any specific requirements as to the status of directors or shareholders?
Not as such. Certain U.S. federal tax laws, investment company regulations and securities laws have some provisions that facilitate securitisation by providing special rules for special purpose entities that satisfy certain requirements. Most domestic securitisations in the United States use entities organised as corporations, limited liability companies or statutory trusts under the laws of Delaware. Trusts created under the laws of New York are also common. Some types of U.S. securitisations, such as CDOs, use entities domiciled in offshore jurisdictions such as the Cayman Islands.
7.3 Non-Recourse Clause. Will a court in the USA give effect to a contractual provision (even if the contract's governing law is the law of another country) limiting the recourse of parties to available funds?
Courts in the United States typically will enforce non-recourse clauses and any carve-outs thereto. These courts will determine, based on the facts of each case, whether any of the carve-outs to the non-recourse clause apply in a particular situation. In interpreting the non-recourse provision and its carve-outs, courts will analyse their language in an attempt to determine the intent of the parties. Courts will enforce the agreement of the parties, giving the contract language its normal and usual meaning. If a court determines that a carve-out to the non-recourse clause applies in a particular case, then recourse may not be limited. Courts generally will give effect to a non-recourse provision in a contract where the governing law is that of another country, unless the enforcement of that provision would offend the public policy of the state in which the court convenes.
Under section 1111(b) of the Bankruptcy Code, however, the general rule is that a secured claim in a Chapter 11 case is treated as a recourse claim, whether or not it is non-recourse by agreement or applicable law. This section of the Bankruptcy Code converts non- recourse claims to recourse claims, but also permits classes of undersecured creditors to elect to waive their deficiency claims and have their entire allowed claims treated as secured claims. This provision does not apply if the property is to be sold.
7.4 Non-Petition Clause. Will a court in the USA give effect to a contractual provision (even if the contract's governing law is the law of another country) prohibiting the parties from: (a) taking legal action against the purchaser or another person; or (b) commencing an insolvency proceeding against the purchaser or another person?
"Covenants not to sue" typically are governed by state law, and courts will interpret them in accordance with the rules governing the construction of contracts. To be enforceable, a covenant not to sue should be supported by adequate consideration by the beneficiary of the covenant. Courts very rarely refuse to enforce covenants not to sue that are negotiated in business transactions. However, they will not enforce covenants not to sue that violate applicable law or public policy.
Courts typically will also enforce contractual provisions prohibiting parties from commencing an involuntary insolvency proceeding against a purchaser or another person. Like covenants not to sue, courts will interpret these provisions in accordance with the rules governing the construction of contracts, and they should be supported by adequate consideration. However, covenants preventing entities from filing voluntary bankruptcy petitions probably are unenforceable.
7.5 Independent Director. Will a court in the USA give effect to a contractual provision (even if the contract's governing law is the law of another country) or a provision in a party's organisational documents prohibiting the directors from taking specified actions (including commencing an insolvency proceeding) without the affirmative vote of an independent director?
Independent directors are often found in U.S. securitisation transactions in order to limit the ability of the SPE to commence voluntary bankruptcy proceedings. However, an agreement by an entity not to file a voluntary bankruptcy petition may be unenforceable as against public policy. In fact, failure of a director to commence bankruptcy proceedings when he/she properly concludes that it would be in the best interest of the SPE to do so may constitute a breach of fiduciary duty.
8 REGULATORY ISSUES
8.1 Required Authorisations, etc. Assuming that the purchaser does no other business in the USA, will its purchase and ownership or its collection and enforcement of receivables result in its being required to qualify to do business or to obtain any licence or its being subject to regulation as a financial institution in the USA? Does the answer to the preceding question change if the purchaser does business with other sellers in the USA?
Receivables purchases generally do not subject a purchaser to licensing or other qualification requirements to do business in the United States, although there may be exceptions to this rule from state to state depending upon the type of receivable. Collection and enforcement activities are more likely to require an entity to obtain a licence and qualify to do business within a state especially in the case of consumer receivables.
8.2 Servicing. Does the seller require any licences, etc., in order to continue to enforce and collect receivables following their sale to the purchaser, including to appear before a court? Does a third party replacement servicer require any licences, etc., in order to enforce and collect sold receivables?
No general servicing licence is required. However, a servicer or replacement servicer may require the same licences possessed by the originator operating company depending upon the type of receivables and the jurisdiction involved. In addition, a servicer may need to meet certain licensing and other requirements with respect to collection and enforcement activities in limited instances.
8.3 Data Protection. Does the USA have laws restricting the use or dissemination of data about or provided by obligors? If so, do these laws apply only to consumer obligors or also to enterprises?
Confidential consumer information cannot generally be disclosed to third parties and can only be used for the purposes for which such information was provided. Entities possessing consumer information are generally obligated to safeguard such information from unauthorised access and disclosure.
8.4 Consumer Protection. If the obligors are consumers, will the purchaser (including a bank acting as purchaser) be required to comply with any consumer protection law of the USA? Briefly, what is required?
Consumer protection laws exist at both the federal and state levels in the United States. A purchaser may be liable for the acts of the seller originating the receivable, as these liabilities are considered to pass to the holder of the receivable. In addition, a purchaser could be subject to debt collection laws, reporting laws and confidentiality laws, among other laws.
8.5 Currency Restrictions. Does the USA have laws restricting the exchange of the USA's currency for other currencies or the making of payments in the USA's currency to persons outside the country?
Federal anti-money laundering laws require financial institutions to implement due diligence procedures with respect to their customers in order to prevent the transfer of cash to certain prohibited persons.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.