Another item to add to the growing list of possible unintended consequences of financial reform in connection with ABS: Section 210(a)(11) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Reform Act”)—Avoidable Transfers.
Here’s the who, what, where, when, why and how ABS are affected.
WHO? A “covered financial company” of which the FDIC becomes the liquidating receiver. Under the Reform Act, a “covered financial company” is a “financial company” as to which a “systemic risk determination” (such financial company is deemed to pose a significant risk to the financial stability of the U.S. upon its failure) has been made by the Secretary of the U.S. Treasury in consultation with the President. Entities most likely to be affected are non-bank “financial companies,” bank holding companies, and non-bank U.S. subsidiaries of either– if such subsidiary is in a financial business. An insured depository institution cannot be a “covered financial company.”
WHAT? The Reform Act’s “Orderly Liquidation Authority” (“OLA”) provides that if the FDIC is appointed as receiver of a “covered financial company,” the FDIC has the power to void transfers, preferential as well as fraudulent, such that security holders end up left with an unsecured claim in the FDIC receivership if the security interest in the assets was perfected solely via UCC filing (and not, for example, by possession or by filing plus stamping)– a different result than under either the Bankruptcy Code or, in the case of a bank, the Federal Deposit Insurance Act.
WHY? It has been noted by industry trade groups that the above-described outcome is most likely the result of an unintentional drafting error caused by trying to combine into the OLA section of the Reform Act both Section 547 and Section 548 of the Bankruptcy Code. Industry trade groups plan to meet with the Senate Banking Committee and the House Financial Services Committee, speak with the FDIC, and submit a comment letter under the October 19, 2010 FDIC NPR which asks for comments on the FDIC’s avoidance powers under Section 210 of the Reform Act.
HOW does this affect ABS transactions? Affected securitizations would, for the most part, include auto or equipment loan/lease (and certain student loan) securitizations. The underlying assets in these types of securitizations are generally characterized as “chattel paper” or “instruments” under the UCC and therefore the security interest may have initially been perfected solely by filing a Form UCC1. The problem arises when ultimately, under the UCC, a “bona fide purchaser” of the collateral trumps earlier perfection that was accomplished via UCC filing. This would not be the result under the Bankruptcy Code.
The legislative history and the FDIC’s October 19, 2010 NPR suggest that creditors should be similarly treated under the Bankruptcy Code and the OLA provisions. Further, no public policy supports such a distinction. Still, without further guidance, legal counsel will not be in a position to give a legal opinion as to whether a transfer could be avoided as a preference under the OLA or whether any given financial company could be determined to be a “covered financial company.”
As the musical group Bowling for Soup has sung, there will be No Opinion.
By Laurie Nelson.