What happens when a debtor, whose loan is pooled and securitized, files for bankruptcy? Are payments made to investors recoverable as fraudulent transfers or preferences?

Until recently, no published court opinion addressed this issue.  However, in what is sure to be welcome news for investors in securitization vehicles, late last month, a Bankruptcy Court in Illinois shed light on the issue and ruled that such payments are in fact protected from avoidance. Specifically, the court held that the securities contract safe harbor found in section 546(e) of the Bankruptcy Code generally protects payments made to investors in the two-tiered securitization structures so commonly used in CMBS transactions (i.e. mortgages pooled together and held by a REMIC trust) from fraudulent or preferential transfer claims. This section of the Bankruptcy Code has long been understood to provide stability to securities markets by shielding from avoidance pre-petition payments which met certain criteria, including being made by or to certain financial market participants and being made in connection with a securities contract. Until this decision, however, while many believed that these protections extended to payments made to investors in typical two-tiered CMBS transactions, there was no legal precedent directly on point. We now know that at least one court thinks that they do – the question now is whether other courts will follow suit.

For more information on this decision, please see: Payments to Investors in a Securitization Structure Protected from Avoidance