Banking & Financial Services Law : Canadian and U.S. / Cross-Border Credit Market Lawyers & Attorneys : Osler Hoskin & Harcourt Law Firm

At its Canada Legal and Regulatory Committee meeting on February 11, 2010, the International Swaps and Derivatives Association, Inc. (“ISDA”) announced that it would continue to seek legislative reforms designed to reduce uncertainties and increase efficiencies with respect to cash collateral under Canadian personal property security law.
 

The Current PPSA Regime

Currently, if cash collateral is held in a bank account, the “collateral” is the asset created by the deposit—the debt obligation of the deposit-taking institution. Because such collateral is an “intangible” under the Personal Property Security Act (Ontario) (together with the Personal Property Security Act (Alberta), the “PPSAs”), the only available means of perfection is the registration of a financing statement. Priority relative to other consensual secured creditors is determined by order of registration. Consequently, searches should be conducted against the name of the debtor (and prior names) and subordination agreements, waivers or estoppels may have to be obtained from prior registrants. This process can be a costly one and is often impractical given the large number of registrations against certain debtors.
 

Proposed Amendments

On June 8, 2009, ISDA wrote to the governments of Ontario and Alberta proposing the adoption of legislative provisions similar to those in Article 9 of the Uniform Commercial Code (“UCC”) with respect to cash collateral held in deposit accounts. Under the UCC, a secured party may perfect its security interest in a deposit account if:

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In October 2009, the United States Bankruptcy Court for the Southern District of Florida issued a decision that sent ripples of concern across the U.S. lending community.  

The Decision

In Re TOUSA, Inc. involved a challenge of certain guarantees and liens granted by subsidiaries of Tousa, Inc., a Florida-based home builder. The guarantees and liens were provided in connection with US$500 million in loans made to Tousa about six months before it filed for Chapter 11 bankruptcy protection. The loans were made to finance a litigation settlement relating to a “disastrous” joint venture project. The relevant subsidiaries did not themselves receive any loan proceeds, nor were they liable under the litigation settlement (meaning they did not directly benefit from payment of the settlement from the proceeds of the loans).  

"Savings Clauses" in Upstream Guarantees

Following the Official Committee of Unsecured Creditors’ challenge of the subsidiaries’ guarantees and liens, and the Bankruptcy Court disallowed such guarantees and liens as an avoidable fraudulent conveyance under U.S. federal bankruptcy law and State law. In so doing, the Bankruptcy Court imposed a number of relatively harsh remedies, effectively unwinding the loan transactions and settlement refinancing and imposing consequential damages on the lenders. But probably the most notable holding in the case was its rejection of so-called “savings” provisions in upstream guarantees.

Upstream (and sidestream) guarantees in the U.S. have long been acknowledged to be subject to fraudulent conveyance or fraudulent transfer risk – that is, the risk of invalidation on the basis that the guarantor was insolvent (or rendered insolvent) and did not receive reasonably equivalent value in exchange for providing its guarantee. 

Traditionally, one of the most common methods of attempting to mitigate such risk has been to include a “savings” clause in the guarantee - i.e., a provision limiting the guarantor’s obligations to the maximum amount that would not give rise to a fraudulent conveyance. The Tousa Bankruptcy Court effectively held, in dictum, that “savings” clauses are per se unenforceable as attempts to contract around the protections of the Bankruptcy Code, and found that the multiple savings clauses at issue in this case were “inherently indeterminate” and “unenforceable as a matter of contract law”.

Concerns

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On September 18, 2009, amendments to Canadian insolvency legislation came into effect. On December 22, 2009, DBRS issued a press release explaining its policy response to such amendments in connection with lease structured finance transactions. The policy response required that certain steps be taken by February 26, 2010. As we are now beyond that date, the DBRS policy is fully in effect for these transactions.

Background

The September 18, 2009 amendments to the Bankruptcy and Insolvency Act and the Companies’ Creditors Arrangement Act incorporated specific provisions permitting insolvent debtors subject to reorganization proceedings to disclaim personal property leasing contracts. In many lease structured finance transactions some or all of the rights of the party providing the financing arise under agreements which are leases of personal property. In general, DBRS will not approve transactions where (1) the rights of the financing party arise under a lease contract which may be disclaimed under an insolvency proceeding, and (2) there is a risk that the lessor will become subject to insolvency proceedings. 

The DBRS policy only applies to those lease transactions which have not achieved bankruptcy remoteness after consideration of the amendments. While not specifically explained in the press release, presumably this is a reference to so called “two-step” transactions whereby the lease assets are first transferred in a sale transaction to a special purpose bankruptcy remote entity which then finances the assets. With bankruptcy remoteness achieved by the first sale, the assets are removed from the risk of the bankruptcy of the original seller. While there may still be a lease involved in the structure (the assets are often leased by the special purpose entity to another entity which in turn issues the asset backed securities), the lessor is a bankruptcy remote entity where the risk of an insolvency proceeding is not material. 

The transactions which have not achieved bankruptcy remoteness are presumably “one-step” transactions where the lessor is an operating entity and so subject to the risk of an insolvency proceeding. 

Requirements Under the New Policy

Lease structured finance transactions which seek to obtain or retain a DBRS rating now must meet the following requirements: 

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Bill 26, the Securities Transfer Act, was recently introduced in the Nunavut Legislative Assembly. As of today, “STA” legislation is in force in every province and territory of Canada, other than Yukon territory, Nova Scotia, Prince Edward Island and Nunavut (where Bill 26 is pending).

STA legislation in Canada is based on the Uniform Securities Transfer Act (“USTA") - a model act that was developed and endorsed by the USTA Task Force of the Canadian Securities Administrators. The intent behind this legislative initiative is to have substantively uniform statutes across the country governing the holding and transfer of securities and other investment property. Just over three years after the first STA legislation came into force in Alberta and Ontario, the objective of uniformity has almost been achieved.

Both the STA and USTA are modeled after Revised Article 8 of the Uniform Commercial Code. The close similarities among STA legislation and Revised Article 8 assist in creating a more consistent cross-border legal framework governing securities transfers.
 

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On February 24^th, 2010, the U.S. Securities and Exchange Commission (SEC) released a “Statement in Support of Convergence and Global Accounting.” This is the first statement of the SEC considering the transition from U.S. GAAP to International Financial Reporting Standards (IFRS) since November of 2008. 

In its statement, the SEC:

• supports the objective of financial reporting in the global markets pursuant to a single set of high-quality globally accepted accounting standards;
• encourages the convergence of U.S. GAAP and IFRS;
• attaches a “Work Plan” for its staff to lay out the work that must be done to support the decision of the SEC (to be taken in 2011) on the appropriate course to incorporate IFRS into the U.S. financial reporting system for U.S. issuers, including the scope, timeframe, and methodology for any such transition;
• indicates that if the Commission determines in 2011 to incorporate IFRS into the U.S. domestic reporting system, the first time U.S. issuers would report under such a system would be approximately 2015 or 2016, such timing to be considered further under the Work Plan;
• states that it will provide public progress reports on the Work Plan beginning no later than October 2010 and frequently thereafter until the work is complete.

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