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Securitization transactions are an important source of liquidity for many companies, and frequently these transactions are their primary funding source. It was not surprising, then, that a decision in the LTV Steel Co.bankruptcy proceeding that allowed the bankrupt parent company to use cash owned by its two special-purpose subsidiaries not only sent shock waves through the securitization world, but rocked the financial services industry as well. When In re LTV Steel Co. Inc., No. 00-43866 (Bankr. N.D. Ohio 2000), was rendered moot nine weeks later, market participants were left wondering whether that lack of finality would encourage other challenges to securitization transactions. LTV and certain affiliates (collectively, the “LTV companies”) filed petitions for voluntary bankruptcy in the U.S. Bankruptcy Court for the Northern District of Ohio with Judge William T. Bodoh on Dec. 29. On the same day, LTV filed an emergency motion for interim authority to use “cash collateral,” consisting of the proceeds of inventory and accounts receivable owned by, respectively, LTV Steel Products, L.L.C. (Inventory SPV) and LTV Sales Finance Co. (Accounts SPV), two securitization subsidiaries of LTV. The debtors claimed that those assets were part of the bankrupt estate because they had not been transferred by LTV to Inventory SPV and Accounts SPV in “true sales.” Judge Bodoh approved the motion on an interim basis, but without ruling expressly on the issue of true sale. It is worth noting that LTV and its subsidiaries are among the largest steel manufacturers in the United States, collectively employ more than 17,500 people and provide continuing employment benefits to more than 100,000 people — statistics not lost on Judge Bodoh. In fact, on the date of the emergency order, two members of Congress requested to be heard in the proceedings in order to emphasize the importance of LTV to the local economy. LTV’s two securitization facilities followed a two-tiered structure fairly typical in the industry. Accounts SPV would purchase receivables from the LTV companies. Inventory SPV would purchase LTV’s inventory and then sell the receivables generated by sales of the inventory to Accounts SPV. Accounts SPV and Inventory SPV would finance their purchases by issuing promissory notes to lenders. Accounts SPV was rated AAA by Standard & Poor’s; Inventory SPV was rated BBB by Fitch. The facilities were revolving and required to purchase available assets on a daily basis. Apparently, virtually all “eligible” inventory and receivables of LTV were sold to these subsidiaries. LTV attacked the structure of these securitization transactions, arguing that the transactions did not involve “true sales,” but instead constituted financings designed to deprive “unsecured creditors of the ability to realize any meaningful recovery from the lenders’ enormous equity cushion, and to enable the lenders to exercise remedies without any accountability to this court or any other parties in interest.” The debtors asserted that “through a bewildering and complex array of documents … the lenders have conjured the illusion that the debtors do not own their inventory, do not own their accounts and are not in the business of manufacturing and selling steel products.” LTV pointed to five primary indicia that it believed established a financing rather than a true sale of inventory and receivables. These consisted of the absence of fair market value or standard payment terms under the sale agreements; the allocation of risk to the debtors if the value of inventory or accounts would be insufficient to repay the debtors; the control that the debtors exercised over the inventory and receivables; the economic benefit that inures to the debtors if the inventory and receivables generate excess proceeds and the failure to treat the SPVs consistently as separate entities in a manner that otherwise would suggest true sale rather than financing transactions. The debtors then cited a variety of factors supporting these indicia, including the following: a complex formula for the purchase price of assets unrelated to fair market value; the fact that payment of servicing fees are subordinated to repayments to lenders; indemnifications from the servicer for such things as returned inventory, failure to deliver customer inventory in accordance with specifications and hazardous materials associated with the ownership and servicing of inventory, as well as with other indemnities from the sellers and servicer; the fact that cash generated under the facilities was paid directly to LTV as servicer and not to the special purpose vehicles; that the subsidiaries did not maintain separate employees, payroll or offices and that proceeds from the accounts were commingled with funds of LTV; and that the lenders filed “precautionary” UCC financing statements against the sellers of the inventory. In its fairly brief order holding for the debtors, the court recognized that all parties preserved their rights, including the rights of the securitization lenders to contend that the transactions constituted true sales. It then scheduled a final hearing for the relief sought by the motion for Jan. 31. However, on Jan. 9, Abbey National Treasury Services PLC, one of the lenders in the receivables securitization facility (and the only lender that was not also a participant in the inventory securitization facility), filed its own emergency motion seeking to modify the interim order. Abbey National contended that it was not a lender to the debtors; that the triple A rating of LTV Sales Finance and the lower interest costs of that subsidiary were predicated on the understanding of all parties, including LTV; that the subsidiary was bankruptcy-remote; and that there was no basis for the court to determine that the receivables which are Abbey National’s collateral are property of the debtors’ estate. Following a hearing Jan. 18, the bankruptcy court issued a memorandum opinion Feb. 5 denying Abbey National’s motion and expanding further its analysis in support of the debtors’ position. The court stated that the debtors’ equitable interest in the inventory and receivables was property of the debtors’ estate sufficient to support entry of the interim cash collateral order, noting that “there seems to be an element of sophistry to suggest that debtor does not retain at least an equitable interest in the property,” and to suggest that the “debtor lacks some ownership interest in products that it creates with its own labor, as well as the proceeds to be derived from that labor, is difficult to accept.” The court went on to say that it was satisfied that the interim order was “necessary to enable debtor to keep its doors open and continue to meet its obligations to its employees, retirees, customers and creditors,” and further that denial of the motion “would put an immediate end to debtor’s business, would put thousands of people out of work, would deprive 100,000 retirees of needed medical benefits, and would have far more reaching economic effects on the geographic areas where debtor does business.” Abbey National immediately appealed this decision. That appeal was further supported by amicus briefs from numerous industry participants, including the Bond Market Association and the New York Clearing House Association L.L.C. The issue would never reach a final hearing. On March 9, the court initially approved, and on March 20, it issued a final approval of two different, but related, debtor-in-possession (DIP) financing arrangements provided by Ableco Finance LLC (with CIT as the administrative agent) and a group of lenders led by J.P. Morgan Chase (the agent under the inventory financing facility and the former agent under the accounts facility) and Abbey National. The Ableco facility is a working capital facility and the Chase/Abbey facility will be used exclusively to repurchase the securitization assets from the SPVs and cause the payment in full of the prepetition securitization facilities. Repayment of the securitization facilities effectively mooted the issue of taking cash collateral from the securitization lenders. The DIP financing order left unanswered the challenges and arguments exchanged between the parties on the issue of whether, in fact, a “true sale” occurred. At the request of the DIP financing lenders, the bankruptcy court expressly included in its order approving the replacement loan facility a statement that the securitizations involved true sales; however, the substantive issues of true sale were neither litigated nor resolved by the court. REACTIONS VARY Reaction to the LTV decision has varied. There were suggestions that the motion was a strong-arm tactic to pressure securitization participants to provide DIP financing. Others feel that a challenge will remain a continuing possibility until definitively addressed by the appellate courts. There are certainly elements of the LTV case that distinguish it from other securitizations. Political pressures were clearly a factor. In addition, inventory securitizations coupled with receivables securitizations have been viewed by some as more susceptible to challenge than solely receivables securitizations. Finally, it appears that virtually all current assets of the LTV companies were financed through its securitizations. This not only meant that the debtors had no liquid assets to finance, but also the absence of a revolving credit “balance sheet” lender to the parent corporation effectively eliminated the logical candidate to provide DIP financing. In the wake of its disappointment with the LTV decision, industry attention has turned to a promising development in the guise of a hitherto little-known section of the proposed Bankruptcy Reform Act of 2001. Both the House and Senate versions of that bill contain a similar proposed “safe harbor” that provides true sale treatment for certain transfers of assets, making it clear that if the conditions in that section are satisfied, the property transferred would not be considered part of the estate of the transferor. The safe harbor (� 912 of the proposed act), which takes the form of an amendment to Bankruptcy Code � 541, applies to transfers of “eligible assets” to an “eligible entity” in connection with an “asset-backed securitization.” The term “eligible assets” is defined to include “financial assets … including residential and commercial mortgage loans, consumer receivables, trade receivables … and lease receivables, that by their terms, convert into cash within a finite time period, plus any residual interest in property subject to receivables included in such financial assets plus any rights or other assets designed to assure the servicing or timely distribution of proceeds to security holders; cash and securities.” An “eligible entity” is an entity engaged exclusively in the business of acquiring and transferring eligible assets directly or indirectly to an issuer, or an entity engaged exclusively in the business of acquiring and holding eligible assets and issuing securities backed by eligible assets. And an “asset-backed securitization” requires a transaction in which eligible assets are transferred to an eligible entity that has at least one class of securities-rated investment grade. While there is little legislative history available in regard to this section, there has been some suggestion that the term “eligible assets” is to be interpreted as consistent with the eligibility requirements for “asset-backed securities” under Securities and Exchange Commission Form S-3, which also requires that registered securities be rated “investment grade.” The proposal would render potentially obsolete the existing complex “true sale” opinion analysis for transactions that qualify for safe harbor treatment. Such factors as accounting and tax treatment of the conveyance, repurchase or servicing obligations of the transferor or the extent of the transferor’s equity investment in the special purpose vehicle would become irrelevant for qualifying transactions. While it would change the true sale analysis, the safe harbor would not affect the requirements in regard to substantive nonconsolidation, which examines the separateness and independence of the transferor and transferee. The LTV decision clearly rattled cages in the securitization industry. If the result, however, is to mobilize support behind � 912 of the new Bankruptcy Reform Act, it may turn out to be a blessing in disguise. Barbara M. Goodstein is a partner in the banking and insolvency group at Clifford Chance Rogers & Wellsin New York. She specializes in equipment finance, securitization and restructurings. Telephone: (212) 878-8020; e-mail: [email protected] cliffordchance.com.

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