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Trust Law/Level VI · Protection/6.2 Offshore/Lesson 6

Special purpose trusts in finance

How securitisation uses special purpose vehicles, orphan structures held by charitable or purpose trusts, and US statutory trusts to keep assets apart from the sponsor.

Education, not legal advice. Trust law changes from country to country and state to state, and the right structure depends on your situation. Anything you sign should be drafted or reviewed by a qualified lawyer where you live.

The lean path

The cheapest, lowest-tax, simplest and most private route the law allows, best first. Each step names the rule it rests on and the condition that keeps it lawful.

  1. For an individual, the leanest use is a Delaware statutory trust interest as like-kind replacement property: Rev. Rul. 2004-86 allows exchanging real property for it without recognizing gain under §1031. Catch: identify within 45 days and close within 180.
  2. Investors in asset-backed notes rely on true-sale and non-consolidation opinions the sponsor paid for; the prospectus ‘issuing entity’ section is free to read. Catch: substantive consolidation is rare but possible (In re Owens Corning, 2005).
  3. A sponsor’s orphan SPV held on a charitable trust (England) or purpose trust (Cayman, Bermuda) keeps assets bankruptcy-remote. Catch: keep separate books, bank accounts and decisions, or a court may recharacterise the sale or consolidate the entities.
  4. Accounting looks at control, not shareholding, so an orphan SPV may still be consolidated under US standards or IFRS. Catch: these structures suit large transactions; small users pay fees for no added protection.

MaterialsLesson 6.2.5, on purpose trusts and the STAR and VISTA regimesThe ‘issuing entity’ section of an asset-backed securities prospectus, if you are reading oneA law firm guide to orphan special purpose vehicles from a source you trust

Wonder

  1. Why would a bank sell loans to a company it does not own?
  2. Who owns an ‘orphan’ company, and why would anyone hold shares in it?
  3. What can undo the separation between a special purpose vehicle and its sponsor?

Explore

  1. In a securitisation, an originator, often a bank, sells a pool of assets such as mortgages, car loans or credit card receivables to a special purpose vehicle (SPV). The SPV pays for them by issuing notes or certificates to investors, who are repaid from the assets’ cash flows. The aim is ‘bankruptcy remoteness’: if the originator later fails, its creditors should not be able to claim the assets, because they were sold in a ‘true sale’ rather than pledged as security for a loan.
  2. If the originator owned the SPV, the SPV could be treated as part of the originator’s group for accounting, regulatory or insolvency purposes, defeating the point of the separation. A common answer is an ‘orphan’ SPV: its shares are held by a professional trustee on a charitable trust or a purpose trust, so no party to the deal owns it. The SPV usually has independent directors from an administration firm and limits on what it may do, and it grants security over its assets to a note trustee for investors.
  3. Charitable trusts were used first and remain common in English structures, because English law generally does not allow non-charitable purpose trusts (lesson 6.2.5). In jurisdictions with purpose trust statutes, such as the Cayman Islands (STAR trusts) or Bermuda (Trusts (Special Provisions) Act 1989), a purpose trust is often used instead. Its purposes are typically to hold the SPV’s shares and support the transaction, sometimes with a charity as residual beneficiary. When the notes are repaid, the SPV is usually wound up and any small surplus passes to the trust.
  4. In the United States, many asset-backed issuers are themselves trusts. A common choice is the Delaware statutory trust, a trust formed under the Delaware Statutory Trust Act, first enacted in 1988 as the Delaware Business Trust Act and renamed in 2002. Investors hold certificates or notes, and the trust agreement limits what the trustee may do. Using a trust as the issuer is one way to place the assets in a separate entity with its own creditors and governance.
  5. Separation can fail. Courts may recharacterise a ‘sale’ as a secured loan, leaving the assets in the originator’s estate. In US bankruptcy, a court may order ‘substantive consolidation’, merging an SPV’s assets and liabilities with those of a related company. In In re Owens Corning (3d Cir. 2005), the court called it a rare remedy of last resort, available where entities disregarded their separateness so much that creditors relied on them as one, or where their affairs are hopelessly entangled. For this reason transaction documents usually require separate books, bank accounts and decision-making, and lawyers often give opinions on true sale and non-consolidation.
  6. Orphan structures attract criticism as well as use. Accounting standards in the US and under IFRS look at who in substance controls an SPV, not just who owns its shares, so an orphan SPV may still be consolidated in a sponsor’s accounts. These structures serve large financial transactions, and their costs vary widely by deal and place. This lesson explains how they work; it does not suggest using one.

Key facts

  • In a securitisation, an originator sells assets to a special purpose vehicle that funds the purchase by issuing notes or certificates to investors.
  • Bankruptcy remoteness depends on a true sale, so the originator’s creditors cannot claim the assets if it fails.
  • An orphan SPV’s shares are held by a trustee on a charitable or purpose trust, so no party to the deal owns it.
  • Charitable trusts are common in English orphan structures; purpose trusts are used where statutes allow them, as in Cayman and Bermuda.
  • Many US asset-backed issuers are Delaware statutory trusts, formed under the act enacted in 1988 as the Delaware Business Trust Act.
  • US bankruptcy courts may order substantive consolidation, a rare remedy merging an SPV with a related company, if separateness was disregarded or their affairs are hopelessly entangled.

Exercise nine, six, three, one

9CollectList up to 9 features of a securitisation described in a prospectus summary or article you are reading (some have fewer), such as the originator, the assets sold, the issuer’s form, who holds its shares, its directors and the note trustee.
6ClusterSort them into 6 categories: the parties, the assets, the issuer’s legal form, ownership of the issuer, governance and separateness, and facts you are unsure about.
3DistillReduce the 6 categories to 3 groups: features that support bankruptcy remoteness, features that could weaken it, and questions you would ask a lawyer about.
1CrystallizeWrite 1 sentence explaining, in your own words, why a securitisation vehicle is often owned by a trust rather than by the bank that set it up.

Fact check

Dates, figures and claims checked against the published sources listed below.

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