Although true sale analysis under New York and English law starts from a similar point, treating the two systems as equivalent can lead to costly, unintended consequences in commodity trade finance transactions. In this article, we explain why.

Introduction

True sale analysis cannot be treated as an afterthought, because it serves as the basis for capital treatment, risk allocation and enforcement. For many commodity trade finance structures, including receivables purchase programmes, sub-participations, pre-export finance arrangements and inventory repo structures, whether the underlying transfer is characterised, as a matter of law, as a sale or as security for a loan is crucial to the legal risk analysis. The legal characterisation determines which party bears the risk in an insolvency scenario and may also be relevant to the accounting treatment, including balance sheet presentation, which is assessed under separate accounting standards.

This analysis becomes even more critical where similar structures are deployed across multiple jurisdictions, often involving standardised documentation but non-standardised approaches under the relevant governing law. Early, deal-specific true sale analysis should therefore be viewed as a critical gateway to avoid changes to structure, documentation and/or credit support down the road.

True sale analysis under English law

True sale analysis under English law is rooted in established case law1, which sets out defined parameters to differentiate between a sale and a transfer by way of security. These parameters include whether there is:

  • equity of redemption
  • an obligation to return surplus proceeds
  • an obligation to make good on shortfalls

As English case law has progressed, the Courts have ultimately adopted the view that where a transaction is structured in substance as a sale and documented accordingly, it will generally be upheld as such. It is only if certain provisions of the agreement are inconsistent with a sale or a transfer of a beneficial ownership interest that the Court will examine the agreement as a whole to determine the nature of the relationship between the parties. In the leading case of Welsh Development Agency v Export Finance Co Ltd2, the Court emphasised that “the agreement must be regarded as a whole - its substance must be looked at. The parties cannot, by the insertion of any mere words, defeat the effect of the transaction as appearing from the whole of the agreement into which they have entered. … you must look at the agreement as a whole and see what its substantial effect is“.

True sale analysis under New York and United States federal laws

Unlike English law, there is no dispositive guidance in New York, or even on the federal level in the United States, when it comes to true sale analysis. On the one hand, US Bankruptcy Courts clearly specify that property that has been completely and unequivocally transferred by the debtor does not constitute part of the debtor’s bankruptcy estate. On the other hand, they have also clearly specified that property transferred as collateral to secure a debt, or property which the other party is obligated to return under circumstances indicating there was no intent to transfer title or shift risk would, in each case, constitute property of the debtor’s bankruptcy estate. However, what the US Bankruptcy Courts have not clearly specified is what constitutes a complete and unequivocal transfer of property in the first instance. Perhaps the Court in Savings Bank of Rockland County3 said it best when it concluded that “[t]he cases that address whether or not certain transactions are to be considered purchased receivables or sales do not lay down a clear rule of law on the issue…“.

There is substantial case law establishing that where the parties’ intention is clearly and unambiguously set forth in the agreement, effect must be given to the expressed intent. However, unlike the English law approach, in which the analysis would likely stop there if the intent in the documentation was clear, courts in the US have from time to time either ignored or given only cursory attention to such expressed intent where they deemed it necessary to prevent an inequitable result or where the stated intent was manifestly at odds with the actual purpose or economic substance of the transaction. The US can therefore be described as taking more of a ‘totality of the circumstances approach’, but where the circumstances vary not only in their nature and their applicability but also in the weight afforded to them dependent upon the opinion cited.

While not an exhaustive list, some of the factors commonly considered by the US Courts are:

  • the level of recourse and the risk of loss associated with the ownership interest transferred
  • the level of control retained by the transferor
  • the intent of the parties to the transaction, including the language of the agreement and the conduct of the parties
  • whether the transferee must account to the transferor for any surplus received
  • whether the transferor has the unrestricted right to redeem the assets
  • whether the transaction is at arm’s-length for adequate consideration

In summarising prior decisions, the United States Court of Appeals for the Third Circuit found that courts have examined the parties’ practices, objectives, business activities, and relationships, and determined whether the transaction was a sale or a secured loan “only after analysis of the evidence as to the true nature of the transaction.”4

Accordingly, while the underlying transaction documents are given substantial weight, they are not necessarily determinative in the same way they may be under English law and the courts in the US will evaluate these agreements against the background of the entire transaction. In a recent decision by a Montana bankruptcy court, In re Shoot the Moon5, it was determined that the conduct of the parties revealed an apparent debtor-creditor, rather than seller-buyer, relationship, notwithstanding the language in the agreements describing the relevant transaction as a sale of receivables.

Ultimately, in those instances where a transaction was found to be an assignment for security rather than a sale, the courts have relied on the combined presence of recourse and other factors to reach their conclusion.

Comment

Whether operating under English or New York law, parties to a transaction intending to achieve a true sale should take care to conduct early analysis under applicable laws to ensure their transaction is properly structured and documented as a sale. For transactions governed by English law, structuring the transaction in substance as a sale and documenting it accordingly is likely to be persuasive, but for transactions subject to New York (or other US) law, this is likely to be only a step - or a first of many steps - towards establishing the true sale nature of the transaction.

The trade finance team at HFW has both English and New York qualified lawyers who work regularly with clients to structure, document and advise on transactions under both governing laws and which require a true sale element.