This two-part article discusses the key concerns, from a non-consolidation and true sale perspective, that arise when an insurance company, as opposed to a bankruptcy-eligible entity, is a sponsor/seller in a securitization or similar structured finance transaction. This Part One introduces the main contrasts between non-con and true sale analysis in a traditional bankruptcy context and such analysis in an insurance-law scenario. Part Two, also appearing in this issue of Debt Dialogue, explores in more detail some of the practical challenges and legal nuance involved in preparing and negotiating these opinions in an insurance-company transaction.
In many transactions involving a new or special-purpose entity (SPE), and/or a conveyance of financial assets with some recourse back to the seller, non-con and true sale issues are among the most sensitive. Principals and counsel grapple with the likelihood that such an SPE could be equitably consolidated into the future insolvency estate of a sponsor or the risk that such conveyance could be re-characterized by a court as a secured loan. Any of such legal outcomes could frustrate the whole motivation behind the transaction, which relies on the separateness of the SPE and/or the effective transfer of interests in the sold assets. Third-party opinions of counsel delivered to banks, underwriters and other sources of credit address these matters in highly reasoned and equivocal fashion, delving into the nuances of separateness covenants, intent of the parties, the extent of recourse available against the seller and numerous similar factors.
In the typical non-con and true sale scenario, where the sponsoring entity is an eligible debtor under the Bankruptcy Code, cases decided under that law furnish the main body of authority relied on by counsel to render these opinions and to implement appropriate safeguards in the transaction.
- In the non-con arena, federal bankruptcy cases such as In re Vecco, 4 B.R. at 410 (Bkrcy. Court, ED Va., 1980), and In re Augie/Restivo Baking Co., 860 F.2d 515 (2d Cir., 1988), have presented a number of related but distinct approaches to determining when veil-piercing in an insolvency context is appropriate. These approaches include, among others, (i) a consideration of various elements of corporate separateness, (ii) balancing the benefits of consolidation against potential harm to creditors and (iii) assessing the reliance by creditors on corporate separateness. These and other cases are commonly cited in third-party opinions, which extrapolate from the findings in these cases to weigh the likelihood of consolidation in the subject transaction.
- In the true sale context, opinions often proceed from a U.S. Supreme Court decision, Butner v. United States, 440 U.S. 48 (1979), that defers to state law in determining ownership of an asset, i.e., whether an asset is the property of buyer or seller. After some discussion of relevant state law, however, these opinions tend to focus on additional federal bankruptcy cases that have taken up the characterization of sales in an insolvency context, often distilling two distinct threads of reasoning — cases that focus on the “intent of the parties” in deciding whether the professed sale was a sale or secured loan (see, e.g., In re Kassuba, 562 F.2d 511 (7th Cir., 1977)), and cases that hinge more on the economic characteristics and consequences of the transaction, such as recourse to the seller (see, e.g., Major’s Furniture Mart, Inc. v. Castle Credit Corp., 602 F.2d 538 (3rd Cir., 1979)).
The issues involved in both non-con and true sale in a bankruptcy context tend not to hinge significantly on the choice-of-law components of the underlying transaction. In other words, the law of the sponsor’s or SPE’s home jurisdiction, the governing law of transaction documents or the locus of the contracting parties is not paramount in reaching ex ante legal conclusions on the likelihood that corporate separateness or a true sale will be respected. Instead, practitioners tend to focus (as courts do) on principles derived from bankruptcy cases. When an insurance company is a sponsor, however, opinions must take a different tack insofar as an insurance company is not subject to the Bankruptcy Code (11 U.S.C. §109), although, as we shall see, bankruptcy-type principles still figure prominently in the analysis.
Insurance Company Insolvency
When an insurance company becomes insolvent,1 the insurance commissioner of the domiciliary state of the insurer2 has the statutory authority to petition a state court for an order to place the insurer in receivership.3 An insurance company receivership proceeding resembles in many respects a bankruptcy case. For instance, the insurance commissioner is vested with title to the assets and properties of the insolvent insurer in much the same way that a bankruptcy trustee (where one is appointed) assumes control over a debtor. Proofs of claim are entertained by the presiding court (the bankruptcy court or the state court, as the case may be) with a view toward achieving an orderly, albeit imperfect, workout of obligations owed by the insolvent company. The court has broad equity-like powers to alter contracts and take similar remedial actions.
One key difference, however, between the two regimes relates to policyholder protection. In the bankruptcy context, there is no organic bias toward a particular class of general unsecured claimants of a debtor entity, whereas in an insurance company receivership proceeding, policyholders with outstanding claims generally are senior to even the most senior-ranked unsecured debt or other obligation. This super-priority naturally puts some strain on non-con and true sale analysis because of the perception that the receiver,4 with his focus on policyholder protection, will be more likely than his bankruptcy counterpart to pierce the corporate veil or re-characterize an asset sale as a loan.
Non-Con and True Sale
Traditional non-con and true sale opinions have become quite commonplace, giving rise to a robust body of precedent as well as norms and customs to guide the practitioner in executing the analysis. There is far less precedent in the insurance context. This tends to lead to more fundamental differences of viewpoint about how to approach the analysis. For instance, consider a bankruptcy-law opinion involving a Pennsylvania-incorporated (bankruptcy-eligible) sponsor, a Delaware-organized SPE and New York-law-governed transaction documents. Counsel to the sponsor will typically be New York-qualified and will render a comprehensive non-con and true sale opinion (in addition to more familiar, non-reasoned opinions such as enforceability). Pennsylvania and Delaware counsel will need to be involved in order to opine on fundamentals such as due organization, due authorization and the like, as well as certain building blocks of non-con and true sale analysis including ability to petition for bankruptcy. However, the main analysis of non-con and true sale issues is set out in deal counsel’s reasoned opinion, which is not particularly state-specific.
However, in a similar situation involving a Pennsylvania-domiciled insurer sponsor, the tables turn somewhat. The lenders or initial purchasers may, quite sensibly, seek a third-party opinion from Pennsylvania-qualified counsel to the insurer to the effect that, were the insurer to be placed in receivership by the Pennsylvania insurance commissioner, the presiding Pennsylvania state court would not grant a motion to recover the SPE’s assets into the estate or re-characterize the conveyance as a loan by the insurer. Pennsylvania counsel might be asked to render such opinion based on an analysis of Pennsylvania insurance law and cases decided thereunder.
In Part Two, we will explore some of the key consequences of this allocation of opinion-giving responsibility.