Rendering Structured Finance Opinions of Counsel: Substantive - - PowerPoint PPT Presentation

Rendering Structured Finance Opinions

• f Counsel: Substantive Consolidation,

Authority to File Bankruptcy and More

Navigating Assumptions, Qualifications, Limitations and Use of Letters; Reducing Risks for Opinion Givers Today’s faculty features:

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Presenting a live 90-minute webinar with interactive Q&A Scott J. Gordon, Partner, Kirkland & Ellis, New York Michelle P . Quinn, Partner, Berger Harris, Wilmington, Del.

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RENDERING STRUCTURED FINANCE OPINIONS OF COUNSEL: SUBSTANTIVE CONSOLIDATION, AUTHORITY TO FILE BANKRUPTCY AND MORE

NAVIGATING ASSUMPTIONS, QUALIFICATIONS, LIMITATIONS AND USE OF LETTERS; REDUCING RISKS FOR OPINION GIVERS

MICHELLE P. QUINN, ESQUIRE mquinn@bergerharris.com

INTRODUCTION



Why Delaware?



LLCs



Opinions Provided



Non-dissolution opinion or the “Delaware State Law” opinion



“Authority to file” opinion



UCC Opinion



Entity Authority Opinion



Non-consolidation opinion



True Sale opinion



Series LLCs

5

WHY DELAWARE?



The Delaware Limited Liability Company Act



Increase of use of LLCs in the mid-1990s

200 400 600 800

In Thousands

Delaware Business Entities

Statutory Trusts Limited Partnerships Limited Liability Companies Corporations As of March 29, 2013 from the Delaware Division of Corporations

6

EASY ADMINISTRATIVE PROCEDURES



Online Services



Expedited and same day service



Filing of UCC documents



Payment of franchise taxes



Access to relevant provisions of the Delaware Code



Help with finding a registered agent



Name reservations



Status check for Delaware entities

7

EXPERTISE OF JUDICIARY IN BUSINESS MATTERS



Delaware's Court of Chancery



Limited jurisdiction



High volume of corporate and LLC matters



Corporations Section of the Delaware State Bar Association



Generates legislation after careful study of case law and business trends



Easy access to elected and appointed officials due to the small size of the state

8

CONTRACT FLEXIBILITY



Section 18-1101(b) of the DE LLC Act: “It is the policy of this chapter to give the maximum effect to the principle of freedom of contract and to the enforceability of limited liability company agreements.”



"Except as provided in a limited liability company agreement“ or similar language is found in most provisions of the DE LLC Act.



Delaware LLC Act is friendly to the SPV structure.

9

THE DELAWARE STATE LAW OPINION

THE “NON-DISSOLUTION” OPINION

DOCUMENTS REQUIRED



A certified copy of the Certificate of Formation from the Delaware Secretary of State.



A fully executed limited liability company agreement



A Certificate of Good Standing from the Delaware Secretary of State

11

CONTENTS OF THE OPINION LETTER



The Company has been duly formed and is validly existing in good standing as a limited liability company under the laws of the State of Delaware.



In Delaware, this requires an LLC Agreement and a Certificate of Formation. Should not be based solely on a good standing certificate.



The LLC Agreement constitutes a legal, valid and binding agreement of the Member, and is enforceable against the Member, in accordance with its terms.



Given with standard enforceability carve-outs, including bankruptcy



Sometimes drafted to cover only the Special Member provisions

12

CONTENTS OF THE OPINION LETTER (CONT.)



If properly presented to a Delaware court, a Delaware court applying Delaware law, would conclude that (i) [so long as any Obligation is

• utstanding,] in order for a Person to file a voluntary bankruptcy petition on

behalf of the Company, the prior unanimous written consent of the Member and all Independent Managers, as provided for in Section ___ of the LLC Agreement, is required, and (ii) such provision, contained in Section ___ of the LLC Agreement, that requires, [so long as any Obligation is outstanding,] the prior unanimous written consent of the Member and all Independent Managers in order for a Person to file a voluntary bankruptcy petition on behalf of the Company, constitutes a legal, valid and binding agreement of the Member, and is enforceable against the Member, in accordance with its terms.



Given with only an equitable principles carve-out. No bankruptcy carve-out.



Should track language of LLC Agreement.



LLC Agreement should not prohibit a bankruptcy filing or require lender consent for a bankruptcy filing

13

INDEPENDENT MANAGER



Disinterested third party granted authority to vote on bankruptcy of the LLC



Often serves as the special member



Lender limits on identity and replacement



Designate as a “manager” within the meaning of the LLC Act.

14

CONTENTS OF THE OPINION LETTER (CONT.)



While under the Delaware Limited Liability Company Act, 6 Del. C. § 18-101, et seq.) (the "LLC Act"), on application to a court of competent jurisdiction, a judgment creditor of the Member may be able to charge the Member's share

• f any profits and losses of the Company and the Member's right to receive

distributions of the Company's assets (the "Member's Interest"), to the extent so charged, the judgment creditor has only the right to receive any distribution

• r distributions to which the Member would otherwise have been entitled in

respect of the Member's Interest. Under the LLC Act, no creditor of the Member shall have any right to obtain possession of, or otherwise exercise legal or equitable remedies with respect to, the property of the Company. Thus, under the LLC Act, a judgment creditor of the Member may not satisfy its claims against the Member by asserting a claim against the assets of the Company.



Under the LLC Act (i) the Company is a separate legal entity, and (ii) the existence of the Company as a separate legal entity shall continue until the cancellation of the LLC Certificate.

15

CONTENTS OF OPINION LETTER (CONT.)



Under the LLC Act and the LLC Agreement, the Bankruptcy or dissolution

• f the Member will not, by itself, cause the Company to be dissolved or its

affairs to be wound up.



LLC Agreement should override LLC Act regarding bankruptcy of a member



Mandatory Events Dissolution 1. As specified in the limited liability company agreement 2. At such time as there are no remaining members 3. When ordered by the Court of Chancery

16

THE SPECIAL MEMBER



A special member/springing member becomes a member of the LLC upon occurrence of any event that would causes the last remaining equity member to cease to be a member by operation of law or contract



Provisions:



May not resign or transfer its rights unless a successor Special Member has been admitted



Has no interest in the profits, losses and capital of the Company



Has no right to receive any distributions of Company assets



Is not required to make any capital contributions to the Company, 6 Del. C. § 18-301(d)



May not bind the Company except as required by any mandatory provision of the LLC Act



Has no right to vote on, approve or otherwise consent to any action by, or matter relating to, the Company, including, without limitation, the merger, consolidation or conversion of the Company

17

THE PERSONAL REPRESENTATIVE



“Unless otherwise provided in a limited liability company agreement, within 90 days or such other period as is provided for in the limited liability company agreement after the

• ccurrence of the event that terminated the continued membership of the last remaining

member, the personal representative of the last remaining member agrees in writing to continue the limited liability company and to the admission of the personal representative

• f such member or its nominee or designee to the limited liability company as a member,

effective as of the occurrence of the event that terminated the continued membership of the last remaining member; provided, that a limited liability company agreement may provide that the personal representative of the last remaining member shall be obligated to agree in writing to continue the limited liability company and to the admission of the personal representative of such member or its nominee or designee to the limited liability company as a member, effective as of the occurrence of the event that terminated the continued membership of the last remaining member.” Section 18-801(a)(4) of the DE LLC Act



Provision works with the Special Member provision to continue the LLC in the event of a dissolution.

18

THE “AUTHORITY TO FILE” BANKRUPTCY OPINION



Reasoned opinion that addresses whether a federal bankruptcy court would look to federal or state law to determine the parties with authority to file a bankruptcy petition on behalf of the LLC.



Required because federal bankruptcy law does not specifically address LLCs.

19

THE UCC OPINION



The Financing Statement is in an appropriate form for filing with the Division.



Insofar as Article 9 of the Uniform Commercial Code as in effect in the State of Delaware on the date hereof (the "Delaware UCC") is applicable (without regard to conflict of laws principles), upon the filing of the Financing Statement with the Division, the Lender will have a perfected security interest in the Company's rights in that portion of the Property described in the Financing Statement in which a security interest may be perfected by the filing of a UCC financing statement with the Division and the proceeds (as defined in Section 9-102(a)(64) of the Delaware UCC) thereof.

20

OPINIONS REGARDING DUE AUTHORITY AND AUTHORIZATION



Under the LLC Act and the LLC Agreement, the Company has all necessary limited liability company power and authority to execute and deliver the Loan Documents to which it is a party, and to perform its

• bligations thereunder.



Under the LLC Act and the LLC Agreement, the execution and delivery by the Company of the Loan Documents to which it is a party, and the performance by the Company of its obligations thereunder, have been duly authorized by all necessary limited liability company action on the part of the Company.

21

OPINIONS REGARDING DUE AUTHORITY AND AUTHORIZATION (CONT.)



No authorization, consent, approval or order of any Delaware court or any Delaware governmental or administrative body is required to be obtained by the Company solely as a result of the execution and delivery by the Company of the Loan Documents to which it is a party, or the performance by the Company of its obligations thereunder.



The execution, delivery and performance by the Company of the Loan Documents to which it is a party do not violate (i) any Delaware law, rule

• r regulation, or (ii) the LLC Agreement or the LLC Certificate.



For both opinions, assume no assets or activities in Delaware

22

SERIES LLCS



Provide for isolated assets in separate series within one LLC



Require only one filing with the DE Secretary of State and one annual tax



Series are not separate legal entities under DE law



Cannot provide standard structured finance opinions on a series



Not recognized in every state or under federal bankruptcy law



Concern over whether a series can hold title to real estate in other jurisdictions

23

Rendering Structured Finance Opinions of Counsel: Substantive Consolidation, Authority to File Bankruptcy and More

Navigating Assumptions, Qualifications, Limitations and Use of Letters; Reducing Risks for Opinion Givers

Scott J. Gordon, Esq. scott.gordon@kirkland.com

www.kirkland.com  24

Bankruptcy Estate

• Estate includes all legal and equitable rights of

debtor

• Imposes automatic stay, which prohibits:
• judicial proceedings against debtor
• enforcement of pre-petition judgments
• actions to possess or control debtor’s property
• enforcement of liens against debtor’s property
• actions to collect pre-petition debts
• set-offs of pre-petition debts

www.kirkland.com  25

Effects of Bankruptcy

• Debtor may use collateral, despite security interest,

if creditor has adequate protection

• Debtor may substitute for collateral if new property

is indubitable equivalent

• Debtor may give collateral to other parties if creditor

is over-secured

• Debtor may reject obligations under executory

contracts and leases

www.kirkland.com  26

Bankruptcy Remote Structures – 3 Key Attributes of Isolation

• Effect true sale of assets by originator
• keep assets out of BK estate of originator
• Minimize risk of substantive consolidation
• avoid consolidation of purchaser’s assets and

liabilities with those of originator

• Structure purchaser as bankruptcy-remote
• minimize likelihood of purchaser independently

filing for BK due to unforeseen problems

• First Two attributes supported by legal opinions

www.kirkland.com  27

True Sale Opinion

• Supports key structured finance principle of isolation
• f assets in SPE
• Is one of two “creditor’s rights” opinions (along with

the Non-Consolidation Opinion) key to supporting the legal isolation of the SPE’s assets from creditors of the SPE’s affiliates

• Although speaks to outcome in Bankruptcy, is based
• n state law principles
• Is relied upon by accountants for accounting sale

treatment

www.kirkland.com  28

What Constitutes True Sale

• Keys to “True Sale” are
• Risk transfer / recourse
• Intent
• Securitization Statutes
• Delaware, ("ABSFA” (2002)), Texas, Ohio
• Attempt (largely ineffective) to create true sale

safe harbor

• Most transfers under securitizations continue to be

governed by New York law

www.kirkland.com  29

True Sale – Applicable Law

• Property interests are created and defined by state law,

including in bankruptcy, unless federal interest requires

• therwise Butner v. United States, 440 U.S. 48, 55

(1979)

www.kirkland.com  30

True Sale – Indicia of Sale

• Purchase price = fmv
• Buyer keeps all collections
• Buyer services receivables
• Obligors notified of sale
• Seller makes representations regarding nature of

receivables

• Buyer takes interest rate risk
• Buyer takes obligor credit risk

www.kirkland.com  31

True Sale – Indicia of Secured Loan

• Overcollateralization of loan
• Lender receives P + I only
• Debtor services receivables
• Obligors not notified of sale
• Seller makes reps re nature of receivables
• Debtor retains interest rate risk
• Debtor retains obligor credit risk

www.kirkland.com  32

True Sale - Recourse

“[T]here may be a true sale of accounts or chattel paper although recourse exists.” UCC section 9-502, comment 4 “Castle required Major’s to retain all conceivable risks of uncollectibility of these accounts. . . Guaranties of quality alone, or even guarantees of collectibility alone, might be consistent with a true sale, but Castle attempted to shift all risks to Major’s, and incur none of the risks or obligations of

• wnership.” Castle’s Furniture Mart, 602 F.2d At 545

www.kirkland.com  33

True Sale – Recourse – How Much is OK?

• Loss-based
• e.g., Equal to historical losses
• Percentage-based
• X% of pool size
• Dodd-Frank Act risk retention requirements
• Ratings-based
• e.g., Seller retains only investment grade risk

www.kirkland.com  34

Two-Step Transfer

www.kirkland.com  35

Originator/Servicer

True Sale of Receivables

Intermediate SPE

Transfer of Receivables Cash, Note & Stock Note & Certificate Proceeds

Issuer SPE

Notes and Certificates Owner Trustee

Servicing

True Sale Opinion

• You have requested our opinion whether, in a properly

presented proceeding under title 11 of the United States Code:

• compel the turnover of the [relevant property] or proceeds

thereof to the bankruptcy trustee under Section 542 of the Bankruptcy Code based on a determination that the [relevant property] is property of the originator’s/transferor’s bankruptcy estate under Section 541 of the Bankruptcy Code;

• r
• prohibit the SPE from enforcing its rights under the

[relevant property] pursuant to the automatic stay provisions

• f Section 362(a) of the Bankruptcy Code.

www.kirkland.com  36

True Sale Cases -- Intent

• One line of cases relies substantially upon the intent of the
• parties. Provided that the characterization of the transaction by

the parties is supported by the facts, where commercially sophisticated parties have characterized a transaction as a sale and have acted consistently with that characterization, courts have been unwilling to recharacterize the transaction even though it may also bear certain attributes of a secured loan. Kassuba v. Realty Income Trust (In re Kassuba), 562 F.2d 511, 514 (7th Cir. 1977) ("If the parties actually intended to effect an absolute transfer of ownership, a court of equity will not ignore that intent and make another contract for them")

www.kirkland.com  37

True Sale Cases – True Nature of Transfer

• The other line of cases looks beyond the stated intent of the

parties and seek to ascertain the "true nature" of a transaction, regarding the parties' intent as only one factor in analyzing a transaction, and weighing those characteristics of a transaction indicative of a true sale against those indicative of a secured loan to determine whether the transaction most resembles one or the other. In Major's Furniture Mart, Inc. v. Castle Credit Corp., Inc., 602 F.2d 538, 544 (3rd Cir. 1979) the court asked "whether the nature of the recourse, and the true nature of the transaction, are such that the legal rights and economic consequences of the agreement bear a greater similarity to a financing transaction or to a sale."

www.kirkland.com  38

Substantive Consolidation -- Derivation/Foundation

• The power of a bankruptcy court to consolidate the assets and

liabilities of separate, but related, entities

• Judicially created doctrine; not codified; based on equitable

jurisdiction

• Derives from the U.S. Supreme Court’s decision in Sampsell
• v. Imperial Paper & Color Corp. , 313 U.S. 215 (1941)
• Remedial action
• Extraordinary remedy
• Determination made on case-by-case basis
• Distinct from procedural consolidation

www.kirkland.com  39

Substantive Consolidation -- Framework

• Courts consider:
• The corporate structure and conduct of the entities

proposed to be consolidated and their relationship with their creditors and other third parties

• The impact upon creditors and whether they

would be unfairly prejudiced or treated more fairly by substantive consolidation

www.kirkland.com  40

Substantive Consolidation – Framework (Cont’d)

• Consideration of many factors; none dispositive:
• In In re Vecco Construction Industries, Inc., 4 B.R.

407, 409 (Bankr. E.D. Va. 1980) the court considered the following seven factors:

• (1) degree of difficulty in segregating assets and liabilities;

(2) presence of consolidated financial statements; (3) increased profitability due to consolidation at a single physical location; (4) commingling of assets and business functions; (5) unity of interests and ownership; (6) existence of intercorporate guaranties or loans; and (7) transfer of assets without

• bservance of corporate formalities
• www.kirkland.com  41

Substantive Consolidation – Framework (Cont’d)

• Other courts have added additional factors:
• (1) the parent owning the majority of the subsidiary’s

stock; (2) the entities having common officers or directors; (3) the subsidiary being grossly undercapitalized; (4) the subsidiary transacting business solely with the parent; and (5) both entities disregarding the legal requirements of the subsidiary as a separate organization

• Subsequently, courts have created tests from the foregoing

factors.

www.kirkland.com  42

Substantive Consolidation – Auto Train

• In Drabkin v. Midland-Ross Corp. (In re Auto Train Corp.),

810 F.2d 270 (D.C.Cir. 1987), the court laid out a winding path

• f analysis that started with applying factors, as set forth in

Vecco, to determine whether “substantial identity existed,” which, if it did exist, would require the proponent of substantive consolidation to establish a prima facie case, which if established would shift the burden to opponents of substantive consolidation to demonstrate harm, which, if established would shift the burden back to the proponent to demonstrate that the benefits of substantive consolidation “heavily” outweigh the harm

www.kirkland.com  43

Substantive Consolidation – Augie/Restivo

• In Union Savings Bank v. Augie/Restivo Baking Co. (In re

Augie Restivo Baking Co., Inc.), 860 F.2d 515, 518 (2d Cir. 1988), the court stated that the factual predicates used by courts (such as the Vecco variables) to determine whether to order substantive consolidation of entities are “merely variants of two critical factors: (i) whether creditors dealt with the entities as a single economic unit and did not rely on their separate identity in extending credit (citations omitted) or (ii) whether the affairs of the debtors are so entangled that consolidation will benefit all creditors.”

www.kirkland.com  44

Substantive Consolidation – Augie/Restivo (cont’d)

• Augie/Restivo Emphasizes whether creditors have

been harmed based on their expectations and reliance in extending credit

• Augie/Restivo concluded that the course of dealing

and the expectations of the parties did not justify consolidation

• Coupled with the court’s general reluctance to grant

substantive consolidation except where estates are “hopelessly” entangled, Augie/Restivo represents a conservative approach to substantive consolidation

www.kirkland.com  45

Substantive Consolidation – Eastgroup

• In Eastgroup Properties v. Southern Motel Assoc., Ltd. 935

F.2d 245, 250 (11th Cir. 1991), the court stated that the essential analysis is whether “the economic prejudice of continued debtor separateness” outweighs “the economic prejudice of consolidation.”

• The Eastgroup court upheld the lower courts’ substantive

consolidation orders

• Both the lower courts and the 11th Circuit Court considered

the relative recoveries of the proponent and objecting creditors

• Eastgroup styled itself as the “liberal” approach to

substantive consolidation

www.kirkland.com  46

Substantive Consolidation – Owens Corning

• In In re Owens Corning, 419 F.3d 195 (3d Cir. 2005), 419

F.3d 195, cert. denied sub nom. McMonagle v. Credit Suisse First Boston, 126 S. Ct. 1910 (2006), the court stated, “What must be proven (absent consent) concerning the entities whom substantive consolidation is sought is that (i) prepetition they disregarded separateness so significantly their creditors relied on the breakdown of entity borders and treated them as one legal entity, or (ii) postpetition their assets and liabilities are so scrambled that separating them is prohibitive and hurts all creditors.”

www.kirkland.com  47

Substantive Consolidation – Owens Corning (Cont’d)

• The Owens Corning court:
• criticized the mere recitation of factors as omitting

analysis and failing to separate the important from the unimportant

• discounted the mere presence of a parent

guarantee of a subsidiary SPE’s obligations as evidence of lack of separateness

www.kirkland.com  48

Substantive Consolidation -- Opinion

• You have requested our opinion whether, in a

properly presented proceeding under title 11 of the United States Code in which SPE is the debtor, the bankruptcy court would, under applicable federal bankruptcy law, apply the doctrine of substantive consolidation to consolidate the assets and liabilities of SPE with the assets and liabilities of [designated affiliates of SPE]

www.kirkland.com  49

Creditors’ Rights Opinions -- Reasoned Opinions

• True Sale and Non-Consolidation Opinions are reasoned opinions
• Reasoning:
• Sets forth:
• legal precedent including facts, holdings and principles

derived therefrom

• facts of transaction and parties covered by the opinion
• Conveys lack of certainty based on absence of
• precedent with identical facts
• codified legal principles
• The conclusion and the reasoning upon which the conclusion is

based, link the facts at hand to precedent cases that have established tests, albeit in the context of different facts

www.kirkland.com  50

Creditors’ Rights Opinions -- Diligence

• As with all legal opinions, reasoned opinions require diligence
• Review certified copies of formation documents of the SPE
• Assure presence of requirements for SPE to, among other things:
• establish and maintain its separate identity and present itself to

creditors accordingly

• pay its own bills from its own funds
• not incur indebtedness other than as contemplated in the

transaction documents or become liable for the debt of others

• not act as agent for its members or affiliates or permit them to

act as agent for it

www.kirkland.com  51

Creditors’ Rights Opinions -- Diligence (Cont’d)

• not commingle its assets with those of any other person
• Appoint and at all times maintain at least one

Independent Director (or manager) whose consent is required to file Bankruptcy and take other “Material Actions” that could jeopardize the entity’s status as an SPE

• Review all relevant contracts
• Assure that transactions contemplated
• maintain arms-length relationship between the SPE

and its affiliates

• contain covenants of reliance by the SPEs

counterparties and creditors on the separateness of the SPE

www.kirkland.com  52

Creditors’ Rights Opinions -- Diligence (Cont’d)

• Identify any guarantees of the SPEs obligations by

any affiliate

• Receive Officer’s Certificates certifying as to the

intended operation of the SPE in a manner consistent with the separateness and solvency of the SPE, and, to the extent the SPE is not a newly-formed entity, addressing the conduct of the SPE from the time of its formation through the date of the opinion.

www.kirkland.com  53

Creditors’ Rights Opinions – Other Considerations

• Purpose of opinion
• Doesn’t assure outcome
• Hopefully assures thorough consideration of

relevant factors in forming SPE structuring/documenting transactions to which SPE is a party

• Opinion shopping
• Appropriate pairings for Non-Consolidation
• pinions
• Appropriate assumptions for counsel reliance

www.kirkland.com  54

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