The ABC of SPVs
25 March 1997
There are many circumstances in which an SPV may provide a convenient legal structure for a financing arrangement. Favourable tax treatment may be achieved by SPVs being incorporated in and managed from some offshore jurisdictions. Limited liabilities companies are frequently incorporated in Jersey as SPVs for purposes such as raising money by issuing debt securities, structuring security arrangements ancillary to bank financing, making investments off-balance sheet, tax driven financing structures and asset repackaging/securitisation transactions.
A key consideration in establishing SPVs used in the context of asset repackaging/securitisation programmes is often that the SPV must be and remain "off" the balance sheet of the arranging participants.
A frequent structure used to give effect to this is a general charitable trust established by a fiduciary service provider with the intention that the trustees of that trust will hold the entire issued share capital in the SPV, thus separating ownership of the SPV from the arranging parties. This gives rise to the so-called "orphan" company. Whether an orphan structure is appropriate will depend on the originator's objectives and accounting treatment in its jurisdiction.
Although the capacity of a Jersey company is not limited by anything contained in its constitution, directors authority can be restricted and the SPVS's memorandum of association will usually specifically provide for the purposes for which it has been incorporated as the sole permitted activities of the company. In addition, the SPV will enter into various contractual restrictions under the programme documentation so that the parties to the programme have some assurance that the SPV is tailored solely for the purposes of the programme for which it was created.
As the SPV is only created to provide a clearly defined function in the context of a given securitisation/repackaging arr-angement, a good deal of attention has to be paid to the "ring-fencing" of the underlying assets for the benefit of those investors having an interest in the SPV and to limiting recourse against the SPV so that the obligations of the SPV itself (under the funding documentation) are limited in recourse to the assets it has available to discharge those obligations.
The "investors" should be taking a risk on the assets acquired by the SPV and not the SPV itself. This is a key issue for the prospective directors of the SPV which will typically have a paid-up share capital of only £2.
Where a separate SPV is incorporated for the purposes of issuing a single series of securities, the proceeds of which are used to acquire the underlying assets, the security offered to the investors in the securities (and any relevant swap counter- party) may take the form of a security interest over the underlying assets. This will sometimes involve the use of an independent security trustee.
Where the same vehicle is being used for various note issues "ring-fencing" becomes particularly important so that investors in the notes "backing" a particular acquisition of underlying assets have recourse only to those assets.
In conjunction with these provisions defining investor recourse one has to consider the issue of limited recourse from the viewpoint of the SPV itself.
Corporate benefit flowing to SPVs in these types of structures can be difficult to find - the SPV is raising money or receiving assets and passing them through to acquire assets or rights, making little return on its role in the transactions. The programme documentation will usually provide for the SPV to make a turn so that there will be a residual amount in it to enable the directors to satisfy themselves as to the corporate benefit issue. However, these margins are usually small and it will be important for the directors to ensure that they are satisfied that the liabilities of the SPV should never exceed the assets to be made available to the SPV under the terms of the transaction.
Unless recourse against the SPV under its funding arrangements is limited to the assets it has available to meet its obligations it will be taking a credit risk on the underlying assets without any bona fide commercial return flowing to it.
This approach to the limited recourse provisions that must be included in the programme documentation complements the desire of the participants to ensure that the SPV is a so-called "bankruptcy remote" vehicle.
It is generally accepted that this refers to the SPV being a limited purpose entity, the parties to the programme undertaking not to commence bankruptcy proceedings against the SPV until after repayment of the relevant securities and expiration of any applicable preference period under relevant insolvency laws, and that there must be a true sale of the relevant assets to the SPV (which requires analysis of applicable insolvency laws in the jurisdiction of the originator and the SPV to assess the risk of any challenge to set aside the sale on an insolvency of the originator or the SPV whether as a transaction at an undervalue or on some other basis).
To include appropriate limited recourse language must be to assist the bankruptcy-remote nature of the SPV. It will also assist the SPV's directors in considering any possibility of "wrongful trading" arguments where the cash flows may at some future time indicate an inability to source repayment of the funding obligations from the cash flows originating from the underlying assets. This will be a material consideration throughout the period of the life of the programme.
Common in US securitisation structures is language which deems any obligations of the SPV to be extinguished to the extent that it does not have sufficient assets available in accordance with the programme documentation to discharge them.
That must surely be a preferred practice in any such structure. It is clearly important that all the programme creditors join into the documentation to contractually agree that treatment. The SPV should not have any other creditors given the limited nature of its proposed functions. This underlines the importance of identifying a responsible service provider to provide the board of the SPV.