Publication

Financing and Financial Services Team

On January 21, 2003, the Ontario Superior Court of Justice confirmed¹ that a revolving receivables securitization was a true sale and the use of securitization proceeds to redeem certain bonds of the seller of the receivables was not oppressive.

THE CASE

The Widows and Orphans case considered a dispute between holders of bonds issued by BC Tel (a predecessor of Telus Communications Inc.) and the issuer regarding a covenant in the 1946 deed of trust and mortgage pursuant to which the bonds were issued. That covenant provided that BC Tel could not redeem any bonds directly or indirectly from funds obtained through borrowings having an interest cost to the issuer of less than 11.35% per annum. BC Tel entered into a securitization arrangement with an effective cost to it of substantially less than 11.35% per annum and used the proceeds to redeem the bonds.

True Sale Analysis

The bondholders argued, among other things, that the securitization was a disguised form of borrowing and not a "true sale", resulting in a violation of the covenant.

Bipartite Test of Intention. The Court determined that it was the clear intention of the parties to the securitization transaction that it be a true sale based, first, on the language of the contract and, second, on the lack of clear unequivocal conduct of the parties negating the language of the contract. Recharacterization Test. The Court examined a number of factors that courts traditionally have used to determine whether, notwithstanding the intention of the parties, a transaction should be recharacterized as a secured lending.

1. Right to Surplus and Collection of Receivables. The Court rejected the contention that a right to surplus and the collection of receivables by the seller are significant factors to be used in recharacterizing sale transactions as secured loans. In these areas, the parties were free to make their own arrangements.
2. Ownership Risk and Recourse. The Court canvassed the conflicting authorities without making a determination as to the importance of recourse in recharacterizing a sale. The Court did note, however, that in the BC Tel securitization the purchaser assumed the collectibility risk of the obligors after termination of the securitization, a common feature in programs of this type. The Court determined that that level of ownership risk assumed by the purchaser was sufficient to eliminate the need to further consider this potential ground for recharacterization.
3. Certainty of Purchase Price and Ascertainability of Assets. The Court determined that it was critical to a true sale to be able to glean from the documentation at any time (a) the purchase price and (b) which assets were purchased. With some effort, the Court found that the subject documentation satisfied these requirements.
4. Right of Redemption or Repurchase. The Court held that a right of redemption or repurchase of the purchased assets is an essential term of a secured loan transaction. The existence of such a right in a securitization would be a strong factor in determining whether to recharacterize the securitization as a secured loan. In this case, the ability of the seller to repurchase the purchased receivables following both a change in law and a demand by the purchaser for reimbursement for consequential increased costs did not constitute a right of the seller to redeem or repurchase the sold receivables.

Oppression Analysis

The Court considered whether, regardless of the characterization of the securitization, the approval of the use of this financing mechanism by the board of directors was oppressive to the bondholders. In examining this issue, the Court was faced with the difficult task of determining the obligations of the board of directors when confronted with a decision where substantial benefits to the corporation, and consequently its shareholders, could only be achieved at a cost to other stakeholders. The Court found that the BC Tel board of directors understood the potential harm to the bondholders and sought advice as to whether the securitization transaction could legitimately be treated as a true sale and the likelihood of a successful challenge.

The Court held that so long as the directors proceed honestly and in good faith in the best interests of the corporation and its shareholders and so long as the reasonable and legitimate expectations of the other stakeholders are not frustrated by the actions of the directors, such actions do not constitute oppressive conduct. In this case, the bondholders were aware that the proceeds of asset sales could be used to redeem the bonds. Their expectations were frustrated by the emergence of a new financing technique, not by the board of directors.

IMPLICATIONS

The Widows and Orphans case gives guidance as to the issues to be analysed in determining whether or not a fairly typical revolving receivables securitization transaction is a true sale. It also explores the role and duties of directors in transactions of this type and provides a consideration of circumstances where directors must balance their obligations to various constituents in the context of a securitization.

However, facts are important and this decision can be easily distinguished on its facts. Moreover, as a decision of the Superior Court of Justice of Ontario, it is subject to review and reversal².  Finally, the evolution of accounting standards for securitizations and the variable interests held in them may influence future court decisions. Although there is no reason at law why a court could not disagree with the accounting profession as to whether a particular transaction is or is not a sale, a court could take the accounting treatment of a transaction into account. This is particularly true in the present environment where a considerable amount of public policy analysis is going into the formulation of accounting standards. It would not be wise to be complacent in structuring future transactions based on the Widows and Orphans judgment without reference to the factual matrix at the time.

1. Metropolitan Toronto Police Widows and Orphans Fund v. Telus Communications Inc., [2003] O.J. No. 128 ("Widows and Orphans").
2. On February 19, 2003, a Notice of Appeal was filed in the Court of Appeal.

 Retour aux résultats de la recherche de publications