US: the role of the securitisation trustee

Transcription

Global Securitisation and
Structured Finance 2004
Susan J. Macaulay
Gardner Carton & Douglas LLP
Sponsored by
Susan J. Macaulay
It is the rare child indeed who gazes up into the eyes of his adoring parents and
says, “Mom, Dad, when I grow up, I want to be a securitisation trustee.”
For the past 125 years, the role of corporate trustee in the US has been filled
not by the traditional distinguished and trusted individual who comes to mind
when one thinks of the word trustee, but by a corporate entity, traditionally a
bank or other financial institution. And for the 20 years or so that corporate
trustees have been participating in securitisations as indenture trustees and
collateral trustees, many of those years were good ones.
For the past few years, however, as more securitisation structures falter, the
life of the securitisation trustee has become increasingly more difficult. Pressure
has come to bear on securitisation trustees to take on more active roles. More
than one rating agency has called upon the trustee to be responsible for more
closely monitoring the servicing of the transactions in which the trustee is
involved. And lawsuits, once a rarity in the securitisation trustee’s world, have
now become a somewhat more familiar event.
© Gardner Carton & Douglas LLP
The growth of the securitisation market
Securitisation as a financing vehicle is a relative newcomer in the world of
corporate finance. The earliest of these structured finance transactions was
developed in the early 1980’s and consisted of mortgage-backed
securitisations. The product grew to maturity in the late 1980’s in the forms of
both mortgage-backed and asset-backed securitisations. Now, a mere twenty
years after its inception, the market has grown to a nearly trillion dollar industry
in the US alone. And of the more US$362.1 billion in mortgage-backed
transactions and the US$573.6 billion in asset-backed transactions that closed
in 2003 in the US, more than US$678 billion, or 72.5%, involved the use of
trusts, and therefore trustees. According to www.thomsonfinancial.com,
Deutsche Bank, Bank of New York, JP Morgan Chase and Wells Fargo held the
largest share of the asset-backed market as trustees in 2003, with 20.4%,
Global Securitisation and Structured Finance 2004
US: the role of the securitisation trustee I Global Securitisation and Structured Finance 2004
15.3%, 10.9% and 10.5%, respectively. That same year,Wells
Fargo, Bank of New York, JP Morgan Chase and Deutsche
Bank were the leaders in the mortgage-backed arena, each
with 15.2%, 12.5%, 10.1% and 8.4%.
While the role of trustee in the context of a
securitisation transaction may be relatively new, however,
the principles that guide the conduct, risks and liabilities of
the securitisation trustee are not. The reason for this is that
at the heart of virtually every securitisation involving a trust
is a trust indenture, and trust indentures have been in use in
the United States for more than 170 years.
The development of the trust indenture
A trust indenture is nothing more than an agreement,
typically between the issuer of a debt instrument, such as a
note, bond or debenture, and the trustee, containing the
terms by which that instrument will be issued and
administered. (Ah, but were it that simple!). It not only
provides an efficient means of funnelling funds from a group
of disparate lenders through a single entity, the trustee, to
the borrower; it also provides a set of instructions for how
the loan is to be administered in both a pre- and post-default
setting.
Trusts and trust indentures were largely unregulated in
the United States for nearly one hundred years. In 1939,
however, as a way to shore up public confidence in the public
debt markets (together with the Securities Act of 1933 and
the Securities Exchange Act of 1934), the US Congress
passed the Trust Indenture Act of 1939 (the TIA). The TIA
provided protection for all public debt securities holders by
requiring an indenture, administered by an independent
financial-institution trustee. Under the TIA however, there
are a number of exempt transactions that do not require a
TIA-compliant indenture. For those transactions, the
transaction participants may, and often do, nevertheless
incorporate many of the provisions of the TIA into the
indenture.
Under the TIA, certain provisions of the act must be
reflected in every trust indenture that is subject to the TIA,
and certain provision may or may not be included in any
particular trust indenture, at the discretion of the parties to
the transaction.
The trustee’s role in a typical securitisation
The trustee’s primary purpose is to administer the trust for
the benefit of the investors in accordance with the terms of
the trust documents, primarily the indenture. The trustee
does this in a number of ways.
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Pre-default
Prior to default, the Trustee’s only real duties are those
defined in the Indenture. Typically those responsibilities
would include the following:
Administer collections
The trustee manages and holds any collections it receives
from the servicer, generally in one or more segregated
deposit accounts for the benefit of the various parties to the
transaction. The trustee is usually also responsible for
transferring funds into separate reserve accounts, generally
also at the direction of the servicer, and distributing funds at
the appropriate time of each payment cycle.
The trustee typically has little or no discretion in how or
how much to transfer or in which accounts or reserves to
deposit funds, or in what or how much it distributes. All of
the funds transfer mechanisms are laid out in those sections
of the indenture referred to as the waterfall provisions,which
the trustee applies according to the periodic reports required
to be provided to the trustee by the servicer. In most cases,
even if the servicer reports are incorrect, or even fraudulent,
absent manifest error, the trustee simply has no way of
knowing that there is a problem, and must allocate the funds
into the appropriate accounts, and make the mandated
distributions, in accordance with the servicer reports.
It is almost always an event of default under the
indenture if the trustee does not receive a servicer report
within a specified period of time, and the trustee must
typically report such a failure to the investors, any credit
enhancement provider, the rating agencies and others.
However, the trustee generally has no duties beyond that
with respect to the contents of the report, although under
the TIA, the trustee must review any reports furnished to it
to determine whether there is any violation of the terms of
the indenture. Presumably this would include verifying that
any ratios represented in any reports conform to financial
covenants contained in the indenture, etc. It would not
however, require the trustee to go beyond the face of the
report, ie to conduct further investigation to determine
whether the data underlying the information on the reports
presented to it were, in fact, true. Virtually all indentures,
whether or not governed by the TIA, explicitly permit the
trustee to rely on statements made to the trustee in officers’
certificates, opinions of counsel and documents delivered to
the trustee in the manner specified within the indenture.
Administer collateral
It is generally the indenture trustee’s responsibility for
acquiring, holding and selling collateral on behalf of the
investors. This is not always the case however as in some
transactions, this responsibility is placed in the hands of a
separate trustee, known as the collateral trustee. The
trustees’ respective roles will be spelled out in detail in the
trust documentation.
Disseminate information
One critical function of the trustee in any securitisation is to
disseminate information it receives from others to interested
parties to the transaction.To that end, the trustee distributes
the servicer reports concerning collateral, cashflow and other
transaction data it receives monthly, weekly or even
sometimes daily to the noteholders or bondholders, rating
agencies, insurers and other interested parties. Another vital
reporting obligation of the trustee is the trustee’s
responsibility to notify other transaction parties of any event
of default, or trigger event, that may occur under the
transaction documents of which the trustee is notified. It
should be noted however, that it is not always the trustee’s
obligation to disseminate such information if the trustee
becomes aware of such information other than from
specified sources. All of the trustee’s reporting obligations
will be described and defined in the transaction documents.
Effect redemptions
To the extent that the indenture contemplates redemptions
of the notes or bonds, the trustee will be responsible for
administering any such redemptions in accordance with the
terms of the indenture, including obtaining any necessary
approvals, enforcing any appropriate notice or waiting
periods and otherwise ensuring that any conditions
precedent are adhered to precisely as they are described
within the indenture terms.
Issue supplemental indentures and other amendments
Most indentures have provisions permitting certain types of
amendments or modifications without the noteholders’ or
bondholders’ consent, such as when it is necessary to correct
an ambiguity or where the modification gives additional
collateral to the noteholders or bondholders. Often it will be
within the trustee’s authority to determine whether an
amendment will fall within that discretionary authority.
Issuing supplemental indentures may or may not require the
approval of the existing noteholders or bondholders.
In each of the foregoing functions, the standard of care
that a trustee is required to meet pre-default is generally a
negligence standard (note that if the document is not
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governed by the TIA, a gross negligence standard is
permissible). In other words, under Section 315(d) of the TIA,
a trustee will not be held liable for “any error of judgment
made in good faith by a responsible officer, unless it shall be
proved that such trustee was negligent in ascertaining the
pertinent facts.” Virtually all indentures contain provisions
protecting the trustee from acting or refraining from acting
based on a written opinion of counsel satisfactory to the
trustee and unless the trustee is assured that it will be
indemnified for all of its costs and expenses.
Post-default
Once an event of default has occurred and is continuing, the
trustee’s level of responsibility is no longer mere negligence.
At that point, in administering a trust, the trustee must
conduct itself as a prudent person “in the conduct of his own
affairs” in administering the trust. In addition, the trustee
may be called upon to perform additional duties:
Enforce remedies
If a trigger event, such as a failure to pay an amount when
due, or the breach of a covenant, occurs under the terms of
the indenture, the trustee will normally be charged with
enforcing remedies under the terms of the indenture
(including replacing the servicer). In some cases, the trustee
has the discretion to enforce remedies itself (provided it
receives adequate indemnification), but in most indentures
must take action at the direction of the majority noteholders
or bondholders or the insurer (depending upon the terms of
the indenture) to enforce the obligations of the issuer.
Serve as backup servicer
Although not required by the TIA, it is not uncommon for
trustees to commit to provide or even to act as backup
servicer in the event that the servicer is removed under the
terms of the indenture while generally a sub-servicer
directed by the majority of the noteholders or the insurer or
some other combination of interested parties together
typically are given the authority to remove the servicer upon
a trigger event. In rated deals in fact, rating agencies often
look to whether the trustee has agreed to fulfil this backup
servicer function in determining the rating of the transaction
in question. In some cases, the trustee may have an affiliated
entity that can actually take over the servicing function itself.
In other cases, the trustee may prefer to appoint a
subservicer, particularly where the collateral is a form of
receivable that the trustee or its affiliate does not have the
expertise or desire to service itself, or to have the entity that
removed the servicer appoint a sub-servicer to perform the
servicing functions. In the case where a sub-servicer is
appointed, the trustee must take care to separate its
functions as trustee from those of sub-servicer and,
particularly where the sub-servicer is a non-affiliated entity,
to insure that the trustee is not at risk for the sub-servicer’s
performance in any way. In all cases, the trustee attempts to
obtain full indemnification from the sub-servicer for any and
all losses, costs and expenses that the trustee might incur as
a result of the subservicer’s performance of its obligations as
sub-servicer.
Take action in a bankruptcy
In the event that either the originator or the servicer or both
is involved in a bankruptcy, the trustee may be required to
take any number of actions, either independently or at the
direction of the insurer, the majority or all of the noteholders
or otherwise. The trustee may be called upon to defend the
true sale nature of the transaction by which the receivables
were originally transferred into the trust or, failing that, its
first priority interest in the receivables or other assets its
holds. It may need to file proofs of claim or otherwise
become involved in the originator’s bankruptcy as a creditor,
particularly if there was any type of note arrangement for
parking excess proceeds between the originator and the trust
or servicer, as is sometimes the case.
How courts have viewed the trustee’s role
Lawsuits against securitisation trustees, although certainly
not unheard of, have occurred in only a relatively small
percentage of the securitisation transactions that have
closed over the twenty years that the product has been in
existence.The amount of litigation involving securitisation
trustees over the past five years, however, has clearly risen.
Until recently, among the most highly publicised cases was
the Towers Financial bankruptcy, in which investors lost
nearly USUS$450 million as a result of a Ponzi scheme for
which one individual was ultimately sentenced to twenty
years in prison. In the Towers Financial transaction, the
trustee was sued by institutional holders of the bonds issued
by Towers as a result of the trustee allegedly having:
(a)
received actual knowledge of the issuers’ breaches of
their reporting obligations under the relevant servicing
agreements;
(b)
failed to give the bondholders notice of the breaches
of the reporting obligations under the indentures;
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(c)
failed to ensure that payments were made by obligors
into the appropriate lockboxes; and
(d)
failed to have given notice or to have declared an event
of default of certain other indenture breaches.
There were also allegations of commingling of funds and
a number of other violations of the various transaction
documents (LaSalle Nat’l Bank v. Duff & Phelps Credit Rating
Co., 93 Civ. 4692 S.D.N.Y filed July 12, 1993). In 1997, before
any of these issues could be resolved in court, a settlement
was reached, and a Final Judgment and Bar Order was
entered, dismissing the action with prejudice as between the
trustee and the plaintiffs. The terms of the settlement were
not disclosed.
Another case of potential interest to trustees is the
Heilig-Meyers bankruptcy. In this case, the trustee of a
Master Trust, and also had the responsibility to serve as
backup servicer in the event that the originator, HeiligMeyers, failed to perform its role as servicer of the
receivables, which it did. Upon the originator’s bankruptcy, a
number of noteholders filed suit, alleging, among other
things, that the trustee had not adequately monitored the
servicer nor gathered the data and records necessary to step
into the role of backup servicer. At this writing, most of the
lawsuits connected with this matter appear to have been
settled.
In Mill Pond Associates v. Bank of New York, et al, Case
No. 98-cv-1050 (D.Md.), the court addressed the issue of
whether the trustee could be held liable for the malfeasance
of the servicer in misappropriating funds, even when the
servicer was not selected by the trustee.At its April 20, 2000
meeting, HUD decided not to take any action against
trustee.
Current litigation
At the time of writing, there are several well-publicised cases
pending involving securitisation trustees. In the Avianca
Airlines bankruptcy, the debtors sued the trustee under the
Avianca Airlines Ticket Receivables Master Trust, seeking to
enforce the automatic stay against the trustee in using
collections on purchased receivables to pay noteholders
(Aerovias Nacionales de Colombia S.A. Avianca, et al. v. The
Bank of New York,Adv. Pro. No. 03-2204 (US Bankr. Ct. for
the Southern District of New York)). At the end of October
2003, a mediator was appointed by the court. More recently,
in The Official Committee of Unsecured Creditors of DVI,
Inc., et al. v. US Bank National Association, Nomura Credit &
US: the role of the securitisation trustee I Global Securitisation and Structured Finance
Capital, Inc., Fairway Finance Corp., and Harris Nesbitt Corp.,
Adv. Pro. No. 03-59022 (US Bankr. Ct. for the District of
Delaware), the creditors committee sued the trustee to
enjoin the trustee from disposing of securitised assets
constituting collateral for the securitised notes through a
UCC sale. This case has been appealed to the District Court.
To date, however, no case has generated more litigation
against a securitisation trustee than the highly-publicised
National Century Financial Enterprises bankruptcy. Founded
in 1991, National Century Financial Enterprises (NCFE) was,
prior to its filing for bankruptcy in 2002, one of the largest
financing companies for health care receivables in the United
States. NCFE is alleged to have purchased ineligible
receivables with noteholder funds, to have advanced funds
using noteholder funds for nonexistent receivables to
companies in which NCFE officers and directors had an
interest, to have plundered reserves meant to protect
noteholders, and to have improperly transferred moneys
among reserve accounts and between two theoretically
separate securitisation vehicles in order to deceive
noteholders into thinking that the reserves were fully funded
when, in fact, they were not.The trustees for the two
securitisation facilities have been named as defendants for
their roles as trustees of the two trusts that held NCFE’s
health care receivables in at least nine of lawsuits totalling in
the billions of dollars, most of which have been consolidated
in US District Court in the Northern District of Ohio.
The range of theories under which the two trustees have
been sued include breach of contract, breach of fiduciary
duty (both contractual and tortuous), fraud, negligent
misrepresentation, negligence, gross negligence, aiding and
abetting, respondent superior (three of one of the trustee’s
employees were directors of NCFE and officers of one of the
securitisation facilities), liability for the acts of its authorized
agents, various federal and state securities laws and
miscellaneous other state statutes.
Of the cases that have been filed thus far against
securitisation trustees, the consolidated National Century
cases already have drawn the most attention to and seem to
have the greatest potential to affect the standards to which
trustees are held. At this writing, answers have been filed
seeking to have all claims against the trustees dismissed, and
the bankruptcy court has confirmed a liquidating Chapter 11
plan for NCF and its affiliated debtors.
Following the NCFE default, and prompted, in part, by
NCFE and several other high profile defaults, Moody’s
Investors Service issued a report on February 3, 2003,
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announcing that it would reconsider its ratings of
mortgagebacked and asset-backed securities transactions in
light of what Moody’s believes the role of the securitisation
trustees to be. The report highlighted three areas of concern
relating to the role of the securitisation trustees - the
monitoring of the application of cash; the investigation of
covenant breaches and the taking of action where a breach
is discovered and the transistion of servicing to a successful
servicer at the servicing fee specified in the transaction
documents.
In response, at least in part, to the Moody’s report, in
March of 2003, the American Bar Association Corporate Trust
Committee issued a position paper entitled ‘The Trustee’s
Role in Asset-Backed Securities’ which emphasised both the
ministerial nature of the securitisation trusee and the
importance of the roles played by the other participants in
securitisations, specifically refuting a number of positions
taken in the Moody’s report.The ABA paper went on to state
“to suggest that there are implied or vague oversight duties
imposed on trustees is financially unfair to trustees, legally
indefensible as an abrogation of their rights of contract and
destructive to the certainty of debt terms that underlies
successful capital markets...” The paper also noted that Fitch
has taken a somewhat different view of the trusteee in
securitisation transactions, placing more responsibility on the
seller/servicer.
Conclusion
As the role of the securitisation trustee has come under
renewed scrutiny, it is now more critical than ever that the
parties reach a clear understanding of exactly what duties,
obligations and liabilities the trustee is undertaking, and that
the understanding of the parties be documented accurately
and thoroughly. Trustees are subject to being held
accountable for acting beyond the scope of their authority or
for failing to follow the standards of care prescribed by the
agreements by which they are bound. But should they be
held accountable for duties not specifically contained in the
indenture or prescribed by law? Forty-one years ago, Judge
Learned Hand wrote,“The law ought not make trusteeship so
hazardous that responsible individuals and corporations will
shy away from it.”
Author biography
Susan J. Macaulay
Partner, Chicago
Email smacaulay@gcd.com
Susan J. Macaulay is a partner in the Financial Institutions
practice and group head of the firm’s Banking Practice
group. She graduated with a B.Mus. in Piano from the
Oberlin Conservatory of Music, a Master of Liberal Arts
from the University of Chicago, a J.D. from the Loyola
University of Chicago School of Law, and an LL.M. from the
Chicago-Kent College of Law, where she is currently a
member of the Adjunct Faculty.
Ms. Macaulay’s primary area of concentration is
structured finance transactions (including troubled or
restructured securitisations), representing trustees, issuers
and investors. Ms. Macaulay also has extensive experience
in virtually all forms of private corporate and institutional
debt, including senior, subordinated, secured and unsecured
transactions, acquisition finance, debtor-in-possession
finance, equipment finance, aircraft finance, project finance,
swaps and other forms of derivatives and all forms of
leasing, including leveraged leasing.
Practice Areas Commercial finance, structured finance,
banking, restructuring
191 N Wacker Drive, Suite 3700,
Chicago, Illinois 60606 USA
Tel +312 569 1124 Fax +312 569 3124
Web www.gcd.com
Other offices Washington, D.C., Milwaukee, Albany

US: the role of the securitisation trustee

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