THE DECISION

IN

BC T E L C A S E - A V A L I D A T I O N
IN

OF THE

TRUE SALE

CONCEPT

SECURITISATION TRANSACTIONS

SECURITISATION EXPLAINED Securitisation is the process of conversion of existing assets or future cash flows into marketable securities 1. Securitisation is a type of structured financing in which a pool of financial assets or future cash flows (such as car finance loans, home or commercial mortgages, corporate loans, royalties, leases and non-performing receivables) is transferred to a "special purpose vehicle" (SPV) that then issues debt-backed solely by the assets transferred and payments derived from those assets. The sale of the assets by the originator to the SPV is structured in such a manner that it removes, to the extent practical, the assets from the estate of the originator in the event of the bankruptcy or insolvency of the originator. The assets are owned by the SPV and the realization or collection of those assets by the SPV services the notes issued by the SPV. The holder of the notes, therefore, looks to the cash flow from the assets and not to the credit of the originator for repayment. The separation of the originator from the assets themselves enables the originator to raise funds less expensively through the notes issued

for the purpose of distinction, the conversion of existing assets into marketable securities is known as asset-backed Securitisation and the conversion of future cash flows into marketable securities is known as future-flows securitisation
1

by the SPV, than it would cost the originator to raise funds through securities issued directly by the originator. There is also an "off balance sheet" advantage to the originator in that the cash that is raised by the sale of the assets will not require an offsetting liability to be shown on the balance sheet of the originator. The cash from the sale of the assets and the off-setting decrease in accounts receivable are reflected on the asset side of the originator's balance sheet but there is no offsetting liability in that the notes issued to raise such cash is a liability of the SPV and not of the originator.

Securitisation has been said to be primarily intended to afford a method of financing that insulates the credit products from the credit risk of the owner of those products 2, this reduces the risk to the public of investing in the securitised assets and increases the credit rating of the SPV, thus lowering the cost of the monies obtained through the process by the originating company raising capital. Securitisation requires that the future payment stream 3 be legally separated from the originator. Where this occurs and the

originator later becomes bankrupt/insolvent, the creditors of the originator will be unable to meet the future payment stream. Thus, the commercial importance and integrity of the structure lies on
2

the

legal

separation

of

future

payment

stream

from

the

Edmund K.A. Kwaw, Structuring Issues in Securitization: Transfer and Ownership of Assets (1996) 15 Natl Banking L. Rev. 65; 1996 C.N.B.L.R LEXIS 10 expected income from the financial asset, receivables or future cash flow
3

originator as large amounts of capital may be ventured on the faith of the validity of the transaction. This Article seeks to examine the decision of the Canadian Superior Court of Justice and the Court of Appeal in the case of Metropolitan Toronto Police Widows and Orphans Fund v Telus Communications Inc. 4 (the BC Tel Case) and its impact on the

legal true sale theory in securitisation transactions.

THE QUINTESSENCE

OF A

TRUE SALE LEGAL OPINION

IN A

SECURITISATION TRANSACTION No written contract is ever complete; even the most carefully drafted document rests on volumes of assumptions that cannot be explicitly expressed." -Arthur Rosett

The principal major risk with securitisation is that it may be recharacterised as a mortgage or other secured lending transaction. If this is so, the effect is that the financing is treated as a loan secured on the asset 5 of the originator. If the transaction is (recharacterised as) a mortgage, it then may be void as a prohibited non-possessory chattel mortgage for lack of registration (the principal risk); it may be subject to onerous enforcement remedies; it may conflict with negative pledges; it

may loose priority to a prior floating charge or loose the priority

[2003] O.J. No. 128 Phillip R. Wood: Law and Practice of International Finance, Sweet & Maxwell page 18
4 5

benefits of title ownership; the owner loses the right to the residual value; it may be subject to bankruptcy freezes and special rules relating to mortgages, e.g. formalities, maximum amount, no secured amount in foreign currency, no unapproved financiers, and limitations on default clauses; it may conflict with money lending and usury laws; and it may violate a contractual borrowing limit 6. The result will usually be disastrous for the financiers/investors. The security given by the SPV to the investors would be a submortgage limited to the loan by the SPV to the seller (originator). Access by the investors to the receivables might be subject to potentially restrictive mortgage enforcement procedures (noted above). It may also be treated as a mortgage loan for taxation purposes or be treated as on-balance sheet and lose its accounting advantages 7. Given the potential risk of the above catastrophe, a true sale legal opinion obtained from the solicitors to a securitisation transaction remains a key document in structuring the transaction. Merely structuring the securitisation vehicle to be bankruptcy remote does not guarantee that its assets will be secluded from the estate of the seller/originator in the event that the seller/originator becomes subject to insolvency. Thus the transfer must be an absolute assignment or true sale of those assets.

6 7

ibid at page 18 ibid at page 18

Rating Agencies 8

attend cautious consideration to the legal

structure being used in securitisation transaction as such a factor impacts significantly on the rating of the security 9. They will typical seek assurance that the securitisation entity (SPV) is a bankruptcy remote vehicle, thus Rating Agencies will usually require a legal opinion to the effect that the assets being

securitised have been transferred to the securitisation vehicle pursuant to a true sale and will not be considered as part of the originators insolvent 10. Thus, the solicitors advisory role is critical and influential to the other parties 11 making a financing decision in a securitisation transaction as it forms the foundation on which the structure 12 of the process gains its legitimacy. Thus, utmost diligence must be engaged in formulating a True Sale Legal Opinion. However, it is noteworthy to observe that determining whether a contract reflects a true sale or a loan is not simply a mechanical exercise of assessing and tallying up a list of factors and then deciding whether they net out to one or the other 13 BC T E L C A S E THE FACTS
which may be the single most important player in the securitisation process Rating Agencies will rate tranches of asset backed securities based on expected losses for the different tranches.
8 9

estate

in

the

event

that

the

originator

becomes

Particularly in the US jurisdiction Rating Agencies always seek a true sale legal opinion
Auditors, Accountant Advisors, Rating Agencies, Trustees, Credit Enhancement Providers, Investment Banks, Tax Advisors and Underwriters
11

10

12
13

the true sale of the assets of the originator

Court of Appeal in BC Tel Case, Blair JJA. at par 39

BC Tel (the predecessor of Telus Communications Inc.) issued Series AL Bonds (the Bonds) on October 31, 1985 pursuant to a Trust Deed between BC Tel and the Bondholders. The Bonds had the benefit of a No Financial Assistance Covenant (NFAC) in the Trust Deed that prohibited their redemption and read as follows:

"The Company shall not, however, redeem any of the Series AL Bonds by the application, directly or indirectly, of funds obtained through borrowings having an interest cost to the company of less than 11.35% per annum" (i.e. lower than the Bond coupon).

BC Tel later securitised its receivables through the SPV RAC Trust via a Receivables Purchase Agreement 14 (the Agreement) and used the securitisation proceeds to redeem the Bonds. RAC raised these funds through commercial paper borrowings with a funding cost significantly lower than the rate on the Bonds (i.e. the 11.35% coupon). On the redemption date, the market price of the Bonds was $115 and the redemption price paid by BC Tel pursuant to the Trust Deed was approximately $103. This resulted in a substantial loss to the bondholders ($12 per $100 principle amount). The Bonds were not set to mature until 15 November, 2005.

The Bondholders (the Plaintiffs) argued that BC Tel had violated its non-redemption covenant because the securitisation was either a direct borrowing or an indirect borrowing by BC Tel rather than a sale. The Plaintiffs further argued that the redemption of the

Bonds unfairly disregarded the interests of the Bondholders. The

between BC Tel and RAC Trust dated 20 November 1997

14

Plaintiffs attempted to attack the securitisation transaction by arguing that BC Tel did not in fact sell the receivables to RAC Trust.

ISSUES FOR DETERMINATION The three issues for determination by the Trial Judge, Ground J. were as follows: (x) was the redemption of the Bonds a refunding operation by BC Tel by the indirect application of the borrowed funds having an interest cost to BC Tel of less than 11.35%? (y) was the redemption of the Bonds a refunding operation by BC Tel by the direct application of the borrowed funds having an interest cost to BC Tel of less than 11.35%? (z) did the redemption of the Bonds by BC Tel effect a result that unfairly disregarded the interest of the holders of the Bonds?

In determining the above issues, the Trial Court sought to settle on certain facts in dispute by the counsel in their submissions, which were considered material to the issues to be determined by the court, thus the issue then became whether the sale of the receivables to RAC by a Receivables Purchase Agreement was a true sale.

Direct Application of Borrowed Funds

On the issue of whether the funds received by BC Tel through the securitisation transaction and applied to the redemption of the Bonds were borrowed funds Ground J. in paragraph 15 noted that To determine whether the securitisation transaction should be characterized as a sale or as a secured loan requires an analysis of the criteria which the courts have considered in determining whether a transaction is a sale. In interpreting a contract, the court must look to the intention of the parties as by the language of the contract itself. The court may also look at the factual matrix or the circumstances existing at the time the contract was entered into to determine which of two possible interpretations of the contract should be preferred. The court must look into the substance of the transaction and not merely the form 15

The Trial Court further noted that the factors to be considered by the courts in determining whether a transaction constitutes a true sale are: (a) the transfer of ownership and risk and the level of recourse;(b) the ability to identify the assets sold; (c) the ability to calculate the purchase price and (d) whether the return to the purchaser will be more than its initial investment and a calculated yield on such investment 16. In case of the sale of receivables, other factors to be considered are: (a) the right to retain surplus collections; (b) a right of redemption; receivables (c) and the (d) responsibility the ability of for the collection vendor of to the accounts the

extinguish

the court referred to the dictum of Lord Hanworth, M.R in Inglefield Ltd., Re, [1933] Ch.1 at pg 17 Par 39
15 16

purchasers receivables 17

right

from

sources

other

than

the

collection

of

the

The Court analyzed the Agreement entered between BC Tel and RAC Trust under the above mentioned considerations in

determining whether the transaction was a true sale, and observed as follows:

Intention of the Parties While the court observed that the wording of the Agreement clearly indicated the intention of both parties that the transaction be a true sale 18, it further noted that the true nature of a transaction can be determined not only by the wording of the Agreement but can also be gleaned from an examination of how the relationship in fact transpired and the conduct of the parties. In the words of Ground J., in looking at the factual matrix or context in which the transaction was entered into, it was clearly the intention of BC Tel that it be a sale in order to avoid any problems with breach of the NFAC contained in the Trust Deed under which the Bonds were issued. In the case of RAC, it was clearly the intention of RAC that the transaction be a sale in order to obtain the highest rating for the commercial paper issued by RAC to the public. It accordingly appears to me that both parties could only get the full benefit of the transaction if it was a true sale. It was the intention of both BC Tel and RAC that the

Par 39 ante the Agreement was clearly crafted to use the language of a sale throughout, there were no references to a loan or to payments of principal or interest on a loan
17 18

transaction be a true sale and the conduct of the parties does not clearly and unequivocally negate that 19

Ownership Risk and Recourse In any true sale transaction there must be a transfer of ownership risk to the purchaser. In the case of a sale of accounts receivable the risk with regard to the non-payment of the receivable must pass to the purchaser subject to whatever forms of recourse the purchaser may have against the vendor. The court noted that the risk of ownership obviously decreases with the amount of recourse which the purchaser has as against the vendor, in the event that the asset purchased is defective or subject to liens or encumbrances 20. In the case of accounts receivable, the recourse against the vendor would be with respect to

uncollectibility of the accounts receivable. Schwarcz in an article 21 stated that The most significant factor appears to the extent of recourse the transferee of the receivables has against the transferor. As the degree of recourse increases, the likelihood that a court will find a true sale decreases. The existence of some recourse does not by itself preclude characterization of the transaction as a true sale. If recourse is present, the issue is 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

Par 40 ante Par 44 ante An Article by Stephen L. Schwarz Structured Finance: The New Way To Securitise Assets: (1990) Cardozo Law Review, Vol. 11 pg 621
19 20 21

10

greater similarity to a financing transaction [that is, a secured loan] or to a sale

The plaintiffs had submitted that, in addition to the right of RAC to have defective or ineligible receivables replaced both before and after termination, RAC was further protected by an internal credit enhancement via overcollaterisation provided by a Reserve 22 which was far in excess of the bad debt experience of BC Tel. The plaintiff submitted that the recourse available to RAC is not a recourse for collectibility but an economic recourse which is the equivalent of a warranty to the buyer of a return of its investment plus an agreed upon yield unrelated to the collectibility of the assets. Thus the plaintiff asserted that an economic recourse which ensures a return unrelated to the collectibility of the accounts receivable is indicative of a secured loan transaction where the receivables serve simply as collateral. The defendant on the other hand submitted that full recourse granted to a purchaser of an asset is not inconsistent with a true sale transaction and that warranties and representations and guarantees regularly provided by vendors of assets do not detract from the characterization of the transaction as the true sale of an asset. In both British and Canadian authorities it had been held that even full recourse is not incompatible with a concept of legal sale.
The Reserve is determined by a rather complex calculation but, for purposes of the transaction between BC Tel and RAC, is 5% of the Outstanding Cash Payments at any time. It is agreed that the historic bad debt ratio of BC Tel was between 1% and 2%.
22

11

In

Welsh

Development

Agency

Export

Finance

Co. 23

the

purchaser was fully protected by way of recourse to the seller. Lord Justice Ralph Gibson, although concluding that no real risk passed from the seller to the purchaser, found that the transaction was nevertheless a sale.

Schwarcz in an article 24, stated that under contract law, parties generally are free to enter into and enforce any contract that is not illegal or against public policy, there is nothing about recourse, for example, that either is illegal or in violation of public policy..There is no legal or public policy that precludes a transferor from improving the value of an asset sold by adding its own guarantee.Endorsement with recourse has never been viewed as precluding the existence of a sale.

The trial court observed that the fact that RAC had a back up credit enhancement arrangement with a Swiss bank did not impact on the analysis of the Agreement with respect to the assumption of risk and recourse as between RAC and BC Tel, the court regarded the credit enhancement arrangement as a type of insurance taken out by RAC in the event of uncollectible purchased receivables exceeding the amount of the reserve.

Right to Surplus

[1992] B.C.L.C 148 (Eng. C.A.) Rethinking the Role of Recourse in the Sale of Financial Assets November 1996, The Business Lawyer, Vol. 52, p. 159 pages 160 to 161
23 24

12

The Plaintiffs counsel argued that the fact that a surplus is returnable to BC Tel is conclusive of the issue as to whether the securitisation transaction is a loan as opposed to a sale. The trial court observed that in leading English cases, the inability of the purchaser to retain surplus has not been found to be fatal to the characterization of a transaction as a true sale 25. The court referred to the case of Inglefield Ltd., Re 26 in which Lord Hanworth in analyzing a financing agreement, stated if one approaches clause 18 without any prejudice, either one way or the other, it really amounts to more than that when the discount company have been paid more than they are entitled to receive under the assignment to them of the benefit of the hire purchase agreement, they will pay the excess to George Inglefield, Ltd. That is because the discount company are not entitled to retain payments in excess of those to which they were entitled under the hire purchase agreement. I cannot find from that clause any sufficient ground for treating this assignment as a charge 27 Consequently, the court opined that the absence in RAC to retain the surplus from the collection of accounts receivable was not fatal to the determination of the securitisation transaction between BC Tel and RAC as a true sale of the purchased receivables.

Determination of Purchase Price

Welsh Development Agency v Export Finance Co. (Supra) Ralph Gibson L.J at 177; Inglefield Ltd. Re. (Supra) Supra pages 19 and 20 Eve J, the Judge at first instance from whom the appeal was successfully taken found in clause 18 a factor which was consistent, to his mind , only with the transaction being one of a charge
25 26 27

13

On the submission by the plaintiffs counsel that the provisions of the Agreement resulted in a sale in which the purchase price is unknown to the parties 28, Ground J. observed as follows 29: Purchase Price is not a defined term in the Agreement. Subsection 2.01(3) of the Agreement provides that, in effect, the purchase price for any Purchased Receivables will be comprised of the immediate cash payment made by RAC on the purchase of any receivables and the Deferred Amount. The Deferred Amount is not defined in the Agreement. It then becomes necessary to find a provision of the Agreement which would give meaning to the term Deferred Amount. I accept the defendants submission that the only provision of the Agreement which could be referred to is Subsection 2.07(2) which in effect provides that, on termination of the Agreement and the completion of the liquidation of the Purchased Receivables, one can determine what portion of the Reserve is not required to be applied to compensate RAC for uncollectible Purchased Receivables and that the unused portion of the Reserve is the Deferred Amount as referred to in the definition of purchase price. A c c o r d i n g l y , i t a p p e a r s t o m e t h a t , o n a n y g i v e n day during the term of the Agreement, if the Agreement was terminated it would be possible to calculate the purchase price for the Purchased Receivables held by RAC as of that date. [Emphasis added] The position of the Trial Court suggests that the pass test for determination of purchase price does not elude a contractual arrangement whereby the purchase price is not expressly stated but

28

29

Par 60 ante Par 57 ante

14

can be determined by the computation of an agreed formula at any given date by the parties to establish same.

Identification of Assets It was acknowledged by both parties (i.e. RAC and BC Tel) that a particular receivable may be a Purchased Receivable on day 1, not be a Purchased Receivable on day 2, and again be a Purchased Receivable on day 3 with the result that title to such receivable will move back and forth between BC Tel and RAC. However, as of any particular day, one could determine exactly which Eligible Receivables are Purchased Receivables 30 by applying the Trial Balance Sequence as defined in the Agreement which establishes an order in which Eligible Receivables are determined to be Purchased Receivables 31. The plaintiffs had submitted that such provisions in the Agreement were inconsistent with a true sale. The court observed that clearly the intention of the parties as stated in the Agreement was to construct a sale transaction with title to the receivables passing to RAC, subject only to reconveyance in certain events contemplated by the Agreement. If one follows the procedure set out in the Agreement with respect to the General Trial Balance, on any particular day, it is possible to determine which receivables constitute
The Agreement contains definitions of Eligible Receivables which must meet certain criteria set out in Schedule A to the Agreement and a definition of Purchased Receivables and provides that RAC purchases from BC Tel and BC Tel sells, assigns and transfers to RAC, all of BC Tels right, title and interest in and to the universality of all Eligible Receivables which, from time to time, constitute Purchased Receivables and all Related Security, all without the need of any formal or other instrument of assignment.
31 30

Par 5 ante

15

Purchased Receivables and accordingly the subject matter of the sale of receivables by BC Tel to RAC is ascertainable on any given day. The fact that the Agreement contemplated that a particular receivable may, under certain circumstances, be reconveyed to BC Tel, does not, in my view, derogate from the fact that the original conveyance of the receivable to RAC was a true sale. A c c o r d i n g l y , i n m y v i e w , t h e subject matter of the sale of receivables from BC Tel to RAC being ascertainable that the on any particular matter of day the satisfies sale must the be

requirement

subject

a s c e r t a i n a b l e 32 [Emphasis added]

Collection of Receivables Article 5 of the Agreement provided that BC Tel would carry out all servicing and collection of the Purchased Receivables as agent for RAC and would receive no fee for performing such services. RAC may not replace BC Tel as its collection agent unless there has been a default under the Agreement. The plaintiffs argued that these provisions are a further indication that the transaction was one of secured borrowing rather than sale, reference was made to the Schwarcz Article where the author stated that in practice, the seller often is appointed as the collection agent initially. This is not necessarily inconsistent with sale

characterization if (1) the seller as collection agent will be acting as an agent for the purchaser pursuant to established standards, much like any other agent, (2) the seller will receive a collection agent fee that represents a n a r m s l e n g t h f e e f o r t h e s e s e r v i c e s , and (3) the
32

Par 63 ante

16

purchaser has the right at any time to appoint itself or another person as collection agent in place of the seller. [Emphasis added] The Court differed with the above criteria set out by Schwarcz as being determinative of the nature of transaction between BC Tel and RAC. The Court noted that though the Agreement clearly provided that as BC Tel will for service and and set collect out Purchased of

Receivables

agent

RAC

standards

performance, in respect of payment of fee, it was the evidence of the former Assistance Treasurer of BC Tel that BC Tel was prepared to provide these services without a fee in view of the fact that the fee would have, in any event been reflected in the Purchase Price which BC Tel would have received for the

Purchased Receivables. Accordingly, the Court opined that the provisions of the

Agreement relating to the collection of the Purchased Receivables by BC Tel on behalf of RAC were not inconsistent with a true sale.

The Courts approach on this issue, however, seems to negate the concept of interpreting the contract in light of the parties conduct and intentions. Dealings between the originator and the SPV should be conducted at an arms length basis. Therefore the fees to be collected for servicing the receivables if factored into the purchase negates the separability and independence of the several contractual arrangements between the originator and the SPV acting in different capacities, one as purchaser and buyer, and another as agent and principal.

17

Right of Redemption Ground J. stated that the courts have determined that, where the vendor of an asset has a right of redemption or repurchase at its option, this will be a strong factor in favour of the characterization of a receivable transaction as secured loan rather than a true sale

transaction. An essential term of a secured loan transaction is the right of the borrower, upon repayment of the debt, to require the lender to reassign to it all of the lenders interests in the assets secured to pay the debt. I n t h e c a s e o f a t r u e s a l e , t h e v e n d o r h a s n o r i g h t t o require title to the assets sold to be reassigned to it. In my view, this is the ultimate test to be applied to determine whether a particular transaction should be interpreted as a s e c u r e d l o a n o r a s a t r u e s a l e 33 [Emphasis added]

The Plaintiffs had argued that the Agreement granted to BC Tel the right to repurchase the Purchased Receivables from RAC in the event of a Change of Circumstances as defined in the Agreement and that the Agreement also provides that, after the Final

Collection Date, RAC has the option of paying the Deferred Amount 34 to BC Tel or transferring Purchased Receivables in that amount back to BC Tel.

The Plaintiffs further submitted that if the rights of the transferee of an asset can be extinguished upon repayment to the transferee of amounts advanced by it from a source other than the realization

33
34

Par 67 ante

The Deferred Amount can only be calculated on the termination of the Agreement and is, in effect, the portion of the Reserve which is not required to be applied to compensate RAC for uncollectible Purchased Receivables.

18

of the assets transferred, that is indicative of the transaction being a loan and not a sale of the subject assets, the Plaintiffs pointed out that all amounts paid by BC Tel to RAC during the term of the Agreement were paid out of general funds and not directly traceable to the proceeds of the collection of the Purchased Receivables by BC Tel which were not segregated from BC Tels general funds.

Ground J. observed as follows: Subsection 2.07 of the Purchase Agreement provided that after termination of the Agreement and the payment to RAC of all amounts payable to it under the Purchase Agreement, RAC may, at its option, either pay the Deferred amount to BC Tel in case or transfer to BC Tel Purchased Receivables in a total face amount equal to the Deferred Amount. I have difficulty

interpreting this as a right of redemption in favour of BC Tel. Clearly it is at the option of RAC as to whether it wishes to pay the Deferred Amount or in cash and the retain excess the excess

Purchased

Receivables

transfer

Purchased

R e c e i v a b l e s b a c k t o B C T e l Nowhere in the Agreement is BC Tel given any right at its option to repurchase or redeem the Purchased Receivables upon payment of a specified amount of RAC. The only instance in which BC Tel has the right to repurchase the Purchased Receivables is in the event of a "Change In Circumstances" as defined in section 7.06 of the Agreement. Section 7.06 provides that, in the event of any change in law which has the effect of increasing the cost to RAC of complying with its obligation to Purchased Receivables under the Agreement or reducing the rate of return to RAC in connection therewith, BC Tel will upon demand by RAC pay to RAC such increased

19

costs or reduction in rate of return provided that if RAC makes such a demand upon BC Tel, BC Tel may, at its option, terminate the Purchase Agreement on written notice to RAC by repurchasing the Purchased Receivables for an amount equal to the Outstanding Cash Payments, the Purchase Discount and all other amounts payable to RAC pursuant to the Agreement. T h i s a g a i n d o e s n o t a p p e a r t o m e t o b e a r i g h t of redemption or repurchase granted to BC Tel and

exercisable at its option. It only becomes operative in the event of a Change of Circumstances as defined and then only upon a demand being made by RAC to reimburse it for the e f f e c t u p o n i t o f s u c h C h a n g e o f C i r c u m s t a n c e 35 [Emphasis added]

Thus the court failed to concede that the Agreement granted to BC Tel any right of repurchase or redemption of accounts receivable at its option so as to lead to the conclusion that the securitisation transaction was a secured loan transaction rather than a true sale. CONCLUSION The Trial Court concluded
OF THE

TRIAL COURT none of the factors to be

that

considered by the court in determining whether the securitisation transaction in this instance was a true sale or a secured loan transaction negates the clear wording of the Agreement and the clear intention of the parties that the transaction be a true sale of receivables from BC Tel to RAC. On the issues for determination, the court held that:

35

Par 69

20

1.

the redemption of the Bonds was not a refunding operation by BC Tel by the indirect application of borrowed funds,

2.

the redemption of the Bonds was not a refunding operation by BC Tel by the direct application of borrowed funds in that the securitisation transaction was in law a true sale and not a secured borrowing,

3.

the redemption of the Bonds by BC Tel did not affect the result that unfairly disregarded the interests of the

Bondholders so as to give rise to an oppression remedy.

THE COURT ISSUES FOR DETERMINATION

OF

A P P E A L D E C I S I O N 36

The principal issue on appeal, however was whether the use of the proceeds from the Securitization Transaction to redeem the Bonds constituted the application of funds indirectly obtained through borrowing (and at an interest cost of less than 11.35%). Thus Blair JJ.A noted that this appeal is not truly about

securitization, although of necessity a determination of the issues entails a consideration of the nature of that process. This appeal is about the use of the proceeds of a securitization transaction to redeem bonds and whether that redemption violated the terms of the Trust Deed pursuant to which the Bonds were issued. 37

The issues determined at the Court of Appeal was whether BC Tel

36 37

judgment given on June 8 2005 Par 10

21

redeemed the Bonds by the application of funds (i) directly obtained through borrowings or (ii) indirectly obtained through borrowings, and (iii) at an interest cost to BC Tel of less than 11.35%.

The court however observed that a finding that is a true sale is not the end of the matter. What complicates the resolution of these questions is the fact that by its very nature, the securitization transaction is a hybrid phenomenon: it is part sale (the originating company transfers its assets to the SPV) and part borrowing (the SPV borrows money from the public through commercial paper issued on the security of the transferred assets). How, then, should its proceeds be characterized for purposes of their application to redeem the Bonds? 38

Were the Funds Applied by BC Tel to Redeem the Bonds Funds "Directly" Obtained Through Borrowings? The Court of Appeal affirmed the Trial Judges disposition that that in interpreting the contract, the court must look to the intention of the parties as expressed by the language of the contract and that it may also look at the factual matrix existing at the time the contract was entered into, as well as the conduct of the parties.. that the court must look to the substance of the transaction and not merely its form

Therefore in taking these factors and criteria into account, the Trial Judge applied the correct test for determining the legal character of the transaction. Thus Blair JJ.A noted that .in the
38

Par 25 to 26

22

end I am satisfied that his characterization of the Receivables Purchase Agreement as a "true sale" of the BC Tel accounts receivable to RAC Trust was correct. Like the trial judge, I find the lack of any right of redemption in the receivables on the part of BC Tel to be particularly compelling. On the authorities cited, he was entitled to conclude that the fact RAC Trust had no right to retain any surplus from the collection of the receivables -- if such a surplus could conceivably arise in the circumstances -- was not fatal to a determination in favour of a sale: see, Inglefield Ltd, Re supra, at 19-20; Welsh Development Agency v. Export Finance Co.[1992] B.C.L.C 148 (Eng. C.A.). Accordingly, I would not interfere with the trial judge's disposition with respect to the legal nature of the Receivables Purchase Agreement. 39

Therefore, it can be inferred that the issue of whether funds applied to redeem the Bonds were directly obtained through borrowing by BC Tel would fail once the transaction is admittedly a true sale.

Were the Funds Applied by BC Tel to Redeem the Bonds Funds "Indirectly" Obtained Through Borrowings? The Respondent (BC Tel) argued that legally and factually the contractual relationship between BC Tel and RAC Trust

constituted a true sale, and that BC Tel sold its accounts receivable to RAC Trust and applied the proceeds of that sale to redeem the Bonds. Therefore they submitted that there was no breach of the NFAC.

39

Par 42

23

The Court of Appeal failed to give effect to the above submission, but rather observed as follows: In determining whether the proceeds applied to redeem the Bonds were obtained indirectly from borrowings, for purposes of the Trust Deed between BC Tel must and be its Bondholders, at as a the whole. Securitization It cannot from be an

Transaction

looked the

compartmentalized

and

conclusions

flowing

a n a l y s i s o f o n l y o n e a s p e c t o f t h e t r a n s a c t i o n a p p l i e d , without more, to the NFAC. As noted at the outset of this analysis, t h e difficulty arises because of the hybrid nature of a

securitization transaction: it is part sale and part borrowing. It is a sale with an economic function -- to raise borrowed f u n d s . These characteristics cannot be isolated one from the other in considering whether the proceeds of the transaction, as applied to redeem the Bonds, constitute makes funds a obtained indirectly through

borrowings . . W h a t

securitization

transaction

effective for its purposes is the constellation of an number of features, only one of which is the sale by the originating c o m p a n y (in this case, BC Tel) to the SPV (in this case, RAC Trust). The assets do not become "securitized" until they have in effect been transformed by the SPV into negotiable securities and issued to the public in the financial markets. The

transaction is not completed until the funds borrowed from the public are transferred to the originating company in payment of the purchase price for the assets. Do such proceeds

comprise "funds indirectly obtained through borrowings" for

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purposes of the NFAC? I have no hesitation in concluding that t h e y d o . 40 [Emphasis added]

The Court of Appeal further observed that what BC Tel entered into was a securitisation transaction and not simply a sale of assets (although the sale of assets was an integral part of the transaction). BC Tels agreement was to securitize its assets and obtain all the benefits of such a capital raising mechanismprincipally, the lower cost of obtaining funds..These are the funds that were applied to redeem the Bonds. They were funds indirectly obtained through borrowing, whether those funds were borrowed by BC Tel or not 41

The Court referred to a Canadian decision in Manufacturers Life Insurance Co. v Dofasco Inc. 42 and reasoned that the court can apply the "source" rule 43 and thus, look at the true source of the funds used in determining whether there has been a breach of a No Financial Advantage Covenant (NFAC) and in determining whether a redemption of the debentures violates the refunding provision. Where the facts indicate that the redemption was indirectly funded by the proceeds of actual or anticipated debt borrowed at a prohibited interest rate, the redemption would be

40 41
42

Par 46-47 Par 50

(1993) 9 B.L.R (2d) 203 In Manufacturer Life Insurance Case, the court, in the absence of any Canadian authorities considering the subject, referred to a number of American authorities that had decided thereon: see Franklin Life Insurance Co. v. Commonwealth Edison Co., 451 F. Supp. 602 (U.S. S.D. Ill. 1978), Mann v. Oppenheimer & Co., 517 A.2d 1056 (U.S. Del. S.C. 1986); Morgan Stanley & Co. v. Archer Daniels Midland Co. (1983), 570 F. Supp. 1529 (U.S. Dist. Ct. S.D. N.Y.);Shenandoah Life Insurance Co. v. Valero Energy Corp.
43

25

barred regardless of the account from which the funds were withdrawn. The Court further reasoned that the inclusion of that phrase (i.e. the indirectly language) in the NFAC is intended to reach situations in which the underlying economic reality of the

completed transaction is the functional equivalent of a direct loan for purposes of effectuating a redemption and nothing more. The Respondents relied on the Trial Judges reason in concluding that the securitisation transaction did not constitute indirect borrowing that the transaction would have to have been constructed by BC Tel, specifically and exclusively, for the purpose of redeeming the Bonds and have no independent economic function either from the perspective of BC Tel or of RAC, neither of which criteria applies to the case at bar 44. The Court held that the Trial Judge had erred in holding that the proceeds of the transaction could not be funds indirectly obtained through borrowing, for the purposes of the Trust Deed, unless the transaction was constructed by BC Tel specifically and exclusively for the purpose of redeeming the Bonds and had no independent economic function either from the perspective of BC Tel or of RAC. The Court opined that it would not reason that narrowly, but rather it would suffice if the principal economic function of the securitisation transaction is to have such an effect, that is,

44

Par 53

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refunding of the Bonds through the application of funds indirectly obtained through borrowing.

Whether the Borrowing at an Interest Cost to the Company of Less than 11.35% On this issue, the court debunked the argument of the Respondent that there was no interest cost to BC Tel because there was no borrowing by BC Tel, only by RAC Trust, as premised upon the compartmentalization approach to the Securitisation Transaction and the view that all that transpired between BC Tel and RAC Trust was a purchase of BC Tels accounts receivable. The Court thus opined that BC Tel redeemed the Bonds by applying funds obtained indirectly through borrowing at an

interest cost to it of less than 11.35% which constituted a violation of the NFAC.

CONCLUSION

OF THE

COURT

OF

APPEAL

The Appeal was allowed and the judgment of Ground J. at the trial court was set aside, and in its stead an order made declaring that the redemption by BC Tel, the predecessor of Telus

Communications Inc., of the Series AL Bonds was a breach of the No Financial Advantage Covenant contained in a deed of trust and

27

mortgage between BC Tel and Montreal Trust Company dated pursuant to which the Bonds were issued 45.

THE OUTCOME With the decision of the Court of Appeal in BC Tel case, the securitisation market can now breathe a communal sigh of relief. The Court of Appeal upheld the trial court's conclusion that the BC Tel securitisation constituted a sale of its receivables. In doing so, the court validated the basic elements of securitisation that have been utilized since the 1980s, as well as the related True Sale Legal Opinions. The decision will be a critical reference point for analysing whether a particular securitisation will receive sale treatment or be recharacterised as a loan. Thus, securitisation can also enable a corporation to obtain financing backed by its receivables notwithstanding an agreement not to incur or secure direct borrowings (although a securitisation may contravene a restriction against raising debt indirectly).

Securitization as an Indirect Borrowing Although the Appeal Court agreed that BC Tel's securitisation included a true sale, and thus did not involve a direct borrowing that violated its non-redemption covenant (NFAC), the court nevertheless reversed the lower court's decision and found that BC Tel had improperly obtained the redemption funds indirectly from
45

and an order referring the matter of damages back to the trial judge for assessment

28

borrowings. The court characterized securitisation as having a hybrid nature since they constitute a "sale with an economic function - to raise borrowed funds". The Appeal Court's decision affords a useful aide memoire that a company's other contracts, the phraseology of any negative pledges and affiliations must be carefully examined in order to determine the implications of a securitisation transaction. While essential in itself, merely concluding that the transaction includes a sale for legal, tax and bankruptcy purposes will not necessarily provide assurance that the transaction complies with all relevant restrictions, particularly those involving an indirect

raising of borrowed funds. Moreso, the logical extension of the Appeal Courts decision raises some concern if the proceeds of a securitisation transaction in the hands of the originator will be viewed as indirectly borrowed funds.

Chinua Azubike

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