Serving Two Masters: When 'Bankruptcy Remote' Meets Public Policy

One such common provision is a requirement that the BRE have an outside director or member whose vote is required for approval of any bankruptcy filing by the BRE. While a contractual provision prohibiting an entity from filing for bankruptcy protection has long been considered void as against public policy, recent cases evaluate situations where the debtor is not contractually prohibited from making a filing, but where a director or member of the debtor who is beholden to the creditor holds the ultimate power to veto a bankruptcy.

Courts are asked to consider these established financing structure variations in light of the public policy aspects of bankruptcy law and fiduciary duties imposed by corporate law.
This article examines two recent cases, and suggests practices that lenders to BREs can use to reduce the risk of a debtor bankruptcy without compromising the policies underlying bankruptcy and corporate laws.

Securitization: Background

A typical transaction form that uses BREs involves the securitization of receivables. Here, an originator sells its receivables assets, such as equipment leases, to a special purpose entity created solely to hold and manage the receivables assets. Additional restrictions are imposed on the special purpose entity to isolate the cash flow from those assets, making it a BRE. In virtually all securitization transactions, the BRE acquires its assets from the originator in a transaction designed to be a “true sale” and the BRE's organizational documents restrict its activities to minimize the risk of “substantive consolidation” in bankruptcy (i.e., the risk that its assets will be used to meet the obligations of the originator's creditors in the event of the originator's bankruptcy).