Understanding the Securitization Process and the Impact on Consumer Bankruptcy Cases
Securitization is a complex series of financial transactions designed to maximize cash flow and reduce risk for debt originators. This is achieved when assets, receivables or financial instruments are acquired, classified into pools, and offered as collateral for third-party investment. Then, financial instruments are sold which are backed by the cash flow or value of the underlying assets.
In order to create the desired “bankruptcy remoteness,” the pool assets must be transferred by “true sale.” Such a sale also provides the SPV with Holder in Due Course (HIDC) status and protection. In order to gain HIDC status, the SPV must satisfy the requirements of UCC section 3-302. The SPV must: take the instrument for value, in good faith, without notice that the instrument is overdue, dishonored or has an uncured default, without notice that the instrument contains unauthorized signatures or has been altered, and without notice that any party has a claim or defense in recoupment. Additionally, the instrument, when issued or negotiated to the holder, cannot bear any evidence of forgery or alteration or have irregularities that would give rise to questions of authenticity. The main benefit of HIDC status is that the holder may enforce the payment rights under the negotiable instrument free from all by a limited number of defenses as outlined in UCC 3-305. The HIDC takes the note or instrument free from competing claims of ownership by third parties.
Does the Trust Actually Own a Securitized Obligation?
Challenges Based on Standing
Securitization impacts consumer bankruptcy practice in a number of ways, most frequently in the context of motions for relief from stay and proofs of claim. Specifically, debtors’ counsel must consider who actually owns the mortgage note, auto loan or credit card receivable that has been securitized. Is the Trust that is asserting ownership the true owner?
Many times the answer is “NO” because the Trust has failed to properly acquire ownership of the note or receivable.
So, what must a Trust produce to establish ownership of a securitized obligation?
In order for the Trust to asset and establish ownership of an instrument that has been securitized the Trust must demonstrate that it has acquired the note by proper indorsement and delivery in strict accordance with the mandatory transfer procedures and time requirements established in the PSA. This will require producing the original note with all proper indorsements establishing an unbroken chain of transfer from the Originator to the Aggregator, from the Aggregator to the Depositor, and from the Depositor to the Trustee.
In some cases, despite the requirements of the PSA, the note was never transferred to the Trust’s Document Custodian or the note was transferred but was not properly indorsed. Unless ownership is established, a movant lacks standing to enforce a negotiable instrument.