Introduction
Securitisation and receivables sale/purchase agreements (such as discounting and factoring) are effective methods of financing used by entities to monetise their business receivables. In these transactions, a business entity that generates receivables through commercial operations sells the receivables for immediate cash consideration. The most important component of such transactions is achieving a 'true sale' of receivables.
What is 'True Sale'?
A 'true sale' is understood as a sale of receivables by the owner (the seller) to another person (the investor/purchaser/financier), such that the receivables sold are protected from claims against the seller's assets in the event of the seller's bankruptcy. This involves:
Legal Isolation: Complete transfer of the receivables, placing them beyond the reach of the seller's creditors or a bankruptcy trustee/receiver.
Full Ownership: The purchaser's full ownership right in the receivables, including the transfer of risk and rewards and the right to freely deal with the receivables.
Relinquishment of Control: The seller's relinquishment of effective control of the receivables sold, with no or limited recourse to the seller.
Criteria for True Sale Under UAE Law
The UAE's Securities and Commodities Authority (SCA) has defined 'true sale' in its regulations.
The criteria include:
Transfer of Rights and Obligations: All rights and obligations related to the financial assets must be transferred from the originator to the issuer, avoiding any transaction that could be considered as financing.
Situation: A company, ABC Ltd., sells its receivables from customer invoices to a financial institution, XYZ Bank, to obtain immediate cash.
True Sale Criteria: For this transaction to be considered a true sale, ABC Ltd. must completely transfer the receivables to XYZ Bank. This means that the receivables should be legally isolated from ABC Ltd.'s assets, ensuring that in the event of ABC Ltd.'s bankruptcy, the receivables are beyond the reach of ABC Ltd.'s creditors or a bankruptcy trustee.
Outcome: If the receivables are legally isolated, XYZ Bank will have full ownership and control over the receivables, and they will not be part of ABC Ltd.'s bankruptcy estate.
Ring-Fencing of Assets: The financial assets must be ring-fenced from the originator and its creditors, preventing any action related to them.
Example: Full Ownership and Control
Situation: DEF Corp. sells its receivables from a long-term service contract to an investment firm, GHI Investments.
True Sale Criteria: DEF Corp. must transfer all rights and obligations related to the receivables to GHI Investments. 16 This includes the transfer of risk and rewards associated with the receivables, and GHI Investments must have the right to freely deal with the receivables without any interference from DEF Corp.
Outcome: If GHI Investments has full ownership and control over the receivables, it can manage, collect, or even sell the receivables as it sees fit.DEF Corp. will have no control or claim over the receivables once the sale is completed.
No Recourse: The issuer should have no recourse against the originator due to losses arising from the securitisation portfolio, except within the limits of guarantees or credit enhancements provided.
Example: No Recourse
Situation: JKL Enterprises sells its receivables from a series of product sales to a securitisation vehicle, MNO Securitisation Ltd.
True Sale Criteria: JKL Enterprises must relinquish effective control of the receivables and should not have any recourse against MNO Securitisation Ltd. for losses arising from the securitisation portfolio, except within the limits of any guarantees or credit enhancements provided. 19 20
Outcome: If JKL Enterprises has no recourse against MNO Securitisation Ltd., the transaction will be considered a true sale. MNO Securitisation Ltd. will bear the risk of any losses from the receivables, and JKL Enterprises will not be liable for those losses, except as specified in any agreed-upon guarantees or credit enhancements.
Importance of Achieving True Sale
Ensuring that a receivables sale transaction constitutes a true sale is critical. For the seller, it allows derecognition of the receivables from its books. For the purchaser, it ensures that the receivables are not part of the seller's bankruptcy estate and are not subject to any automatic stay. Failure to meet the true sale criteria may result in the transaction being re-characterised as a financing transaction, with the purchaser becoming an unsecured creditor in the event of the seller's bankruptcy.
Legal Opinion Requirement
In all transactions involving a 'true sale', a legal opinion must be obtained to confirm that the true sale criteria have been satisfied, as required by regulators and auditors.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
