(The solid lines in the diagram depict cash flows while the broken lines indicate legal contractual relationships.)
In this typical United Kingdom whole business securitisation, the legal structure is based on that of a secured loan rather than a sale of assets, since the revenues of the entire business are securitised (Pfister, 2000:2). An SPV is set up to raise debt, which the SPV on-lends to the operating company (borrower). The borrower repays the loan out of the cash flows generated from its business. The loan is secured by all of the assets of the borrower, including a security interest over any properties, investments and accounts, and the assignment of the borrower’s rights under any contracts, licences or agreements. In addition, the borrower grants a floating charge over all of its assets. The security is held by a security trustee for the benefit of investors and other secured creditors such as the liquidity facility provider.
In order to protect the cash flows from the insolvency of the borrower, the United Kingdom legal structure relies on the Insolvency Act of 198625. This Act permits the holder of a charge over all of a company’s assets to control the insolvency proceedings of that company through an administrative receiver. If the borrower becomes insolvent, the security trustee, as holder of the fixed and floating charge over all the assets of the borrower, will be able to stop the appointment of an administrator by
25 UK law has recently been amended to make it more debtor friendly. However, due to the importance of whole
business securitisation, a special exemption has been included which is designed to maintain secured creditor control of the insolvency of a company that has raised finance through a whole business securitisation.
Administrative receiver
Operating company Liquidity facility
provider SPV Investors Secured loan Pledge of assets Funding Security trustee Pledge of assets Guarantee Guarantee
the Court, and appoint an administrative receiver of its choice. The administrative receiver will take control of the borrower’s assets and will manage those assets for the sole interest of the creditors until the debt is repaid in full. Alternatively the administrative receiver can choose to liquidate the assets and repay the debt early if it judges this to be a more appropriate course of action. Upon liquidation, investors as holders of a fixed charge will have priority over any other creditors of the borrower. Delays may arise in the process of taking control of the assets and cash flows of the borrower during insolvency proceedings. A liquidity facility, typically covering 18 to 24 months of debt service, is accordingly required to avoid any disruption of debt servicing. The ability to replace the management of the borrower by a substitute manager, the administrative receiver, in an insolvency proceeding is somewhat comparable to the concept of a back-up servicer in a standard securitisation. The expediency of appointing an administrative receiver, as opposed to protracted proceedings in some other countries, and the existence of a liquidity facility should preclude a default under the securitised debt (Pfister, 2000:3).
The administrative receiver is expected to manage the assets of the borrower actively on a day-to-day basis until the secured loan is fully repaid or the portfolio liquidated. Consequently the structure relies upon the critical assumption that another operating company or third-party servicer can be found who would be willing to take over and manage the assets once the borrower becomes insolvent. This in turn assumes that, despite the insolvency of the borrower, its assets and the industry in which it operates will be viable in the long run (Pfister, 2000:4). The intrinsic value of the borrower’s business will be greater if the borrower is not insolvent. It is in the interests of bondholders to recognise early signs of severe problems, which is usually achieved through financial covenants, which if not complied with by the borrower, will lead to a default under the secured loan agreement, the enforcement of the security and the appointment of an administrative receiver. One of the most efficient and often used financial covenants is based on a minimum debt service coverage ratio (DSCR) test, defined as adjusted EBITDA26 over debt service. The EBITDA figure is adjusted for non-cash and exceptional items to reflect the free cash flow of the borrower. The DSCR is normally set at well above one times the debt service, so that an alarm sounds before the borrower is no longer able to generate sufficient cash flows to pay capital expenditure, tax and debt service (Pfister, 2000:5).
Whole business securitisation is best applied to companies within stable or essential industries benefiting from high barriers to entry and limited existing competition, which generate predictable
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cash flows from a portfolio of diverse long-term sustainable assets with substantial alternative use value (Pfister, 2000:9).
7.11 Intellectual Property Securitisation
Intellectual property-backed securitisation transactions are a form of future flow securitisations. However, one characteristic that differentiates intellectual property27 transactions from other types of future flow securitisations is that they are profoundly dependent on popular tastes, adding a layer of complexity and risk to the structure (Eisbruck, 1999:1). Intellectual property transactions to date have largely been backed by future payments generated by music royalty rights. The first music royalty securitisation was completed in 1997, involving the future revenues generated by the music catalogue of pop artist David Bowie, and commonly referred to as “Bowie Bonds” (Eisbruck, 1999:2). As is the case with other types of future flow transactions, the receivables in a music royalty- backed transaction do not exist at the inception of the transaction, but instead are to be generated during the life of the transaction. Intellectual property-backed transactions can be implemented through a secured loan structure or a true sale structure (Lester, 2002:9 - 13).
7.11.1 Secured Loan Structure
In terms of the secured loan structure, the issuing SPV issues notes to provide a secured loan to an intellectual property SPV, which is created specifically to purchase and isolate the originator’s intellectual property rights. The underling obligors from that point on make their royalty payments directly to the intellectual property SPV, which uses the cash flows to repay the secured loan. The intellectual property SPV cedes the intellectual property rights and related contracts as security for the loan to the issuing SPV, which pledge all its assets to the security trustee for the benefit of investors.