Lawyers and investment bankers involved in setting up structured products such as asset backed commercial paper, CDOs, CMBS and CLOs often strive to achieve “bankruptcy remoteness” for the vehicle issuing the product (typically a bond) purchased by the market. Investors in such products want to ensure that the issuer of the bonds is removed from the potential liabilities of originators and sponsors. In addition, any bankruptcy of the issuer may interrupt or delay the pass through of cash flows to third party investors.

A bankruptcy trustee’s or liquidator’s costs are likely to be considerable and will erode some of the recoveries to the investors. Issuers are therefore generally structured to avoid bankruptcy. If a default occurs, the payments of the bonds will usually continue in accordance with a waterfall to reflect the agreed seniority of the bonds until all the assets have been expended – or at least, that is the theory.

Two recent decisions, one at first instance in the UK’s Chancery Court, (ARM Asset Backed Securities S.A. [2013] EWHC 3351 (Ch) (9 October 2013)) taken together with an earlier decision this year, in the Supreme Court, (BNY Corporate Trustee Services Ltd and others v Eurosail-UK 2007-3BL PLC and others [2013] UKSC 28 (9 May 2013)), have cast doubt on whether the procedures put in place to achieve “bankruptcy remoteness” work in practice. These decisions are important as they are likely to have an impact on the rating agencies’ approach to rating structured products.

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