Deconstructing the True Sale Doctrine: Planned Privity and Asset Isolation Under ASC 860

Summary

In a securitization, the conclusion that loans were truly sold is what isolates them from the sponsor’s creditors and supports taking them off the sponsor’s balance sheet. FASB ASC 860 sets the accounting conditions for that treatment, and state commercial law and bankruptcy law decide whether the transfer holds as a sale. In practice the transfer is rarely the product of bargaining between independent parties. The buyer is usually an affiliate created for the transaction, and the price, the structure and the later distribution of cash are settled before the underlying loans exist. We call this arrangement planned privity: the parties to the sale are related by design, and the special purpose vehicles in the chain are formed to supply the steps that the legal and accounting conclusions require.

Planned privity is lawful and openly disclosed. Its significance is that it moves the true sale question away from the documents, which will always describe a sale, and toward conduct. This paper describes the structure, identifies four categories of evidence that an examiner, auditor or compliance officer can test, and states the limits of what a finding means.

Three questions that are often treated as one

• Accounting sale. ASC 860-10-40-5 treats a transfer as a sale only if three conditions are all met: the assets are isolated from the transferor and its creditors, even in bankruptcy; the transferee has the right to pledge or exchange what it received; and the transferor does not maintain effective control. A transferor may continue to service the loans and may hold a beneficial interest in them without losing sale treatment.
• Legal true sale. Whether a court will respect the transfer as a sale or recharacterize it as a secured loan is a question of state law, usually raised in the transferor’s bankruptcy. Courts look at which party bears the risk of loss. In Major’s Furniture Mart v. Castle Credit Corp., 602 F.2d 538 (3d Cir. 1979), the court held that a purported sale of accounts was a secured loan because none of the risks of a true sale had passed to the buyer, while noting that recourse alone does not convert a sale into a loan.
• Separateness. Whether a special purpose vehicle will be treated as distinct from its parent is tested under substantive consolidation and alter ego doctrine. In re Owens Corning, 419 F.3d 195 (3d Cir. 2005), describes consolidation as an extreme remedy. It requires proof that the entities disregarded their separateness so significantly that creditors relied on the breakdown, or that their affairs are too entangled to separate.

Accounting consolidation is a fourth and separate matter. Since 2009, a sponsor that holds both the power to direct a securitization trust and a significant economic interest in it may have to consolidate the trust under ASC 810, whether or not the transfer was a legal sale.

The structure

Party	Role	Relationship to the sponsor	Economic interest
Sponsor	Organizes the transaction and sells or transfers the loans	The parent	Typically keeps servicing and the residual interest
Depositor	Receives the loans from the sponsor and transfers them to the issuing entity	Usually a wholly owned, single-purpose subsidiary	None. It passes the assets through
Issuing entity	Holds the loans and issues the securities	A trust administered by an independent trustee	None of its own. It holds for the certificateholders
Certificateholders	Buy the securities	Unaffiliated investors	Payments in the order the transaction documents set

The two-step transfer through the depositor is the standard method for achieving isolation, and Regulation AB defines each of these roles for disclosure purposes (17 CFR 229.1101). Affiliation between the sponsor and the depositor does not by itself defeat a sale. What it removes is the independent counterparty whose self-interest would otherwise police the terms, which is why conduct after closing carries so much of the weight.

Four categories of evidence

1. Implied recourse. Review whether the sponsor or an affiliate repurchases or replaces non-performing loans beyond what the breach of warranty provisions require. The federal banking agencies define implicit recourse as support given to a securitization in excess of any contractual obligation, and supervisors may require the assets to be brought back on the balance sheet for risk-based capital purposes (Interagency Guidance on Implicit Recourse in Asset Securitizations, May 23, 2002, Federal Reserve SR 02-15). A pattern of support is also evidence on the legal question, because it shows which party is bearing the risk of loss.
2. Commingling. Document whether collections pass through accounts controlled by the parent without ledger segregation, defined holding periods or a clear sweep to the trust’s accounts. Commingling bears on effective control and on separateness.
3. Endorsement and custody. Inspect the notes and the custodial records for a complete chain from the originator through the depositor to the trustee, delivered when the transaction documents required. Two points need to be kept apart here. Under UCC Article 9 the sale of a promissory note can be effective and perfected without endorsement or delivery (UCC §§ 9-109(a)(3), 9-203 and 9-309(4)), so a gap in the endorsements does not by itself undo the sale. The gap matters for a different reason. The right to enforce a note belongs to the persons listed in UCC § 3-301, who the section says may be someone other than the owner, and the gap shows whether the parties performed the transfer steps their own documents required.
4. Governance. Examine the records of each vehicle for separate capitalization, its own books, independent directors who vote on material events, and documented arrangements for shared offices and staff. These are the facts courts weigh under Owens Corning.

What a finding does and does not mean

These tests belong to the people entitled to apply them: auditors, regulators and examiners, and in a bankruptcy the trustee and the transferor’s creditors. A borrower is in a different position. Courts have generally held that a borrower cannot enforce a pooling and servicing agreement and can challenge an assignment only on grounds that would make it void, and they have often treated late or irregular transfers into a trust as voidable at the option of the trust’s beneficiaries (Rajamin v. Deutsche Bank National Trust Co., 757 F.3d 79 (2d Cir. 2014); Reinagel v. Deutsche Bank National Trust Co., 735 F.3d 220 (5th Cir. 2013); Culhane v. Aurora Loan Services of Nebraska, 708 F.3d 282 (1st Cir. 2013)). California allows a wrongful foreclosure claim based on a void assignment after a nonjudicial sale, in a ruling the court itself described as narrow (Yvanova v. New Century Mortgage Corp., 62 Cal. 4th 919 (2016)).

A failed true sale does not extinguish a borrower’s debt. It changes which entity owns the loan and whose creditors can reach it. What the same evidence can show a borrower is narrower and still useful: which party is entitled to enforce the note, whether the party demanding payment has documented its authority, and whether the amounts were computed by the entity responsible for them. Those are the questions our examinations address, and our white paper Reading the Lien After the Loan Is Sold sets out the method.

The contract runs both ways

The limits above concern attacks on the transfer. A borrower’s stronger position does not depend on the transfer failing. A note and a mortgage impose continuing duties on the creditor side as well: applying payments as the note directs, administering escrow, giving the notices the instrument requires before acceleration, and following the servicing rules. Those duties travel with the loan.

Whoever enforces a note takes it subject to the borrower’s defenses and claims in recoupment from the original transaction, unless it is a holder in due course (UCC § 3-305). To hold that status a party must be a holder that took the note for value, in good faith, and without notice that it was overdue or subject to a defense or claim (UCC § 3-302(a)).

Planned privity bears directly on that status. Under the close connection rule, a transferee that supplied the forms and helped set the terms of the underlying transactions is treated as a participant in the original transaction and cannot claim the insulation of a stranger (Unico v. Owen, 50 N.J. 101 (1967)). The rule developed in consumer goods financing, states differ on how far it extends, and its application to securitization trusts is unsettled. The records that speak to it are the ones described above: purchase commitments that predate origination, underwriting standards and forms dictated by the sponsor, transfers completed after default, and endorsements that were never made.

Two statutes reach a similar result for particular loans without any showing about the holder’s status. A borrower’s right to rescind runs against any assignee (15 U.S.C. § 1641(c)), and the assignee of a high-cost mortgage is subject to all claims and defenses the borrower could assert against the creditor (15 U.S.C. § 1641(d)(1)).

Showing that a holder lacks this protection does not create a claim by itself. It removes a shield, so that a defense the borrower already has can be raised against the party now enforcing the note. Examples are a misapplied payment history, an unauthorized charge, a condition that was not met before acceleration, or a misrepresentation at origination. Against a transferee, a claim in recoupment can reduce the amount owing on the note and cannot produce an affirmative recovery (UCC § 3-305(a)(3)).

Conclusion

The accounting and legal conclusions that support a securitization rest on facts about control, risk and separateness. Where the vehicles in the chain operate as administrative extensions of the parent, those facts can diverge from the labels in the documents. Examiners and compliance professionals should test the functional relationships at regular intervals and should not treat the transaction documents as proof of how the parties behave.

Serv Inc. is not a law firm, and this paper is not legal or accounting advice. It describes categories of evidence and cites public sources. It does not assert that any particular transaction failed to achieve a sale.

Sources

• FASB Statement No. 166, Accounting for Transfers of Financial Assets (codified in ASC 860)
• FASB Statement No. 167, Amendments to FASB Interpretation No. 46(R) (codified in ASC 810)
• Interagency Guidance on Implicit Recourse in Asset Securitizations, Federal Reserve SR 02-15
• Major's Furniture Mart v. Castle Credit Corp., 602 F.2d 538 (3d Cir. 1979)
• In re Owens Corning, 419 F.3d 195 (3d Cir. 2005)
• 17 CFR 229.1101, Regulation AB definitions
• UCC § 9-109, Scope
• UCC § 9-309, Security interest perfected upon attachment
• UCC § 3-301, Person entitled to enforce instrument
• UCC § 3-302, Holder in due course
• UCC § 3-305, Defenses and claims in recoupment
• Unico v. Owen, 50 N.J. 101 (1967)
• 15 U.S.C. § 1641, Liability of assignees
• Rajamin v. Deutsche Bank National Trust Co., 757 F.3d 79 (2d Cir. 2014)
• Yvanova v. New Century Mortgage Corp., 62 Cal. 4th 919 (2016)