October 15, 2006
Lands of Opportunity - Why Cayman and Delaware Entities Rule in Structured Finance
Coauthored by Marla Hirshman Norton
In recent years, both the Cayman Islands and Delaware have enjoyed steady increases in the number and sophistication of securitization transactions involving entities formed under their laws, due largely to their modern, flexible and business-friendly legal environments. Delaware has long been a favored domicile in US domestic transactions. Similarly, the Caymans have become a preferred jurisdiction for offshore securitizations. This article briefly examines some of the key characteristics of the entities most commonly used in each jurisdiction for structured finance and securitization deals.
A securitization transaction converts a pool of income-producing assets into marketable securities, such as notes, bonds or preference shares. In the simplest form of transaction, a special purpose, bankruptcy-remote issuer (“SPE”) is formed to purchase receivables, corporate bonds, loan participations or other assets, which may include derivatives, the cash flow from which funds payments on the securities. The assets are generally pledged as collateral. Collateralized debt obligations (“CDOs”) are a securitization structure in which sequential tranches of senior and subordinated debt are backed by a managed pool of underlying assets and/or derivatives.
A number of factors drive the situs decision for the issuer. The most attractive domiciles offer a variety of entity forms adaptable to the needs of a particular deal, predictable legal outcomes and favorable tax treatment. Rating agencies generally require that the issuer and any SPE parent are insulated from the risk of substantive consolidation in the event of an affiliates’ bankruptcy or insolvency. Finally, the parties seek high-quality, sophisticated local service providers to establish and manage the SPE. As discussed below, both Delaware and the Cayman Islands have successfully capitalized on the needs of the marketplace and become the optimal location for SPEs.
Delaware’s reputation as a preeminent jurisdiction for entity formation is well-deserved. Delaware alternative entities are popular for structured finance and securitization transactions, largely because of Delaware’s policy to promote flexibility and freedom of contract, ensuring that Delaware entities can be adapted to a myriad of transactions. Rating agencies are familiar with Delaware entity laws and the legal opinions that Delaware lawyers can issue. Moreover, Delaware entity laws are continually updated to ensure that the legislation remains state-of-the-art and that market concerns (including rating agency concerns) are addressed as they develop.
Delaware is also appealing because it does not aggressively tax non-Delaware source income. Alternative entity statutes piggyback on federal tax rules, thus ensuring that the Delaware tax treatment will yield no surprises. Most alternative entities can issue interests without requiring a capital contribution.
The Delaware judiciary, particularly the Court of Chancery (a business and equity court), is well respected for its sophistication. A U.S. Chamber of Commerce annual poll of judges and lawyers has ranked Delaware courts as the best and fairest in the country for five consecutive years. In addition, the Delaware Division of Corporations (the “Division”) strives to remain technologically advanced and customer-service oriented, offering expedited processing within hours.
A summary of the features and benefits of the Delaware entities most commonly-used in securitizations follows:
Delaware Statutory Trust
Delaware statutory trusts ( “DSTs”) are often used as issuers in securitization transactions. A DST is created pursuant to the Delaware
In recent years, both the Cayman Islands and Delaware have enjoyed steady increases in the number and sophistication of securitization transactions involving entities formed under their laws, due largely to their modern, flexible and business-friendly legal environments. Delaware has long been a favored domicile in US domestic transactions. Similarly, the Caymans have become a preferred jurisdiction for offshore securitizations. This article briefly examines some of the key characteristics of the entities most commonly used in each jurisdiction for structured finance and securitization deals.
A securitization transaction converts a pool of income-producing assets into marketable securities, such as notes, bonds or preference shares. In the simplest form of transaction, a special purpose, bankruptcy-remote issuer (“SPE”) is formed to purchase receivables, corporate bonds, loan participations or other assets, which may include derivatives, the cash flow from which funds payments on the securities. The assets are generally pledged as collateral. Collateralized debt obligations (“CDOs”) are a securitization structure in which sequential tranches of senior and subordinated debt are backed by a managed pool of underlying assets and/or derivatives.
A number of factors drive the situs decision for the issuer. The most attractive domiciles offer a variety of entity forms adaptable to the needs of a particular deal, predictable legal outcomes and favorable tax treatment. Rating agencies generally require that the issuer and any SPE parent are insulated from the risk of substantive consolidation in the event of an affiliates’ bankruptcy or insolvency. Finally, the parties seek high-quality, sophisticated local service providers to establish and manage the SPE. As discussed below, both Delaware and the Cayman Islands have successfully capitalized on the needs of the marketplace and become the optimal location for SPEs.
Delaware
Delaware’s reputation as a preeminent jurisdiction for entity formation is well-deserved. Delaware alternative entities are popular for structured finance and securitization transactions, largely because of Delaware’s policy to promote flexibility and freedom of contract, ensuring that Delaware entities can be adapted to a myriad of transactions. Rating agencies are familiar with Delaware entity laws and the legal opinions that Delaware lawyers can issue. Moreover, Delaware entity laws are continually updated to ensure that the legislation remains state-of-the-art and that market concerns (including rating agency concerns) are addressed as they develop.
Delaware is also appealing because it does not aggressively tax non-Delaware source income. Alternative entity statutes piggyback on federal tax rules, thus ensuring that the Delaware tax treatment will yield no surprises. Most alternative entities can issue interests without requiring a capital contribution.
The Delaware judiciary, particularly the Court of Chancery (a business and equity court), is well respected for its sophistication. A U.S. Chamber of Commerce annual poll of judges and lawyers has ranked Delaware courts as the best and fairest in the country for five consecutive years. In addition, the Delaware Division of Corporations (the “Division”) strives to remain technologically advanced and customer-service oriented, offering expedited processing within hours.
A summary of the features and benefits of the Delaware entities most commonly-used in securitizations follows:
Delaware Statutory Trust
Delaware statutory trusts ( “DSTs”) are often used as issuers in securitization transactions. A DST is created pursuant to the Delaware