“If you think you can go it alone in today’s global economy, you are highly mistaken” Jack Welch, CEO of General Electric, USA  Securitization is considered one of the most prominent developments in international finance, and is its utility is expected to rise further in the future.  Securitization has been defined as “the process of pooling and repackaging of homogenous illiquid financial assets into marketable securities that can be sold to investors.”  The concept of securitization typically offers investors higher quality assets due to the fact that the structure created is insulated from the bankruptcy risk of the Originator. The Special Purpose Vehicle (hereinafter “SPV”) is one such structure. An SPV, or a special purpose entity (SPE), is a “legal entity created by a firm (known as the sponsor or originator) by transferring assets to the SPV, to carry out some specific purpose or circumscribed activity, or a series of such transactions.”  SPV’s gained prominence in light of the Enron scandal, where the directors and auditors utilized SPV’s to clear the debts off the balance book of Enron.  A SPV is an independent entity, usually created for carrying out a specific project, wherein the SPV purchases assets from the Originator and issues securities against the purchased assets. Such a model provides an investor added security insofar that their investment in the SPV is not subject to any subsequent deterioration in the credit quality of the Originator.  Moreover, the investment is secured by the assets of the SPV, or in case of a joint venture, a performance amount. During the course of this paper, the researcher shall endeavor to highlight the advantages of SPV’s in various transactions, with emphasis on the use of SPV’s as an acquisition vehicle and the use of SPV’s for joint ventures. The researcher shall first analyze the concept of a SPV, before dealing with specific issues like the use of SPV’s as an acquisition vehicle and the use of SPV’s by Private Equity firms. SPV’s -The Concept A securitization process typically entails a four step process. First, a SPV is created, which holds the title to the assets underlying securities. Second, the assets held by the Originator are purchased by the SPV, which in turn leads to the third step, i.e. the issuance of securities to the investors which are backed by the assets purchased. The fourth step involves the SPV pays the originator for the assets with the proceeds from the sale of securities.  A securitization deal typically involves three parties, namely  – 1. The Originator: This is the entity on whose books the assets to be securitised exist. It is the Company that generally owns the receivables. The Company then sells these receivables to a newly formed separate legal entity, which can take the form of a company or a trust. In a true sale, the Originator transfers both the legal and the beneficial interest in the assets to the SPV.  This process results in the risks associated with the receivables being separated from the risks associated with the Originator. 2. The SPV: In order to raise funds for the purchase of the receivables, the SPV approaches the capital markets. The SPV would typically buy the assets (to be securitised) from the Originator. The SPV is characteristically a low-capitalised entity with narrowly defined purposes (in order to make it bankruptcy remote) and activities, and usually has independent trustees/directors. An example would be the acquisition of Zain Africa by Bharti, wherein two SPV’s were created, which took the loan to finance the transaction, and the advantage of this process being that the loan was not on the books of Bharti.  3. The Investors: The investors that purchase the securities offered by the SPV can be in the form of individuals, institutional investors, mutual funds, provident funds, insurance companies, etc. These investors purchase a ‘participating interest in the total pool of receivables and receive their payment in the form of interest and principal as per agreed pattern.’  A Special purpose entity is a unique form of joint venture or a separate form of legal structure that is created by a company or a firm for a special purpose, for example, isolation of risk or for providing liquidity or to obtain favorable external funding.  The rationale behind creation of such structures is that many of the infrastructure projects require huge capital investments, specialized technologies, multi-skill and advanced management techniques. The risks involved in such projects are so high that individual entities cannot bear such a huge risk solely on their own and they do not want to burden the existing units with such a risk. Therefore, this leads to the formation of a special structure that enables the firm to successfully complete the project by isolating the risk in such a case.  The unique feature about a SPV is that they have no other purpose other than the sole transaction or project for which they were created and they can make no substantive decisions, the rules governing them are set down in advance and they carefully circumscribe their activities. In other words, SPV’s are single project/purpose entities which are bankruptcy remote, i.e. scope of activities undertaken by the SPV is strictly limited and in most cases, a non-petition agreement is obtained from the creditors.  A Special Purpose Vehicle typically has the following characteristics: They are thinly capitalised; They have no independent management or employees; Their administrative functions are performed by a trustee who follows pre-specified rules with regard to the receipt and distribution of cash and there are no other decisions; The assets held by the SPV are serviced via a servicing agreement. They are structured so that they cannot become bankrupt.  A Working Group setup by the Reserve Bank of India (hereinafter “RBI”) in its report suggested certain features for an ideal SPV  – (a) An SPV must be capable of acquiring, holding and disposing of assets; (b) It would be an entity, which would undertake only the activity of asset securitization and no other activity; (c) An SPV must be bankruptcy remote i.e. the bankruptcy of Originator should not affect the interests of holders of instruments issued by SPV; (d) An SPV must be bankruptcy proof. i.e. it should not be capable of being taken into bankruptcy in the event of any inability to service the securitized paper issued by it. (e) An SPV must have an identity totally distinct from that of its promoters/ sponsors/ constituents/ shareholders. Its creditors cannot obtain satisfaction from them. (f) The investors must have undivided interest in the underlying asset (as distinguished from an interest in the SPV which is a mere conduit). (g) A SPV must be tax neutral i.e. there should be no additional tax liability or double taxation on the transaction on account of the SPV acting as a conduit. (h) A SPV must have the capability of housing multiple securitisation. However, SPV must take precaution to avoid co-mingling of assets of multiple securitisation. In case of transactions involving various kinds of assets, they should restrict the rights of investors to the specific pool. (i) The SPV agreement may not release its employees or trustees from their responsibility for acts of negligence and a wilful misconduct. Thus, the distinctive features of a SPV typically include the fact that such vehicles are utilised for a specific purpose, generally to isolate risk, as the basic principle of structured financings are based on one central, core principle-a defined group of assets can be structurally isolated, and thus serve as the basis of a financing that is independent as a legal matter, from the bankruptcy risks of the former owner of the assets.  SPV’s in the Indian Context In India, an Originator can create a SPV thorough various means, depending on the nature of transaction to be carried out by the SPV. A SPV can be in the form of any of the following legal entities- company, trust, mutual fund, partnership, etc. The instruments issued by a SPV should however, have the following characteristics  – (a) Be capable of being offered to the public or private placement. (b) Permit free or restricted transferability. (c) Permit issuance of pass through or pay through Securities. (d) Represent the amounts invested and the undivided interest or share in the assets (and should not constitute debt of SPV or the Originator). (e) Be capable of being classified as senior / subordinate by differentiation in ranking of security or in receiving payments. (f) May be issued in bearer form or registered in the holder’s name, may or may not be endorsable and may be issued in definitive form or book entry form. The researcher shall restrict the scope of this paper to the study and use of a SPV which is in the form of a Company. A Company, typically a private company, is a familiar form of SPV setup to carry out a particular activity/project. The primary reason for the popularity of this model is the fact that a Company offers flexibility vis-à-vis the nature of securities issued by the SPV. As per the Indian Companies Act, 1956, a private company can be setup with a minimum paid up share capital of Rs. 100,000, with at least two members subscribing to the Memorandum of Association.  The disclosure requirements for a private company are generally lower as compared to a public company.  Such a company may issue shares and debentures backed by the assets that have been transferred to the SPV. In case of a SPV-Company being created for an infrastructure project (for example-construction of a bridge), then the model typically utilized is the BOT model, wherein the assets are transferred to the SPV, the SPV carries out the construction work, operates it for an agreed time period and then transfers it to the government which has the rightful title to the project.  Another form or popular model of SPV is a trust company, wherein a company acts as a trustee. The functioning is similar to the functioning of a company established under the Companies Act. SPV as an Acquisition Vehicle SPV’s are increasingly being utilized as acquisition vehicles by various companies and private equity firms. For example, in a leveraged buyout by a private equity firm, a typical structure is modeled on the following lines. The private equity firm would setup a shell parent and subsidiary company. The shell companies created for the acquisition had no substantial assets of their own but were required to, as per the acquisition agreement, to use a measure of best efforts to complete the transactions contemplated by the agreement. The target company was given assurance as to the availability of finance for the transaction by financial institutions which provided a debt commitment letter.  However, in light of the financial meltdown, a new private equity acquisition structure was created which required the private equity firm to provide a letter of guarantee (generally in non recourse terms) to the target company to pay compensation in the event of the transaction not being completed. In a typical triangular or reverse triangular merger, either a subsidiary or a shell company is created by the acquiring company to take over the target company. The rationale being that post merger, the shell company ceases to exist and only the target company, now a subsidiary of the acquiring company survives the merger. An advantage of this process is that the contracts entered into by the target company, and in many cases the goodwill created by the brand name of the target company survives the acquisition. Conclusion During the course of this paper, the researcher has endeavoured to highlight the concept and the advantages of a SPV. The distinctive features of a SPV typically include the fact that such vehicles are utilised for a specific purpose, generally to isolate risk, as the basic principle of structured financings are based on one central, core principle-a defined group of assets can be structurally isolated, and thus serve as the basis of a financing that is independent as a legal matter, from the bankruptcy risks of the former owner of the assets. SPV’s are increasingly being used for, inter alia, infrastructure projects, as a mode of acquisition vehicle, due to the various advantages that a SPV provides to the Originator. The concept however, came to light for all the wrong reasons as SPV’s were used by Enron executives to hide the debt and clear their balance sheets. Notwithstanding the negative publicity created post Enron, the researcher believes that SPV’s today form an integral part of the M&A landscape in today’s world, and provide a unique and bankruptcy remote way or raising capital.
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