True sale vs secured loan: who owns the asset when things go wrong

True sale vs secured loan: who owns the asset when things go wrong

When an originator raises money against a pool of loans or receivables, it can do it in one of two ways. It can sell the assets outright to a separate vehicle. That's a true sale. Or it can keep the assets and borrow against them, pledging them as collateral. That's a secured loan.

While the originator is healthy, the two look almost the same. Cash flows the same way. Investors get paid the same way. The difference shows up only if the originator goes bankrupt, which is exactly when it matters most.

True sale

In a true sale, the originator transfers the assets to a special purpose vehicle (SPV) and gets paid for them. The assets are no longer the originator's property. If the originator later goes bankrupt, the assets aren't part of its estate. Its creditors can't touch them, and the bankruptcy court has no power to freeze them.

That's the foundation of bankruptcy remoteness. Investors in the SPV are exposed to the assets, not to the originator.

Secured loan

In a secured loan, the originator keeps the assets and grants the lender a security interest in them. The lender has priority over the assets, but they remain the originator's property.

If the originator goes bankrupt, the assets are part of its estate. In the US, an automatic stay freezes enforcement while the court sorts out the claims. The secured lender will usually recover, because its claim on the collateral ranks first, but recovery can be delayed for months or years, and the court can in some cases use the collateral or its cash flows while the case runs.

Recharacterization risk

Calling a transaction a sale doesn't make it one. A bankruptcy court looks at the substance. If the seller kept too much of the risk or reward, the court can recharacterize the "sale" as a secured loan, pulling the assets back into the estate.

Factors courts weigh include:

• Recourse. Does the buyer have a right to demand payment from the seller if assets underperform? Heavy recourse points to a loan.
• Retained upside. Does the seller keep the surplus once the buyer is repaid?
• Pricing. Was the price fair for the assets, or calculated like interest on a loan?
• Control. Does the seller still control collections and decisions about the assets?
• Intent and treatment. How do the documents, accounts, and tax filings describe it?

Lawyers for the buyer typically issue a true sale opinion explaining why the transfer should be respected as a sale. It's an opinion, not a promise, and it rests on the facts staying as described.

Why it matters

| True sale | Secured loan

Asset owner | SPV | Originator

Originator bankruptcy | Assets outside estate | Assets inside estate, subject to stay

Investor exposure | Primarily to the assets | To assets and originator's insolvency process

Key legal support | True sale opinion | Perfected security interest

Neither structure is automatically better. Secured loans are simpler and cheaper to set up and work well with strong collateral controls (see The security package). True sales offer stronger insulation but need more structuring and more care to hold up.

The practical question for an investor is the same either way: if the originator disappeared tomorrow, how quickly and how fully would I be able to reach the assets? The structure, and how it's been documented, is the answer.