The Whole Truth

Whole company securitization is helping non-investment-grade companies raise capital and recognize intangible assets on their balance sheets, but can it overcome its checkered past?

Apparel maker Guess Inc. completed a $75 million royalty deal of its own in January 2003. The company moved the Guess trademark to a shell called IP Holder LP. which then issued bonds backed by the royalty license fees it collects from 14 accessory manufacturers that use the trademark on handbags, belts, shoes, jewelry, and the like.

Before the deal was completed, Standard and Poor’s analyzed the impact of a hypothetical bankruptcy of the parent company, Guess Inc., on the shell company’s cash flow. S&P associate general counsel Sabine Zerarka maintains that since the intellectual-property assets have been transferred to the shell in a “true sale,” not a fraudulent conveyance, the parent’s hypothetical creditors would have no claim on the assets should Guess fall into Chapter 11. Furthermore, because the trademarks and license agreements supporting the WCS represent only 5.4 percent of the parent’s net revenues, the “core assets argument” raised in the Days Inn case would not likely succeed here.

Critics of whole company securitization stress, however, that these complicated transactions have never been tested in bankruptcy court. To be sure, one reason might be that most shell-company trustees quickly settle with bondholders, perhaps to avoid the possibility of losing everything to a parent company’s hungry creditors.

The WCS market will never equal the mammoth asset-backed securities market for trade receivables or residential mortgages, says Moody’s managing director Jay Eisbruck, but he does predict slow, continued growth for the new asset class. For WCS to “take off,” opines Dick Rudder, a securitization attorney with Baker & McKenzie, it would have to become “the focus of the major investment banks.” Rudder believes that the banks would then harness the industry knowledge of their sector groups and marry it with their securitization technology and marketing expertise.

That day may be closer than you might think. Bankers from some of Wall Street’s largest dealmakers cite the $1 billion DreamWorks SKG movie securitization in 2002, and the $750 million Vivendi Universal Entertainment deal in 2003, as proof that more-substantial WCS deals are just around the corner. Other banking sources claim that bulge-bracket firms will bring a few more billion-dollar deals to the market before year’s end.

Marie Leone is a senior editor of CFO.com.

Ghost in the Machine

The $155 million intellectual-property securitization of the Days Inn of America hotel chain — the first whole company securitization in the United States — probably still figures in sleepless nights for potential dealmakers. When the parent company filed for Chapter 11 protection in the late 1980s, the shell company’s independence was put to the test.

Some experts say that the Days Inn deal proved the strength of the shell company’s bankruptcy remoteness. Others claim the deal was a failure. At issue is why the solvent shell, which held the Days Inn trademark, agreed to a voluntary reconsolidation with the insolvent parent — essentially sending the shell company into bankruptcy, too.

Dick Rudder, an attorney with Baker & McKenzie, explains that although the deal’s structure transferred the trademark rights to the shell, the parent needed that asset to reorganize and begin operating again under the Days Inn name. Apparently the bankruptcy remoteness was so ironclad that in the eyes of the bankruptcy court, the reconsolidation of the shell was the only way that the parent would have been able to recover the trademark asset.

What transpired remains puzzling. A trustee of the shell company convinced it to enter Chapter 11 with its parent, and a settlement was quickly reached to offer bondholders 95 cents on the dollar — reportedly to avoid a court battle between the shell and the parent over ownership of the Days Inn trademark. Some observers have pointed out that a court challenge to the WCS could have set a dangerous precedent for all such deals.

Rudder and other experts, however, maintain that this deal was in trouble from the beginning. For one thing, the parent company seemed to have transferred a core asset — since the settlement proved that the trademark was necessary to the parent’s ongoing operation. In fact, some sources reckon that the transfer of the Days Inn trademark was akin to a fraudulent conveyance; the assets should have been clear of all liens of the parent company when they were transferred to the bankruptcy-remote shell.

What’s more, the reconsolidation of the shell and the parent was allowed on the basis of certain facts that are not usually present in a well-structured deal, says Sabine Zerarka, associate general counsel with Standard & Poor’s. She points to the commingling of parent and shell accounts and other operating and financial entanglements. “It was a real failure of the barriers that are usually put in place in securitization,” adds Zerarka.

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