Connecticut Statutory Trust beats Delaware for efficiencies
Joseph Capozzi, State Street--Corporate Trust (January 1, 2002)
Gone are the days when the only statutory business trust available for special purpose vehicle financing required that at least one trustee reside in Delaware or have a principal place of business there. Since 1997, trustees acting on behalf of lenders or equity sources have been doing deals utilizing the Connecticut Statutory Trust, which imposes no such residency requirement. That advantage is one of several that make this trust an attractive alternative to its well-known predecessor.
General benefits of the modern business trust
In 1988 Delaware became the first state to offer corporations a "special purpose" trust vehicle for leveraged and synthetic leasing transactions, trust preferred (or capital) securities, and mortgage- and asset-backed securities. This codification of common law trust principles gave parties engaged in corporate financing a higher degree of predictability that courts would enforce the terms of financing agreements.
The Delaware model soon became the business trust of choice with investors gaining a new measure of security against debtors. Whereas previous determinations of applicable common law had entailed interpretation and identification of common principles in court decisions and academic treatises that varied from state to state, the new business trust gave clear guidance regarding its formation and operation. It was also flexible enough so that terms of a trust agreement could be tailored to satisfy tax, accounting and other concerns.
Other key advantages of the modern business trust include:
- The rejection of the subjective "control test" that imposes personal liability on beneficial owners who exert control over the trustees or the management of the trust. The personal liability of beneficial owners is limited as if they were shareholders in a corporation.
- The allowance that beneficial owners may participate in trust management without being deemed a trustee or losing the limited liability conferred upon beneficial owners.
- Limited trustee liability for actions taken while acting as a trustee. Standards of trustee culpability established under common law are codified; however, the trust agreement may limit or expand the nature of a trustee's fiduciary duty to beneficial owners, as parties deem appropriate.
- The lack of personal liability, other than to the trust or beneficial owners, of parties delegated by trustees to manage trust business and affairs for actions taken in that delegated role.
- The protection of trust property, such that creditor claims against beneficial owners are limited to the extent of the beneficial owners' interests in the trust assets.The notion that statutory business trusts are considered separate legal entities that can sue or be sued for debts, obligations and liabilities incurred by trustees or their agents on behalf of the trust.
Connecticut rivals Delaware
Following Delaware's lead, Connecticut (as well as Wyoming) enacted similar business trust legislation. The passage of Connecticut's Statutory Trust Act in 1997 amounted to direct competition for Delaware banks. Offering many of the same benefits, Connecticut's alternative has a few advantages:
- The non-residency requirement for trustees allows the selection of trustees to be made on the basis of expertise rather than location.
- Connecticut stipulates the limited liability of its business trusts by requiring the usage of "Limited", "Statutory Trust" and similar designations in the name of each trust. Such limited liability identification is not required in Delaware.
- Connecticut's use of "statutory trust" as opposed to Delaware's "business trust" terminology may help to distinguish further the modern statutory trusts from common law trusts.
- The distinction between "statutory trust" and "business trust" may also support arguments that a particular trust should not be eligible for bankruptcy protection under the United States Bankruptcy Code ("Bankruptcy Code") (i) and may be a useful distinction for tax and other purposes. A "business trust" is eligible to be a debtor under the Bankruptcy Code. (ii) Whether a particular trust is a business trust as contemplated by the Bankruptcy Code is determined on a case-by-case basis. Courts are divided as to the proper factors to apply in this analysis.
Statutory trusts' broad utility
The uses of the Connecticut statutory trust are many and varied. It can be used to establish a "capital trust," a special purpose vehicle formed to issue preferred securities, the proceeds of which are used in a simultaneous transaction to acquire debt securities. These are usually subordinated to other obligations of the trust's sponsor. The trust preferred securities and the debt obligations generally have identical payment provisions that allow the capital trust to be a "pass through" to the investor. Along with providing an equity security to investors, the issuer gains the advantage of achieving debt treatment of payments. For certain regulated issuers such as bank holding companies, an additional benefit is the favorable Tier One capital treatment afforded the debt on the books of the issuer.
For leveraged and synthetic leasing deals, a Connecticut statutory trust is created to act as the ownership entity of the property or equipment being leased. The beneficiaries of the trust are the equity investors in the leased equipment. The trust borrows the remaining cost and acts as the lessor for the equipment.
With regard to asset-backed securities, the same concept applies. Technically, there is no issuer. The trust is formed for the purpose of acquiring a portfolio of pooled mortgages, pooled credit card accounts receivable, auto loans or other receivables that generate cash flows. The trust then borrows against that portfolio and the bond holders/lenders depend on the borrowers making their payments, rather than an automobile manufacturer's credit company or a household's mortgage company, for example. The trustee is responsible for the administration of the trust agreement. This can include analyzing cash flows for pre-payments, shortfalls, etc., and directing cash to the appropriate certificate class.
The modern business trust, or statutory trust, represents a significant step in the evolution of trusts as special purpose vehicles for commercial financings. State Street provides the expertise to successfully establish and administer these complex financial arrangements.
Joseph C. Capozzi is director of sales and marketing for State Street corporate trust services. The author acknowledges the research of Robert M. Borden, Partner, and Richard Rochlin of Bingham Dana LLP in the preparation of this article.
(i) See 11 U.S.C. õ 109(a) (1994), defining entities eligible for bankruptcy protection.
(ii)Pursuant to Bankruptcy Code õ 109(a) (11 U.S.C. õ 109(a)) only a "person" that resides or has a domicile, place of business in the United States may be a debtor. "Person" is defined as an individual, partnership and corporation. The definition of person, however, does not include a trust. A corporation is defined in the Bankruptcy Code as including a business trust. See 11 U.S.C. õ 101(9)(A)(v) (1994).