When Trustees Take Title to Trust Assets – Bank Representations and Warranties Revisited
November 19, 2014
Publication| Corporate Trust & Agency Services
Trustees are increasingly being asked to hold trust assets in their name in securitization and other structured finance transactions in which both New York and Delaware trusts are used. This is a reversal of sorts of a principal advantage introduced in the securitization industry in the late 1980s by the Delaware Statutory Trust Act: the trust as a separate legal entity. A trust that is a separate legal entity can hold title in its own name and thus avoid many of the byzantine and uncertain common law trust rules that govern vesting title in a trustee. This significant advantage, however, is increasingly being lost when sponsors request that a trustee agree to have trust assets titled in the trustee’s name—specifically, a trustee that is a federally chartered banking institution with trust powers.
The most often-cited reason for titling trust assets in a trustee’s name is federal preemption of state licensing requirements. Sponsors believe that they can utilize a trustee’s federal charter to avoid state licensing requirements in each jurisdiction where trust assets are located or where enforcement proceedings may need to be brought. The benefits from a sponsor’s perspective are obvious: eliminating an expensive and costly licensing process allows sponsors to more quickly and cheaply bring their deals to market. From a trustee’s perspective, the approach is not as advantageous.
While the incentive for sponsors to reduce costs and time is understandable, from a trustee’s perspective entering into the chain of title for the assets poses a variety of risks and issues. Many of these risks are well known by trustees: reputational risk, assignee liability concerns, regulatory scrutiny as the title holder, and asset-specific risks (e.g., environmental and consumer protection laws). These potential risks typically receive the most consideration during the deal intake process. However, the intake stage is not the only time to be mindful of the risks and issues that arise in connection with taking title to trust assets. Among other things, during the deal documentation review process, bank officers and counsel should carefully review the requested representations and warranties in the trust agreement1 in light of the decision to vest title in trust assets in the trustee.
It is not unusual for trust agreements to provide broad representations and warranties to the effect that the trustee bank has all necessary licenses and approvals in each of the jurisdictions in which trust assets are located, and the trustee bank has all necessary regulatory and other consents to perform the terms of the trust agreement. Because federally chartered trustees are generally not licensed under state licensing regimes in all 50 states, when assets are in a trustee’s name such broad representations and warranties could be interpreted as the trustee in effect making representations and warranties as to deal licensing and structuring matters, including the applicability of the doctrine of federal preemption (a complex doctrine where there is little definitive guidance in the context of a securitization). Licensing matters and federal preemption are deal structuring items that can depend on facts and circumstances unrelated to a trustee’s business, such as the types of assets being securitized and the jurisdiction in which they are located. These are subjects that trustees are generally not expecting to address in their representations and warranties to deal parties.
To highlight the risks associated with giving such representations and warranties, one only needs to remember that the trustee’s representations and warranties are typically carved out of the indemnification provisions of the trust agreement. Thus, if in a given jurisdiction the courts or other regulatory bodies were to determine that preemption did not shield the trustee bank from being licensed in a particular jurisdiction, an argument might be made that the trustee was liable for such costs and not entitled to indemnification because it was a specific matter that the trustee represented to the other parties. In light of this risk, trustee representations and warranties relating to licensing and consent matters should be limited to those licenses and consents required under federal laws governing the trustee bank’s trust and banking powers (without regard to any state law that may be deemed applicable pursuant such federal laws).
1It is important to distinguish in this regard representations and warranties that the trustee bank makes in its individual capacity in the trust agreement and those made in its capacity as trustee under other agreements. The former are generally about the bank individually and its business, including its authority to act as a trustee. The latter are made in a representative capacity and generally are focused on the trust and are not intended to be representations that impose individual liability on the bank.