An Overview of the Delaware Statutory Trust Act in Structured Finance Transactions
While Delaware is nationally known as the preferred jurisdiction for corporations, it is likewise recognized as a leader in the area of statutory trusts. The State of Delaware, in 1988, adopted the Delaware Business Trust Act, the name of which was changed to the Delaware Statutory Trust Act (the “DST Act”) in 2002. The enactment of this legislation operated to increase the utility of the trust in structured finance transactions by overruling those principles of common law trusts which were deemed disadvantageous and by including certain new provisions to statutorily authorize a high degree of freedom of contract between the trustor and the trustee in determining their respective liabilities and the manner in which the trust (called a “statutory trust” under the DST Act; hereinafter referred to as a “DST”) could be administered.
Although a number of states have adopted statutes recognizing business trusts, Delaware was the first state to adopt a completely new statutory trust entity which was designed from the ground up as a perfect structured finance special purpose entity. In the decades since Delaware adopted the DST Act, numerous other states have each enacted their own versions of the DST Act. The Delaware version, however, has continued to evolve over the ensuing years and remains several steps ahead of the others.
DELAWARE STATUTORY TRUSTS IN STRUCTURED FINANCE TRANSACTIONS
Whether you are arranging an asset-backed financing, an equipment leasing transaction, or trying to establish a titling trust, the entity that holds the assets being financed is the linchpin of all structured finance transactions. The DST has emerged as the preferred entity in such transactions for a variety of reasons.
A DST is easy to form and maintain.
A DST is formed by filing a certificate of trust with the Office of the Secretary of State of the State of Delaware. This certificate states only the name of the trust and the name and address of the Delaware trustee. There is no requirement that the identity of the beneficial owners of the trust or the provisions of the trust agreement be publicly disclosed, thus protecting the privacy of the parties to the transaction. The DST Act does require that the trust have a Delaware resident trustee, but business decisions and management of the trust may be (and in the context of a structured finance transaction, typically are) delegated to out of state co-trustees and managers. Moreover, the State of Delaware does not impose any annual fees or filing requirements on DST’s; there is a low one-time filing fee for formation of the trust, due to the State upon the filing of the certificate of trust.
The DST offers protection to its trustees, managers and beneficial owners. Under the DST Act, beneficial owners of a DST are entitled to the same liability protections that Delaware law provides to stockholders of a Delaware corporation. Further, trustees (whether they are physically located within Delaware or not) and other managers of the DST are not personally liable to third parties for acts, omissions or obligations of the DST.
The express policy of the DST Act is to give maximum effect to the principle of freedom of contract and to the enforceability of trust agreements. This policy of freedom of contract means the parties are able to agree as between themselves with respect to matters such as management and economic rights of owners, duties and rights of managers, indemnification, mergers and other mixed entity reorganizations and other management and operational issues. Fiduciary duties to the beneficial owners or the statutory trust and related liabilities may be expanded, restricted or eliminated in the trust agreement; provided only that the trust agreement may not eliminate the implied contractual covenant of good faith and fair dealing.
Flexible Tax Treatment.
A DST may be structured as a corporation, a partnership or a trust for federal and Delaware income tax purposes. A DST can qualify as a FASIT (financial asset securitization investment trust), a REMIC (real estate mortgage investment conduit), a REIT (real estate investment trust) or a RIC (registered investment company).
Bankruptcy Remote Characteristics.
A DST is a legal entity separate and distinct from its owners and managers, and this separateness lessens the likelihood that a bankruptcy court will consolidate the assets and liabilities of the DST with those of the trustor.
No creditor of a beneficial owner of the DST has any right to obtain possession of or exercise any legal or equitable remedies with respect to the property of the DST, and a beneficial owner generally has no interest in specific property of the DST.
A DST may not be terminated or revoked by a beneficial owner or other person except in accordance with the terms of its trust agreement. A DST has perpetual existence and will not be terminated or dissolved by the dissolution, termination or bankruptcy of a beneficial owner unless the terms of the trust agreement provide otherwise.
The contractual flexibility provided by the DST Act allows parties to restrict the ability of the DST to voluntarily commence bankruptcy proceedings through the designation of an “independent trustee”. This “independent trustee” may agree in the trust agreement to be responsible for making the determination to seek bankruptcy protection, and any fiduciary duties the independent trustee might otherwise owe to the beneficial owner can be contractually limited. Additionally, in appropriate circumstances, the power and authority of a DST may be limited (e.g., by limiting such power and authority to the preservation of the assets of the DST) so as to render the DST ineligible to file as a debtor under the U.S. Bankruptcy Code.
Sophisticated Dispute Resolution.
The Delaware Court of Chancery has jurisdiction over trust and fiduciary matters and is generally regarded as the preeminent business court in the United States. Furthermore, the Delaware Court of Chancery offers parties to sophisticated business transactions the opportunity to mediate or arbitrate their disputes, provided that their trust agreement contains certain required language.
COMMON USES OF DELAWARE STATUTORY TRUSTS
Asset Securitizations – the DST issues debt/equity securities backed by trust assets, the primary advantage of which can be to protect DST assets from creditors of the originator of such assets and creditors of the beneficial owners of the DST.
- municipal tax liens (i.e. NYC; DC)
- residential mortgages (CMOs and REMICs)
- real estate investment trusts (REITs)
- commercial mortgage loans
- financial asset securitization investment trusts (FASITs)
- collateralized bond obligations (CBOs)
- receivables (credit card, trade, installment sale, healthcare, etc.)
- automobile leases/loans
- corporate bonds and notes
- royalty interest trusts (oil/natural gas properties)
Leveraged Leasing and Equipment/Collateral Trusts – the DST provides limited liability for equity investors, protects lessee and debt investors against risk of equity investor’s bankruptcy, and can significantly reduce the risk that the DST will become a debtor in bankruptcy.
Like Kind Exchanges Under Section 1031 of the Internal Revenue Code – DSTs are frequently used to hold “replacement property” in like kind exchange transactions structured to comply with Revenue Ruling 2004-86.
Structured/Synthetic Securities – the DST acquires and holds the security/asset to be repackaged, enters into a swap transaction to exchange cash flows with the swap counterparty, and issues to investor new debt and/or equity securities having the desired investment characteristics (based on cash flows received from swap counterparty).
Synthetic Leases – the DST’s flexibility and bankruptcy-remote features, and the limited liability of DST beneficial owners, makes the DST a good choice to serve as borrower/owner/lessor in tax retention operating lease (TROL) transactions.
Registered Investment Companies – the DST’s flexibility is key advantage.
- there exists no limit on number of beneficial owners/interests;
- the DST can be authorized to redeem or issue additional beneficial interests without the consent of beneficial owners and without amending a public document or filing;
- inter-series liabilities can be limited to property of the series; and
- no annual meetings are required.
Insulation Of Trust Assets From Attachment
- 10 Del. C. §3502(b) (“Section 3502”) provides that banks and trust companies are not subject to the legal remedy of attachment, therefore money and other assets in the custody and control of a bank or trust company are exempt from seizure by attachment
- Case law has extended the protection of Section 3502 to equitable remedies sought by creditors (“[P]roperty, which is exempt from levy and sale under legal process . . . cannot be reached by a creditor’s bill.”)
- Therefore, a beneficial owner’s interest in a DST is protected from all judgment creditors of such beneficial owner so long as the trust assets are held in Delaware by a bank or trust company.