Potential for Avoidance of Substitutions and Repurchases in Bankruptcy

Abstract

Substitution or repurchase of delinquent contracts from a securitization trust by an insolvent seller-servicer can lead to claims against the trust for avoidance of the substitutions or repurchases as fraudulent or preferential transfers in the event of a later bankruptcy proceeding. This article explores the theoretical underpinnings for avoidance claims and the legal and practical defenses available to a securitization trust to minimize or eliminate liability. The legal causes of action and defenses are examined in the context of the recent DVI Financial Services bankruptcy, where DVI had used its limited cash resources to repurchase delinquent contracts, substitute ?new? contracts for old, and finance obligor prepayments as it slid down the slippery slope to bankruptcy. During the case, the creditors? committee sought to file an action to recover over $130 million of substitutions and repurchases before a global settlement mooted the legal challenge. Using the DVI situation as an example, the article discusses ways to assess the avoidance risk presented by substitutions and repurchases and analyzes the economic disincentives for a trustee to bring the claims in all but most dire economic circumstances.