Leasing Law
Using a Titling Trust to Syndicate Motor Vehicles Titling Trusts can minimize administrative expense and burden. But they’re not for everyone.
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uccessful syndication of lease transactions involving certificate of title motor vehicles may be impeded by the significant administrative burden and expense of retitling the motor vehicles or changing the lienholder notation on the certificates of title, if the syndication is to occur after the initial titling has been done. Particularly if the transaction involves a fleet of motor vehicles, the sheer number of titles to be handled and the filing fees charged by the state titling agencies can be burdensome. In addition, many states also impose an excise or retitling tax in connection with the transfer of ownership of a motor vehicle that could have a significant impact on the economic benefit of the syndication. It is possible to avoid or minimize the administrative burden and potential expense by using a titling trust. Under this structure, the leasing company/syndicator would create a trust pursuant to a trust agreement, for the
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If the transaction involves a fleet of motor vehicles, the sheer number of titles to be handled and the filing fees charged by the state titling agencies can be burdensome. purpose of holding legal title or being designated as the lienholder on the motor vehicles.
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Types & Approaches There are two types of trusts available for use with this program: (1) a common law trust, and (2) a statutory trust. A number of states have adopted statutory trust provisions, and one of the principal advantages of the statutory trust is that one or more sub-trusts may be created within the umbrella of the master trust and assets may be allocated into those sub-trusts. Assets allocated to a sub-trust are insulated from exposure to liability of creditors of other sub-trusts or of the general trust. 12 Del. C. §3804(a). The sub-trust concept is not available under the common law trust structure. All the assets held in a common law trust are exposed to liability of creditors of the trust. The motor vehicles would be subject to schedules executed pursuant to lease agreements with third-party lessees. Although a titling trust may be used either with a lease creating a security interest or a true or tax-motivated lease with either fair market value or terminal rental adjustment clause (TRAC) end of lease options, the benefits are not as significant with respect to a lease for security and this article assumes that the underlying transaction is a true or tax-motivated lease. The motor vehicles would be acquired directly by the trust and the trust would be shown as the registered owner and/or lienholder on the certificates of title. The trust would maintain possession of the original certificates of title. There are two alternative approaches that could be taken in using the titling trust: (1) the trust would enter into the lease as the lessor, and all motor vehicles would be titled in the name of the trust; or (2) the leasing company would enter into the lease and retain the lessor’s interest under the lease, and the trust would only be designated on the certificate of title (the lease being retained by the leasing company and, upon syndication, assigned by the leasing company to the financial institution purchasing the lease and the motor vehicles together with the beneficial ownership interest in the sub-trust, as described below). Trust as the leasing company and registered owner— Under the first approach, the rights and obligations of the leasing company, as well as ownership of the leased assets, would be held by the trust. The downside of this approach is that the trust is a separate legal entity that must qualify to transact business in each jurisdiction in which any other leasing company would be required to qualify by reason of the laws of the individual state and the scope and extent of the leasing company’s activities in that state. There is an
The lessor may transfer beneficial ownership interest of the individual sub-trusts without re-title the motor vehicles, since the conveyance is only for beneficial ownership interest in certain trust assets, and not legal title ownership of the assets themselves. administrative burden and expense associated with qualification to transact business: the burden and expense of the initial qualification process, and the burden and expense of having to prepare and file annual tax reports and returns for each state in which the trust is qualified. Trust as Registered Owner Only—The second approach, bifurcating the leasing company’s interest as lessor under the lease from the designation of owner on the certificate of title, would avoid the necessity of qualifying the trust to transact business in foreign jurisdictions, since the trust would not itself be serving as the lessor and would not be transacting business in foreign jurisdictions. This assumes, and it would remain to be determined, that the laws of an individual state do not require a foreign entity to qualify to transact business merely by virtue of the ownership in that state of motor vehicles. This is a matter of state law and would have to be determined on a state-bystate basis, but it should be noted that the Revised Model Business Corporation Act’s definition of “doing business” provides that merely owning personal property (without other activities) does not constitute transacting business for purposes of requiring qualification. The Revised Model Business Corporation Act or a substantial portion of the Act has been adopted in at least 29 states. The downside of
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Leasing Law
this second approach is that state taxing authorities may be confused by the bifurcation: if the leasing company is the lessor, the leasing company would file sales/use/rental tax reports and returns, and pay those taxes with respect to the lease and rentals, while the personal property tax reports, returns and taxes would be filed and paid on behalf of the trust (since legal title ownership of the motor vehicles is held by the trust). The advantage of this second approach (avoiding the necessity of qualifying the trust to transact business in foreign jurisdictions) far outweighs the downside of the potential for confusion. Lease of Beneficial Ownership Interest—Note that, under the second approach, the trust holds legal title to the motor vehicles but the leasing company is the lessor of those motor vehicles under the lease. Under this scenario, the leasing company’s interest in the motor vehicles is its
The lessor continues to deal with its lenders and investors as it has in the past, using the same loan and sale/assignment documents with only slight modification to reflect the involvement of the titling trust. beneficial ownership interest pursuant to the trust. As lessor, the leasing company is contractually agreeing with the lessee that the leasing company will cause the trust to permit the use of the motor vehicles by the lessee in accordance with the terms of the lease and, if the end of lease options include a purchase option, that the leasing company will cause the trust to convey to the lessee legal title to the motor vehicles. The bifurcation of ownership interest is, essentially, irrelevant to the lessee. Insurance Endorsement—It should be noted that if the second approach is used, the lessee’s insurance (as required under the lease) would have to insure the interest both of the leasing company as well as the trust. This should not be problematic since there should be no additional expense incurred by the lessee in naming both entities as additional insured for comprehensive liability coverage.
The Mechanics Acquisition of Beneficial Ownership Interest—The leasing company would fund the trust in exchange for the beneficial ownership interest in the trust. Fundings would be made to the extent of the acquisition cost of the motor vehicles to be acquired directly by the trust (including the purchase price and all Federal, state and local taxes that are payable up-front). The leasing company could provide the funds directly or could draw against a warehouse line of credit to fund the acquisition cost of the motor vehicles. An advance to the leasing company under the warehouse line of credit would be made by a warehouse lender into an 12
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Leasing Law
account maintained on behalf of the trust and applied to pay the acquisition cost directly to the vendors and/or taxing authorities on behalf of the trust. The warehouse loan would be secured as described below. General Trust Assets—When motor vehicles are acquired by the trust, they would be held, initially, as general trust assets. The leasing company would be the owner of the beneficial interest in the general trust assets. From time to time, the leasing company would direct the trustee to allocate certain motor vehicles from the general trust assets to one or more sub-trusts, or from a sub-trust back to the general trust assets. Allocation to Sub-Trusts—A separate series of subtrusts would be created for use with each Warehouse Lender, each lender making a permanent loan to be secured by the beneficial ownership interest in the motor vehicles, and each investor. Sub-trusts for Warehouse Lender—When the leasing company arranges for the acquisition by the trust of certain motor vehicles using a warehouse loan, the leasing company would direct the trustee to allocate those motor vehicles from the general trust assets to the sub-trust
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The trustee would also serve as the custodian, holding physical possession of the actual certificates of title for the motor vehicles. created with respect to the applicable warehouse lender. When the sub-trust for the warehouse lender is first created, the leasing company would grant a security interest to the warehouse lender with respect to its beneficial ownership interest in the applicable sub-trust, which security interest would be perfected by the filing of a Uniform Commercial Code financing statement (UCC-1) against the leasing company. As additional motor vehicles are allocated to that particular sub-trust, the leasing company’s beneficial ownership interest in those motor vehicles automatically is subjected to the existing security interest in favor of the applicable warehouse lender. Similarly, as motor vehicles are reallocated out of that sub-trust, the leasing company’s beneficial ownership interest in those motor vehicles no longer is subject to the security interest held by that warehouse lender. No UCC statements of partial release or partial termination need be filed. The trust agreement would require the leasing company to allocate motor vehicles to the subtrust created with respect to the applicable warehouse lender; and would restrict the ability of the leasing company to instruct the trustee to reallocate motor vehicles from the sub-trust created for the warehouse lender without the confirmation of that warehouse lender. When the warehouse loan is paid with respect to certain motor vehicles, the warehouse
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lender would confirm to the trustee (a) payment of the warehouse loan to that extent, and (b) authorization for the trustee to reallocate those motor vehicles. The beneficial ownership interest in the sub-trust created with respect to the warehouse lender would be retained by the leasing company. Sub-trusts for Investors—When the leasing company arranges for the sale of certain motor vehicles and the related leases to an investor, the leasing company would direct the trustee to allocate those motor vehicles from the sub-trust created for the applicable warehouse lender to the sub-trust created for the applicable investor. When the subtrust for the investor is first created, the leasing company conveys the beneficial ownership interest in that sub-trust to the applicable investor. If the trust is appropriately structured, each sub-trust will be treated as a separate grantor trust under the Internal Revenue Code so that after the transfer of beneficial ownership interest has occurred the investor would be treated for income tax purposes as the owner of, and therefore entitled to the Federal tax benefits accruing with respect to, all motor vehicles allocated to its sub-trust. Most states follow the Federal treatment of grantor trusts, so that the investor also would be entitled to the state tax benefits accruing with respect to all motor vehicles allocated to its sub-trust. However, it should be noted that there are a handful or problematic states that do not follow the Federal recognition of the trust as a pass-through entity. An investor may encumber its beneficial ownership interest in its sub-trust by granting a security interest to a third party creditor. Such a security interest would be perfected by the filing of a UCC-1 with respect to the investor’s beneficial ownership interest in that sub-trust and would automatically affect all motor vehicles then held in that sub-trust or thereafter allocated to that sub-trust. Assignment of Related Lease—If the second approach to use of the titling trust mechanism is used, the leasing company would be the lessor under the leases and the right, title, interest and obligations of the leasing company, as lessor, under the leases would not be assigned to the trust. The leasing company would separately assign to the investor the applicable lease and related rents pursuant to the leasing company’s standard assignment documents. Sub-Trusts for Permanent Lenders—The leasing company may arrange for permanent financing with respect to
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Leasing Law
If a lessor handles a large volume of certificate of title motor vehicle transactions, and it frequently syndicates those transactions, it may be worthwhile to explore this alternative mechanism. certain motor vehicles. When the warehouse loan is paid with respect to those motor vehicles, the leasing company may instruct the trustee to reallocate those motor vehicles from the sub-trust created for the warehouse lender to a sub-trust created for the applicable permanent lender. When the sub-trust for the permanent lender is first created, the leasing company would grant a security interest to the permanent lender with respect to its beneficial ownership interest in the applicable sub-trust, which security interest would be perfected by the filing of a UCC-1 against the leasing company. As additional motor vehicles are allocated to that particular sub-trust, the leasing company’s beneficial ownership interest in those motor vehicles automatically is subjected to the existing security interest in favor of the applicable permanent lender. Similarly, as motor vehicles are reallocated out of that sub-trust, the leasing company’s beneficial ownership interest in those motor vehicles no longer is subject to the security interest held by that permanent lender. No UCC statements of partial release or partial termination need be filed. The trust agreement would restrict the ability of the leasing company to instruct the trustee to reallocate motor vehicles from the sub-trust created for the permanent lender without the confirmation of that permanent lender. When the permanent loan is paid with respect to certain motor vehicles, the permanent lender would confirm to the trustee (a) payment of the permanent loan to that extent, and (b) authorization for the trustee to reallocate those motor vehicles. The beneficial ownership interest in the sub-trust created for the permanent lender would be retained by the leasing company. The same mechanism with respect to permanent financing is available to the Investors. Servicing Agreement—In order to minimize the hands16
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on involvement of the trustee, the trust would enter into a servicing agreement with the leasing company, as servicer, under which the servicer would make all payments to the vendor of the motor vehicles on behalf of the trust from the account maintained on behalf of the trust; and would do all billing and collecting (to the extent required) and would perform all administrative responsibility for the motor vehicles (including the initial registration and licensing, and subsequent renewal of registration and licensing). Under the second alternative structure, the related leases would not be held by the trust, so billing and collecting of rents and sales/use/rental tax obligations would be handled separately by the leasing company as the lessor. To the extent applicable, personal property taxes for the motor vehicles and highway and other over-the-road use taxes imposed on the legal title owner of the motor vehicles would be billed, collected and remitted to the taxing authorities by the servicer on behalf of the trust.
The Benefits Minimize Administrative Burden and Expense—The purpose of using the titling trust is to avoid the significant administrative burden and expense typically associated with a post-closing syndication of certificate of title motor vehicles. By using the titling trust structure, the trust is designated as the registered owner on the certificates of title. The initial beneficial owner of the trust assets is the leasing company. The leasing company may transfer the beneficial ownership interest of the individual sub-trusts without having to re-title the motor vehicles, since the conveyance is only for the beneficial ownership interest in certain trust assets, and not the legal title ownership of the trust assets themselves. This should avoid the imposition of any sales or excise tax that the conveyance of title to tangible personal property would otherwise incur, since the conveyance is of intangible property only; i.e., the beneficial ownership interest in certain trust assets. Dealing with Lenders and Investors—The leasing company would continue to deal with its lenders and investors as it has in the past, using the same loan and sale/assignment documents with only slight modification to reflect the involvement of the titling trust. Each investor would have the right to terminate its sub-trust and cause the motor vehicles comprising a portion of the assets of its sub-trust to be re-titled, at its own expense.
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Custodial/Fiduciary Duty of Trustee—The trustee would also serve as the custodian, holding physical possession of the actual certificates of title for the motor vehicles. The trustee is an independent financial institution that owes a fiduciary obligation to the beneficiaries of the master trust and the various sub-trusts. The rights, and limitations on the ability, of the trustee to take actions with respect to the trust assets would be clearly delineated in the trust agreement.
Weigh the Expense In considering whether the use of a titling trust is appropriate for a particular leasing company, one must factor in the costs of creating and maintaining the trust. The trustee’s fees would likely include: an initial fee to establish the master trust; an annual administration fee for the master trust; an initial fee to establish each sub-trust; an
annual administration fee for each sub-trust; a custodian’s initial fee; and a custodian’s annual administration fee (or a per transaction charge). In addition, the trustee would also retain counsel to review and negotiate the terms of the trust agreement, and its counsel’s fees would be borne by the leasing company. To determine whether it would be worthwhile to establish and maintain a titling trust, one must estimate the cost of the administrative burden and expense of retitling or changing the lienholder designation, based on the anticipated volume of transactions, to these known trust expenses. If the leasing company handles a large volume of certificate of title motor vehicle transactions, and it frequently syndicates those transactions, it may well be worthwhile to explore this alternative mechanism. ELT thanks Alan J. Mogol, a principal of Ober, Kaler, Grimes & Shriver, for this month’s column.
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