Articles

Repurchase Agreement or Lien Backed Loan

Doron Afik, Esq.
September 14, 2016
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A lender suspects that the collateral offered by the borrower (e.g. a real property or a public company shares) will be difficult to realize. Can one structure a sale transaction with a right of seller to repurchase the asset in the future subject to payment of penalty similar to the agreed interest?

Israeli Courts held that the Israeli Pledge Law will apply to any transaction which is essentially a pledge, regardless of how it was named by the parties. Thus, unless one can show an economic logic to the structure of the transaction created by the parties the Pledge Law will apply even if the parties tried to characterize the transaction as a sale. Application of the Pledge Law is most important for rights of the parties for several reasons. Thus, for example, a pledge will be valid against third parties or in case of bankruptcy unless duly recorded and realization of a pledge is subject to the procedures of the law and the law limits the ability of the parties to contract out of such procedures.

But what about repurchase transactions (or ‘repo’s)? A repo is a transaction underwhich a seller sells a property but reserves the right to repurchase the property at a certain time and subject to payment of a premium. Economically not much of a difference exists between a repo and a security backed loan. However, the Israeli Supreme Court held that, subject to the existence of an economical-business logic a repo transaction will not be considered a loan with a pledge.

At the first stage the Court examines the language of the contract and the circumstances of its execution. For example, have the parties used terms such as ‘seller’ and ‘purchaser’ or ‘borrower’ and ‘seller,’ what is the procedure for realization of the repurchase right, the value of the asset compared to the consideration, etc. At the second stage the Court examines the economic-business logic of the transaction and construes whether the parties intended for a loan with a pledge or a sale with an option to repurchase. For example, in the case where there are significant gaps between the borrower and the lender and the lender dictates a repurchase transaction rather than a loan it is easier for the Court to deduce that the actual intent was a loan with a pledge. By contrast, there is an economical-business logic when the purchaser is one who commonly engages in the purchase of assets and no in loans and insists on a sale agreement however is still prepared (because the seller requires funds but does not wish to sell the property) to grant the seller the right to buy back the property with a fine - even if a substantial fine.

It is important to note that the structure of the agreement is material for the rights of the parties. Thus, it is very important to consult with an attorney specializing in the field before execution of the agreement. However, ultimately, in many cases this agreement will be reviewed by a Court of liquidation or bankruptcy of the borrower/seller, and therefore even the best deal is not bulletproof and is not immune from a Court decision, even if it is wrong. In view of the fact that an appeal on bankruptcy proceedings will likely be heard by the Supreme Court only after many months (and by that time will no longer be relevant and therefore it does not make sense to throw good money at bad money already spent) decisions of the liquidation Courts are sometimes wrong but nevertheless not examined by an appellate Court.