The US Structured Finance Association (the “SFA”), the securitization industry group, has filed an amicus brief in support of a challenge and objection to the Motion for Order Rejecting Certain Unexpired Vehicle Leases Effective Nunc Pro Tunc to June 11, 2020 Pursuant to Sections 105 and 365(A) of the Bankruptcy Code (the “Motion”) filed by The Hertz Corporation (“Hertz”) in the US Bankruptcy Court in Delaware (the “Court”).
Hertz’s operations are financed in part through an asset backed security (“ABS”) securitization whereby it leases vehicles from a special purpose entity pursuant to the terms of a single master lease agreement. All vehicles leased to Hertz under this arrangement are subject to the terms of the master lease agreement and serve as collateral to secure the lease payments owed from Hertz to the special purpose entity.
Hertz argues in the Motion that certain vehicles under the master lease agreement should be rejected from its fleet and severed from the master lease agreement to eliminate expenses that are unprofitable and no longer beneficial to it. Hertz further argues that the rejection of this subset of vehicles into separate and individual lease contracts is appropriate to avoid unnecessary administrative expenses which would otherwise be unfavorable to its stakeholders.
The SFA counters that permitting Hertz to reject a portion of its vehicles would be in conflict with both the contractual terms and intent of the master lease agreement arrangement. The SFA contends that the master lease agreement and the investment risk analysis thereof are each dependent upon the inclusion of all vehicles in the Hertz fleet as collateral to secure the lease payments owed under the master lease agreement. The SFA believes that a ruling in favor of Hertz could: (i) undermine the general ABS market risk assessment understanding that the master lease agreement is a unitary document not divisible in bankruptcy into individual leases and (ii) require rating agencies to reconsider risk levels associated with similar ABS structures throughout the marketplace.
If the Hertz Motion is accepted by the Court, investors could face new risks to consider when deciding whether to participate in the more than $25 billion rental car ABS industry, or in ABS deals for other asset classes dependent upon asset leasing arrangements. If the Court determines that the master lease agreement is in fact divisible and credit agencies are required to reassess risk levels in similar transactions based on a new concept that each underlying asset is subject to its own lease agreement instead of a single overarching master lease agreement, there may be widespread credit rating downgrades that make obtaining financing in comparable ABS arrangements more expensive and less favorable for borrowers.