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7 In'tl Fin. L. Rev. 17 (1988)
Defeasance Comes to the French Scene

handle is hein.journals/intfinr7 and id is 163 raw text is: Defeasance comes to the
French scene

Defeasance is the latest US financial technique to arrive in France.
Georges Berlioz, of Berlioz & Co, Paris argues that it should be accepted
in French accounting law as it is in the United States.

Defeasance, initiated by Xerox in a much publi-
cised deal in 1982, is an operation used by companies
to reduce debt on the balance sheets. The debt arising
from the issue of fixed interest bonds is removed from
the balance sheet of the bond issuer on the basis of an
irrevocable transfer to a trust of bonds of risk-free sec-
urities (basically Treasury bonds). The securities are
selected so as to ensure due payment of principal and
interest to the bondholders, who are in most cases not
aware of the transaction. If defeasance is made when
rates are high, low coupon debt can be covered by
more recent high coupon debt and the company will
defease with a paper profit. Companies may defease
even high coupon debt to remove old debt from the
balance sheet. Companies may consider defeasing at
a loss if the structure of the debt does not fit with long
term corporate objectives.
In the United States defeasance has been regulated
after the practice developed. The Financial Accounting
Standards Board (FASB) released in 1983 a final
accounting statement (SFAS 76) and the SEC has
allowed corporations to use defeasance to remove
debt from the balance sheet.
The technique has spread to the Eurobond market.
It has recently been used by Peugeot to remove Fr lbn
from its balance sheets. The COB has taken a favour-
able stand, while the French accounting authorities
for the moment have reserved their position. The
Commission d'Etudes Comptables of the Commis-
sion Nationale des Commissaires aux Comptes consi-
dered that, because of the new legal aspects of the
question, the accounting treatment should be
decided by the Conseil National de la Comp-
tabilit6.
The defeasance technique must be adapted in
France, as French law does not provide for creation of
trusts, but this adaptation can only strengthen the
extent of the transfer of assets and of liabilities, which
are basic to the accounting treatment.
In the US this transfer is made to an irrevocable
trust. French law does not recognise the concept of
trust, therefore a trust could not be created under
French law. Conceivably a trust could be created
under US law or the laws of any country which has
express provisions as to trusts. The use of a foreign
trust is not advisable unless the issue was made out-
side France and in a foreign currency. Although
analogies to trusts can be found in French law and
French courts have often had to pass on the effects of
trusts and in many ways do recognise them, trusts
create problems which do not assist an operation
which is supposed to be risk-free for the bondholders.
The problems are numerous and arise from the dif-
ficulty of characterisation of trusts under the different

applicable French laws. The tax treatment of
dividends paid to French bondholders out of French
securities but routed through a foreign trust can only
entail a risk of taxation if the trust is not treated as a
simple conduit. The exchange control position is
unclear for securities transferred in trust by a French
issuer, with anon resident trustee and French resident
as beneficiaries. But more significantly the recogni-
tion of a trust created to receive French assets for
French beneficiaries with a French settlor is the most
difficult situation for French courts to accept. In this
situation even the Hague Convention on Recognition
of Trustwould notimpose recognition of the trust. The
use of the trust can therefore only make more difficult
the recognition of the transfer of assets, without
improving the position as to the effects of defeasance
on the liability to the shareholders.

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EJ$TEN11ALISTS p1sc5ssEI CrD ... NOW ITS
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Instead of creating a trust the assets could be depo-
sited with a third party, preferably a bank, with
irrevocable instructions to pay the principal and
interest when due. However, such assets could easily
be seized by creditors. The same applies but to alesser
degree in the case of a trust, as the possibility of other
creditors getting at the trust assets cannot be excluded
under US law.
To reduce this risk it is preferable to provide for an
absolute transfer of assets to a third party subject only
to an obligation of payment of the bonds. Under US
law, as stressed by the dissenting members in the 4/3
FASB decision, the setting of assets in trust does not
constitute an indisputable disposition of assets. The
legal situation as to transfer of assets would therefore
be clearer in case of transfer to a corporation with

International Financial Law Review April 1988

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