True sale: Overview, definition, and example
What is a true sale?
A true sale is a legal and financial concept that determines whether an asset transfer is a genuine sale or merely a financing arrangement. In a true sale, the seller fully relinquishes ownership and control of the asset, meaning it is no longer part of their balance sheet. This distinction is critical in securitization and asset-backed financing, ensuring that transferred assets are legally separate from the seller’s liabilities.
For example, if a company sells its accounts receivable to a third party, a true sale ensures that the buyer assumes full ownership and the seller cannot reclaim the assets later.
Why is a true sale important?
A true sale is essential in financial transactions because it protects buyers from a seller’s potential bankruptcy or financial troubles. If a transaction is not classified as a true sale, creditors may argue that the assets still belong to the seller and should be included in their bankruptcy estate.
For businesses, ensuring a transaction qualifies as a true sale provides certainty in securitization deals, helps manage financial risk, and enables companies to free up cash flow by selling assets without retaining liability.
Understanding a true sale through an example
Imagine a company sells its portfolio of unpaid invoices (accounts receivable) to a financial institution to improve cash flow. If the sale is structured as a true sale, the financial institution fully owns the receivables, and the company has no right to reclaim them. This means if the company goes bankrupt, its creditors cannot seize those receivables because they no longer belong to the company.
In another example, a bank sells a pool of mortgages to investors through securitization. A true sale ensures that the mortgages are legally transferred, preventing the bank’s creditors from claiming them if the bank encounters financial difficulties.
An example of a true sale clause
Here’s how a clause like this might appear in a contract:
“The Parties acknowledge and agree that the transfer of assets under this Agreement constitutes a true sale, with the Seller relinquishing all ownership, control, and rights to the transferred assets. The Buyer shall have full legal and beneficial ownership, and the assets shall not be considered part of the Seller’s estate in the event of bankruptcy or insolvency.”
Conclusion
A true sale ensures that an asset transfer is legally recognized as a sale rather than a financing arrangement, protecting buyers from the seller’s financial risks. This distinction is crucial in securitization, asset-backed financing, and bankruptcy protection, allowing businesses to manage financial transactions with greater security and clarity.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.