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entities, security interests, creditors, debt, priorities, securitizations, captive insurance, mutual funds, Article 9, bankruptcy remoteness


What are business entities for? What are security interests for? The prevailing answer in legal scholarship is that both bodies of law exist to partition assets for the benefit of designated creditors. But if both bodies of law partition assets, then what distinguishes them? In fact, these bodies of law appear to be converging as increasing flexibility irons out any differences. Indeed, many legal products, such as securitization vehicles, insurance products known as captive insurance, and mutual funds, employ entities to create distinct asset pools. Moreover, recent legal innovations, such as “protected cells,” which were created to facilitate such products, further blur the boundaries between security interests and entities, suggesting that convergence has already arrived.

This Article identifies and defends a central distinction between business entities and security interest. We argue that while both bodies of law support asset partitioning, they do so with different priority schemes. Security interests construct asset pools subject to fixed priority, meaning that the debtor is unable to pledge the same collateral to new creditors in a way that changes the existing priority scheme. Conversely, entities are associated with floating priority, whereby the debtor retains the freedom to pledge the same assets to other creditors with the same or even higher priority than existing ones.

The distinction is valuable in understanding financial products, such as securitization, captive insurance, and mutual funds. We show that such products are driven by an appetite for assets pools with a fixed priority scheme, and recent legal innovations are primarily designed to meet this need. This distinction is consistent with the intuitive view of entities as managed going concerns and security interests as mere interests in assets. The distinction is also enduring. Despite the apparent convergence of forms, we predict that the distinction we offer will survive legal and technological innovations.

Library of Congress Subject Headings

Asset-backed financing, Debtor and creditor, Corporations--Finance, Corporate governance