Double the "S". Double the fun.
Just how remote is a "Bankruptcy Remote Entity?"
Submitted by David Larsson on Mon, 06/01/2009 - 08:49
We're about to find out. As Ian Ritter notes today in his Counter Culture blog,
Some of the entities that financed some of the General Growth Properties’ malls want those assets taken out of the REIT’s bankruptcy filing ... Metropolitan Life Insurance, for one, takes issue with the inclusion of White Marsh Mall, in Baltimore.
A closer look at the Reuters article that prompted Ian's note says that
Attorneys for Metropolitan Life Insurance Co (MetLife Inc) (MET.N) and KBC Bank NV, a unit of KBC Groep NV (KBC.BR), wrote in their motion to dismiss entities related to White Marsh Mall in Maryland: "It is clear that the petitions of the White Marsh debtors were not filed with any reorganizational purpose; they were filed solely to obtain leverage and a tactical advantage in any future efforts to extend the maturity of the loan."
General Growth legally created its malls as special purpose entities (SPEs), separate from the parent company. This prevented it from being on the hook for any of the SPEs' obligations.
"In determining to underwrite the loan, MetLife and KBC relied on the separateness and credit worthiness of the borrower and the underlying property, especially because no parent company repayment guaranty was required," attorneys for White Marsh wrote.
The SPEs are governed by independent directors. But some of them, including SPEs related to Fox River Shopping Center in Wisconsin, say that General Growth fired the independent directors minutes before the bankruptcy filing.
This is an important legal development, because the independence of SPEs (such as the entities that own the various General Growth malls) from the companies who established them (such as General Growth) was (is?) a fundamental element of the securitization of real estate mortgages:
Securitizations would not take place without the ability to establish SPEs. Investors do not want to take on any risk associated with the seller. They only are willing to take on a specified degree of risk associated with the specific pool of securitized assets in which they are investing. In other words, SPEs protect investors from the bankruptcy or other adverse credit event affecting the financial institution that establishes and/or sells assets to the SPE. These securitization SPEs are considered “bankruptcy remote” since they are isolated from the financial institution that created and/or sold assets to them, and are precluded from taking on new activities and new financial obligations.
SPEs were (are?) so vital to the commercial real estate mortgage market of the past two decades that many transactions required the issuance of a "non-consolidation" opinion by counsel to the borrower to the effect (as described in an ABA publication) that:
1. upon the insolvency of any of the members ... of the SPE borrower ..., the SPE borrower would not be substantively consolidated with any such member;
2. upon the insolvency of any of the shareholders of the SPE managing member, the SPE managing member would not be substantively consolidated with any such shareholder; and
3. upon the insolvency of the property manager (in the event that the property is managed by an affiliated property manager), the SPE borrower would not be sustantively consolidated with the property manager.
As there is no specific statutory guidance related to substantive consolidation, the related case law has developed on a case-by-case basis.
Looks like we're about to have another big case: in fact, the ABA will hold a teleconference and live audio webcast on Wednesday, June 3, 2009, entitled "Consolidation of SPEs in Bankruptcy After General Growth: Is Bankruptcy Remote Status Achievable?" From the course description:
On May 14, 2009, the United States Bankruptcy Court for the Southern District of New York issued an opinion allowing a parent company, General Growth Properties, Inc., in bankruptcy to use the cash from its subsidiaries owning over 160 malls in the parent's bankruptcy, despite the existence in the subsidiaries' organizational and loan documents of separateness and special purpose entity provisions customary in loans securing commercial mortgage-backed securities (CMBS). This decision raises important questions:
- What effect does this decision have on the concepts of separateness and isolation of assets in loans?
- Is the decision limited to the facts of this case or does it have negative implications for CMBS and other loans?
- Is this decision out of the mainstream of bankruptcy law?
- What effect does this decision have on non-consolidation opinions and other opinions rendered in the CMBS context?
- Should lenders' attorneys representing other lenders modify their loan documents to try to avoid a similar result?
- Should organizational documents of special purpose entity borrowers be modified to avoid certain matters that occurred in this case?
General Growth's bankruptcy filing is therefore going to provide us all with a major test as to just how bankruptcy-remote these "bankruptcy remote entities" really are.
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