A Live 90-Minute Teleconference/Webinar with Interactive Q&A

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1 presents Real Estate Bankruptcies: The Impact of In re General Growth Strategies for Real Estate Companies, Lenders and Investors Dealing With Special Purpose Entities A Live 90-Minute Teleconference/Webinar with Interactive Q&A Today's panel features: Harold Bordwin, Managing Director & Group Head, KPMG Corporate Finance, New York Michael E. Foreman, Of Counsel, Haynes & Boone, New York Lorraine S. McGowen, Partner, Orrick Herrington & Sutcliffe, New York Wednesday, November 4, 2009 The conference begins at: 1 pm Eastern 12 pm Central 11 am Mountain 10 am Pacific Please refer to the dial-in/log-in instructions ed to registrants to access the audio portion of the conference. CLICK ON EACH FILE IN THE LEFT HAND COLUMN TO SEE INDIVIDUAL PRESENTATIONS. If no column is present: click Bookmarks or Pages on the left side of the window. If no icons are present: Click View, select Navigational Panels, and chose either Bookmarks or Pages. If you need assistance or to register for the audio portion, please call Strafford customer service at ext. 10

2 For CLE purposes, please let us know how many people are listening at your location by closing the notification box, clicking the chat button in the upper right corner, and typing in the chat box your company name and the number of attendees. Then click send.

3 Real Estate Bankruptcies: The Impact of In re General Growth, Strategies for Real Estate Companies, Lenders and Investors Dealing With Special Purpose Entities November 4, 2009 KPMG Corporate Finance LLC

4 Economic Overview

5 Overview The U.S. Economy Dow Jones Industrial Average Source: Wall Street Journal Online 2009 KPMG Corporate Finance LLC, a U.S. limited liability company, is a member of FINRA and is registered as a broker dealer with the SEC. KPMG Corporate Finance LLC is a subsidiary of KPMG LLP, a UK limited liability partnership and the UK member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. 2

6 Economic Outlook World Bank Report forecasting real GDP decline 2.9% by end of 2009 and world trade to fall nearly 10% March 2009 outlook estimated a decline of 1.7% in real GDP China real GDP grew 7.7% in first nine months of 2009, expected to surpass growth targets of 8% by end of year U.S. Unemployment September %: Since the start of the recession in December 2007, the number of unemployed persons has increased by 7.6 million to 15.1 million, and the unemployment rate has doubled - Highest on records dating to % of total population employed: Lowest since the early 1980 s Initial and Continued Unemployment Claims ---- Continued Claims ---- Initial Claims (4 weeks moving avg) Source: American Bankruptcy Institute Recovery? U.S. real GDP grew by 2.5% in the third quarter 2009; first rise in real GDP since second quarter 2008 World Bank Report predicts positive GDP growth in 2010 of 2.0% While the global economy is likely to begin expanding again in the second half of 2009, the recovery is expected to be subdued as global demand remains depressed, unemployment remains high, and recession-like conditions continue until Hans Timmer, Director of World Bank s Prospectus Group Source: World Bank Report 2009 KPMG Corporate Finance LLC, a U.S. limited liability company, is a member of FINRA and is registered as a broker dealer with the SEC. KPMG Corporate Finance LLC is a subsidiary of KPMG LLP, a UK limited liability partnership and the UK member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. 3

7 Corporate Bankruptcies $1,116.5 Billion Total Assets ($Billions) $800 $400 Total Assets of Large U.S. Public Companies Filing for Bankruptcy in Billions of Dollars* * Large companies defined as those with greater than $100 million in assets Lehman Brothers and Washington Mutual Assets Z $0 '80 '81 '82 '83 '84 '85 '86 '87 '88 '89 '90 '91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 Year Source: Bankruptcy Research Database 2009 Notable Bankruptcies: General Motors Corp. - $91.1 billion General Growth Properties $29.6 billion CIT Group Inc. - $71 billion Colonial BancGroup, Inc. - $25.8 billion Chrysler $39.3 billion Thornburg Mortgage, Inc. - $36.5 billion Guaranty Financial Group Inc. - $16.8 billion 2008 Notable Bankruptcies: Lehman Brothers Holdings Inc. - $ billion Washington Mutual Inc. - $ billion 2009 KPMG Corporate Finance LLC, a U.S. limited liability company, is a member of FINRA and is registered as a broker dealer with the SEC. KPMG Corporate Finance LLC is a subsidiary of KPMG LLP, a UK limited liability partnership and the UK member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. 4

8 Commercial Real Estate Overview

9 Overview Real Estate Moody s estimates that commercial property values are down 40.6% since mid-2007 peak According to Reuters, YTD U.S. transaction volume through September was $29 billion; 75% lower than same period 2008 Increased rates, tougher underwriting, higher equity requirements make all borrowing difficult CMBS issuance in the U.S. remains nearly comatose with no new issues from July 2008-May 2009 or in August 2009 In June and July 2009, the CMBS market showed signs of life with new issues of a meager $600 million and $300 million Players with long-term debt, minimal leverage will survive; those who closed at the top of the market with heavy debt may not 75% of countries monitored by Royal Institute of Chartered Surveyors have seen a rise in distressed sales in the commercial property market Survival the order of the day Dealmaking replaced by asset management, leasing and workouts Tenant retention, locking in cash flow become major priorities 2009 KPMG Corporate Finance LLC, a U.S. limited liability company, is a member of FINRA and is registered as a broker dealer with the SEC. KPMG Corporate Finance LLC is a subsidiary of KPMG LLP, a UK limited liability partnership and the UK member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. 6

10 CRE Trends / Vacancy-Occupancy Rates Vacancy Rates By Building Type Retail Vacancy Rates By Class Office Hotel Occupancy Rate, Year-Over-Year Change 2009 KPMG Corporate Finance LLC, a U.S. limited liability company, is a member of FINRA and is registered as a broker dealer with the SEC. KPMG Corporate Finance LLC is a subsidiary of KPMG LLP, a UK limited liability partnership and the UK member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. Source: American Bankruptcy Institute 7

11 CRE Trends / Rental Rates Historical Rental Rates Retail (Based on NNN Rental Rates) Historical Rental Rates Office (Based on Full-Service Equivalent Rental Rates) 2009 KPMG Corporate Finance LLC, a U.S. limited liability company, is a member of FINRA and is registered as a broker dealer with the SEC. KPMG Corporate Finance LLC is a subsidiary of KPMG LLP, a UK limited liability partnership and the UK member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. 8

12 One Class Of Property Owners Has Rebounded: REITs REITs posted 33% return in third quarter 2009, biggest gain since index opened in 1989 Source: Wall Street Journal REITs trading at 24% average premium to net asset value because REIT Prices have risen and commercial RE values have fallen so sharply Source: Wall Street Journal REITs up 90% since March lows but still off 35% from 2008 Source: Wall Street Journal 2009 KPMG Corporate Finance LLC, a U.S. limited liability company, is a member of FINRA and is registered as a broker dealer with the SEC. KPMG Corporate Finance LLC is a subsidiary of KPMG LLP, a UK limited liability partnership and the UK member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. 9

13 What s Next for REITs Going Forward Will the Federal Reserve s Term Asset Backed Loan Facility (TALF) help REITs and other CRE owners? Potential first TALF deal is Developers Diversified Realty Corp. loan from Goldman Sachs of $400 million Bank of America is trying to use TALF in its $650 financing portfolio controlled by Fortress Investment GE Capital Real Estate Debt Fund is using TALF qualifying underwriting standards on capital raise of $3 billion in private funding Will REITs be successful with U.S. Treasury's Public-Private Investment Program (PPIP)? Government can contribute $2 for every $1 of private investment in PPIP-qualified loans First PPIP-eligible fund, Invesco Mortgage Capital, hoped to raise $500 million but only attracted $200 million. Will REITs continue to look for Joint Venture opportunities? In October, shopping center REIT Weingarten Realty Investors teamed up with German fund manager Jamestown to close out debt on six shopping centers. Weingarten has reduced debt maturities through 2011 by $1 billion Also in October, RioCan Reit acquired an 80% stake in Cedar Shopping Centers for $181 million. Using proceeds to write down debt balance, Cedar was able to secure more than $220 million commitment in renewal of its secured revolving credit facility Source: Kiplinger s Personal Finance 2009 KPMG Corporate Finance LLC, a U.S. limited liability company, is a member of FINRA and is registered as a broker dealer with the SEC. KPMG Corporate Finance LLC is a subsidiary of KPMG LLP, a UK limited liability partnership and the UK member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. 10

14 Real Estate Capital Markets

15 Commercial RE Debt Maturities- Lenders Banks Over $300 billion coming due in 2010 and 2011 combined Approximately 74% of all loans held by smaller banks (under $1 billion assets) secured by commercial RE; these banks make up 90% of all US banks CMBS $153 billion in loans coming due by 2012 According to Deutsche Bank, estimated $100 billion will face difficulty refinancing Source: Wall Street Journal Mounting foreclosures in the CMBS sector would likely depress values even further as property is dumped on the market. And this would put pressure on banks to write down loans -WSJ 2009 KPMG Corporate Finance LLC, a U.S. limited liability company, is a member of FINRA and is registered as a broker dealer with the SEC. KPMG Corporate Finance LLC is a subsidiary of KPMG LLP, a UK limited liability partnership and the UK member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. 12

16 Debt Maturities Facing REITs 50 Largest REITs $28.5 billion coming due in 2009 $61.3 billion coming due by the end of 2010 $48.0 billion of maturities in 2011, and $38.6 billion in 2012 Source: istockanalyst 2009 KPMG Corporate Finance LLC, a U.S. limited liability company, is a member of FINRA and is registered as a broker dealer with the SEC. KPMG Corporate Finance LLC is a subsidiary of KPMG LLP, a UK limited liability partnership and the UK member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. 13

17 Banks in Deep Banks hold $1.7 trillion of commercial mortgages and construction loans Banks with heavy exposure to risky loans set aside just 38 cents in reserve during 2Q 2009 for every $1 in bad loans; down from $1.58 for every $1 in bad loans at start of 2009 What is happening? Extending troubled loans instead of making struggling developers pay them off now Banks are essentially paying themselves interest from interest reserves that were built into the loans Federal Bank regulators issued new guidelines allowing banks to keep loans on their books as performing even if the value of the underlying properties have fallen below the loan amount New guidelines were designed to limit foreclosures, and encourage banks to restructure problem commercial mortgages with borrowers Source: Wall Street Journal The Agencies recognize that lenders and borrowers face challenging credit conditions due to the economic downturn, and are frequently dealing with diminished cash flows and depreciating collateral values. Prudent loan workouts are often in the best interest of financial institutions and borrowers, particularly during difficult economic circumstances and constrained credit availability. Sheila Bair, FDIC Chairman Source:CoStar Group 2009 KPMG Corporate Finance LLC, a U.S. limited liability company, is a member of FINRA and is registered as a broker dealer with the SEC. KPMG Corporate Finance LLC is a subsidiary of KPMG LLP, a UK limited liability partnership and the UK member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. 14

18 FDIC FDIC has closed on 106 banks in 2009 as of October 26, 2009 FDIC Deposit Insurance Fund, Assets and Estimated Costs Quarterly DIF Assets Cumulative DIF Costs FDIC has flagged another 416 with total assets of $300 billion as at-risk Number of FDIC-Insured Problem Institutions Source: American Bankruptcy Institute Source: American Bankruptcy Institute 2009 KPMG Corporate Finance LLC, a U.S. limited liability company, is a member of FINRA and is registered as a broker dealer with the SEC. KPMG Corporate Finance LLC is a subsidiary of KPMG LLP, a UK limited liability partnership and the UK member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. 15

19 2010 Outlook According to the National Association of Realtors: Office Market: The office sector will continue to suffer the most from job losses, which reduces the demand for space. Vacancy rates will likely increase, while rents are forecasted to fall. Industrial Market: The contracting global economy has constricted the industrial sector. Vacancy rates are likely to rise. Retail Market: Given a pattern of weak consumer spending, the retail vacancy rate is forecast to increase slightly, while rents are expected to fall. Multifamily Market: The apartment rental market is facing higher home sales by first-time buyers, but is also experiencing increased demand from families who have lost their homes. Multifamily vacancy rates will likely decline in 2010, while average rents increase slightly KPMG Corporate Finance LLC, a U.S. limited liability company, is a member of FINRA and is registered as a broker dealer with the SEC. KPMG Corporate Finance LLC is a subsidiary of KPMG LLP, a UK limited liability partnership and the UK member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. 16

20 Real Estate Deal Making & Restructuring Strategies

21 REITs Public CRE Market: Notable successes raising equity and unsecured debt to deleverage and develop war chest. Notable failures raising new capital to buy distressed assets. Capital Raises Success REITs raised more than $13 billion through secondary stock sales between March and June 2009 ProLogis raised $1.0 billion in April SL Green Realty Corp. raised $387.4 million in May Starwood Property Trust Inc. raised $951.5 million on August; 138% of its initial target Goldman Sachs estimates REITs will seek to trim debt by at least $40 billion over next three years; this would ease the process of deleveraging Failure Recent IPO offerings focused on buying distressed assets have failed Apollo Commercial cut stock sale from 20 million shares to 10 million shares Colony Financial reduced its offering from 25 million shares to 12.5 million shares CreXus Investment Corp. downsized offering by twothirds There is no evidence that distressed-focused REITs can be successful at acquiring assets at a discount Source: istockanalyst 2009 KPMG Corporate Finance LLC, a U.S. limited liability company, is a member of FINRA and is registered as a broker dealer with the SEC. KPMG Corporate Finance LLC is a subsidiary of KPMG LLP, a UK limited liability partnership and the UK member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. 18

22 Bid/Ask Gridlock In general: Sellers Those not under compulsion to sell expect pricing Those under pressure to sell have no equity, no upside and therefore no motivation to sell Buyers Conservative, core investors are out of the market Existing buyers focused on: Best properties Best markets Venture capital type returns Banks Internal decision-making gridlock Inter-creditor conflicts Complex capital structures that did not contemplate workouts 2009 KPMG Corporate Finance LLC, a U.S. limited liability company, is a member of FINRA and is registered as a broker dealer with the SEC. KPMG Corporate Finance LLC is a subsidiary of KPMG LLP, a UK limited liability partnership and the UK member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. 19

23 Trends in > Do current conditions represent a systemic change or a blip? One s opinion on this drives frequently drives decision making. Extend & Pretend Negotiate debt extensions to avoid maturity defaults Property Owners Deleverage Hold core investments vs. selling at the bottom Look for opportunities in the distressed market Attempt to raise a fund Fundraising nearly impossible Explore programmatic joint-ventures Future for Mortgagees Need to resolve inter-creditor disagreements, especially with zombie-banks Need to make sound asset-level business decisions rather than focusing on bank s capital base 2009 KPMG Corporate Finance LLC, a U.S. limited liability company, is a member of FINRA and is registered as a broker dealer with the SEC. KPMG Corporate Finance LLC is a subsidiary of KPMG LLP, a UK limited liability partnership and the UK member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. 20

24 When Will the Floodgates Open? Gridlock unlocked when clearing prices established Clearing prices will be based upon: Renewed appreciation of risk Current and projected rental and vacancy rates Conservative leverage Deals will occur based upon: Debt restructurings Foreclosures REO sales 2009 KPMG Corporate Finance LLC, a U.S. limited liability company, is a member of FINRA and is registered as a broker dealer with the SEC. KPMG Corporate Finance LLC is a subsidiary of KPMG LLP, a UK limited liability partnership and the UK member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. 21

25 Contact Details Harold Bordwin Managing Director/Co-Group Head Real Estate Services KPMG Corporate Finance LLC (212) The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation KPMG Corporate Finance LLC, a U.S. limited liability company, is a member of FINRA and is registered as a broker dealer with the SEC. KPMG Corporate Finance LLC is a subsidiary of KPMG LLP, a UK limited liability partnership and the UK member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. 22

26 Real Estate Bankruptcies: The Impact of In re General Growth Strategies for Real Estate Companies, Lenders and Investors Dealing With Special Purpose Entities November 4, 2009 Overview of General Growth Properties Chapter 11 Cases Michael E. Foreman Of Counsel (212) Haynes Haynes and and Boone, Boone, LLP LLP

27 Implications of the General Growth Cases Taken in conjunction with the Bankruptcy Court s other rulings in the General Growth cases, in the Decision evidence of a broader predilection by bankruptcy courts against dismissing as bad faith filings the Chapter 11 case of an SPE in circumstances similar to the General Growth cases? Will the developments in the General Growth cases invite companies structured similarly to GGP to pursue their financial restructuring in Chapter 11, regardless of whether their SPE subsidiaries are insolvent? What impact could these issues have on underwriting requirements, as well as the pricing, recourse and cash management provisions relating to both property-level and CMBS financings? 2009 Haynes and Boone, LLP -1-

28 OVERVIEW General Growth Properties, Inc. ( GGP ) is a publiclytraded real estate investment trust (REIT) operating a nationwide network of approximately 200 shopping malls in 44 states. GGP is the ultimate parent company for approximately 750 subsidiaries, affiliates and joint ventures. GGP and 337 of its affiliates and subsidiaries ( collectively, together with GGP, the Debtors ), filed their voluntary Chapter 11 petitions on April 16 and 23, Their Chapter 11 cases are jointly administered for procedural purposes in the Court, under the caption In re General Growth Properties, Inc., et al., Case No (ALG) (jointly administered) Haynes and Boone, LLP -2-

29 OVERVIEW At the time of the Chapter 11 filings, GGP and its affiliates were obligated on approximately $18.27 billion of debt secured at the project level. Many of the GGP group properties faced covenant defaults. Some lenders began exercising cash control and other remedies over properties that generated sufficient cash flow to cover their own operating expenses. Certain other properties faced loan maturity or hyper-amortization - where the borrower s failure to repay or refinance the loan at a negotiated anticipated repayment date would result in a dramatic increase in interest rates and in the restrictions on GGP s access to the property owners cash - in time-frames ranging from the next few months to years. In addition, GGP and certain of its affiliates had approximately $6.58 billion of unsecured debt. Ultimately, GGP believed that the Chapter 11 filings for it and almost half of its affiliates were necessary to address an overall capital structure GGP believed had become unmanageable and unfinancable due to the collapse of the credit markets Haynes and Boone, LLP -3-

30 OVERVIEW Historically, GGP used bankruptcy-remote special purpose entities ( SPEs ) as borrowers in connection with conventional mortgage and commercial mortgage-backed securities ( CMBS ) financings. Use of SPEs was a fundamental underwriting requirement by lenders, and a critical factor considered by ratings agencies. The bankruptcy-remote structure was intended to shield lenders and their collateral from the potentially adverse impact of bankruptcy filings by their borrowers parents and affiliates. structures. The SPEs were bankruptcy remote, not bankruptcy proof. Typical loan documentation contained separateness covenants requiring the borrower to maintain its legal and functional separateness from its related entities. Each SPE was required to have all rents generated by its property deposited into a lockbox and maintain its own cash management system for property-specific expenses. Parent level debt was structurally subordinate to the debt of the SPE borrowers (although certain parent level debt may have been secured by the equity of SPE borrowers owned by GGP or an intermediate level holding company parent). The loans to the SPEs did not include parent company repayment guaranties (although bad boy guarantees may have been required) Haynes and Boone, LLP -4-

31 USE OF CASH COLLATERAL AND DIP FINANCING At the April 16, 2009 first day hearing, the Debtors sought immediate access to the cash collateral generated by the SPEs, wherever located in the system. The Debtors argued that their use of cash collateral throughout the GGP system, in conjunction with their consolidated cash management system, was needed to continue the operations of all of the Debtors and to preserve the value of the group s assets for a successful reorganization. The DIP Financing motion, as filed, requested that the new DIP lenders be granted a first lien and security interest in the cash collateral generated by each SPE, as well as a first lien and security interest on the cash and assets of non-filing SPE affiliates. No interim authorization for the DIP financing was requested. Project-level lenders and CMBS servicers objected on numerous grounds, including that the Debtors requests would undermine the bankruptcy-remote protections in the mortgage and CMBS financing documents. The Commercial Mortgage Securities Association (CMSA) and the Mortgage Bankers Association (MBA), in their amici curiae brief: The CMSA and MBA and their members are gravely concerned with the filings by the individual Property Owners as part of the GGP Chapter 11 filing and the catastrophic impact such a precedent, if it stands, could have on the CMBS market, as well as on structured finance and the broader capital markets that rely on the same underlying principles of asset isolation in the architecture of securitization. Docket No. 289 at p Haynes and Boone, LLP -5-

32 USE OF CASH COLLATERAL AND DIP FINANCING The Debtors response to the objections: allowing each secured lender to control the cash of its particular SPE borrower to pay only the expenses directly benefiting its collateral would be inconsistent with the Debtors prepetition operations and would leave the Debtors with insufficient liquidity to run the nationwide enterprise that operated for the benefit of all of the properties. The evidence showed that outside of bankruptcy the Debtors had operated as an integrated enterprise, with centralized cash management, and shared overhead expenses for such things as operation and maintenance of each property. Docket No The proposed collection, upstreaming, commingling and use of cash collateral would merely continue the pre-petition status quo. Absent a default or triggering event, the SPE project subsidiaries were not barred or restricted from transferring cash to a parent entity, but had all rents deposited into a lock box and could direct daily transfers out of the lockbox. See Docket No. 397 at 89, 90. The Debtors centralized operations had not been hidden from creditors pre-petition: After all, the entire premise of the REIT structure is that cash will be upstreamed to the parent for distribution as dividends to investors. Docket No. 397 at Haynes and Boone, LLP -6-

33 USE OF CASH COLLATERAL AND DIP FINANCING Regardless of restrictions in the SPEs pre-petition loan and organizational documents, such restrictions could not trump the Bankruptcy Code provisions permitting the use of cash collateral in exchange for adequate protection. See, e.g., In re R.H. Macy & Co., 170 B.R. 69, 77 (Bankr. S.D.N.Y. 1994); In re Federated Dep t Stores, Inc., 1990 WL , at *5-6 (S.D. Ohio July 26, 1990). At the first-day hearing, the Court authorized the use of cash collateral pursuant to the consolidated cash management system on an interim basis while granting the lenders various forms of adequate protection pending the final hearing. Based on the evidence presented at the first-day hearing, the Court observed: [i]t is an obvious fact that the Lenders to the individual properties here did not do business with a single borrower; they did business with one of the largest similarly situated companies in the country and they get protections from that. See Transcript of 4/16/09 Hearing at 88. The Court predicted that many of the other structural issues raised in the objections would come into better focus once the Debtors finalized their DIP financing negotiations Haynes and Boone, LLP -7-

34 USE OF CASH COLLATERAL AND DIP FINANCING Following the interim cash collateral hearing, the Debtors conducted an auction process among three prospective DIP lenders. Project-lender representatives provided input. Certain lenders filed motions to dismiss the Chapter 11 cases of their specific borrowers. On May 14, 2009, the Court entered a final DIP financing order approving a $400 million DIP financing embodying negotiated terms, including adequate protection. (Docket No. 527).... the terms of the DIP loan were designed not to impinge on the rights of the secured creditors or to preclude the secured creditors from preserving their positions in these cases and their fundamental interests. Indeed, the parties, in negotiating the DIP loan, were so successful that the real objections that are outstanding are objections as to the provisions for adequate protection rather than the provisions of the DIP loan per se. Hrg. Tr. at However, several commentators noted that the SPE structures would be tested next through the Court s consideration of and ruling on the pending motions to dismiss Haynes and Boone, LLP -8-

35 The General Growth August 11, 2009 Decision Overview of the Ruling August 11, 2009 Memorandum of Opinion (the Decision ) setting forth the Court s findings of fact and conclusions of law upon which it denied motions by several property lenders and special servicers seeking to dismiss the Chapter 11 cases of certain GGP SPE subsidiaries as bad faith (or, in one instance, an ineligible) filings. In re General Growth Properties, Inc., 409 B.R. 43 (Bankr. S.D.N.Y. 2009). Subsequently, on August 28, 2009 the Court entered its order denying each of the motions to dismiss, based on the Decision. No appeals were taken. The Court also ruled that a SPE Debtor organized as a trust under Illinois law was a business trust eligible to be a debtor under Chapter 11. General Growth at The directors and managers of GGP and its subsidiary Debtors properly considered the interests of the entire GGP group in determining whether or not to file voluntary Chapter 11 petitions for individual SPEs. The Chapter 11 filings of the GGP SPE Debtors in question (collectively, the Subject Debtors ) were not premature even though those specific borrowers were not yet in default or facing loan maturity. The Chapter 11 filings were proper even though the Subject Debtors generated sufficient cash to cover their own operating expenses Haynes and Boone, LLP -9-

36 The General Growth August 11, 2009 Decision Overview of the Ruling The Court credited the current disarray in the real estate financing markets with creating sufficient uncertainty for the borrowers ability to refinance debt maturing years in the future which supported their bankruptcy filings. The Court s consideration of the interests of the GGP group did not trample on the fundamental rights of the lenders who had sought to be insulated with a particular SPE. However, bankruptcy inherently alters some of the rights the lenders had negotiated. The salient point for purposes of these Motions is that the fundamental protections that the Movants negotiated and that the SPE structure represents are still in place and will remain in place during the Chapter 11 cases. This includes protections against the substantive consolidation of the project-level Debtors with any other entities. There is no questions that a principal goal of the SPE structure is to guard against substantive consolidation, but the question of substantive consolidation is entirely different from the issue whether the board of a debtor that is part of a corporate group can consider the interests of the group along with the interests of the individual debtor when making a decision to file a bankruptcy case. Nothing in this Opinion implies that the assets and liabilities of any of the Subject Debtors could properly be substantively consolidated with those of any other entity. General Growth at Haynes and Boone, LLP -10-

37 The General Growth August 11, 2009 Decision Overview of the Ruling Two holders of CMBS debt and a holder of conventional mortgage debt argues that their SPE borrowers Chapter 11 cases should be dismissed as bad faith filings: The movants were now being forced to assume the credit risk of the entire GGP group - a risk that they had not bargained for when investing in specific SPEs. No imminent threat existed to the financial viability of the Subject Debtors at the time of their filing, and they had had no present or impending need for Chapter 11 protection since they produced sufficient cash flow to service their individual debts. The Subject Debtors were not in financial distress, they had been filed for Chapter 11 prematurely, and they had no chance to reorganize because they could not confirm a Chapter 11 plan over the mortgagee s objection and the mortgagee would object to any plan proposed by the Debtors. General Growth at 55. The Court overruled the argument that a debtor s supposed inability to confirm a plan at the time of its Chapter 11 filing evidenced the bad faith of the filing. The Bankruptcy Code contains no filing requirement that a debtor prove a plan is confirmable when it files. This argument reflected the mortgagee s view of the leverage it has in the subject cases. Its invocation of its asserted leverage is ironic, in view of the fact that [the mortgagee] also asserts that the Subject Debtors filings were taken in subjective bad faith. General Growth at Haynes and Boone, LLP -11-

38 The General Growth August 11, 2009 Decision The Kingston Square Assoc. Test Controlling Second Circuit law: bankruptcy petitions should be dismissed as bad faith filings if, on the filing date, no reasonable likelihood existed that the debtor intended to reorganize and no responsible probability existed that it would eventually emerge from bankruptcy. General Growth at 55, citing C-TC 9th Ave. P ship v. Norton co. (In re C-TC 9th Ave. P ship), 113 F.3d 1304, (2d Cir. 1997), quoting Baker v. Latham Sparrowbush Assocs. (In re Cohoes Indus. Terminal, Inc.), 931 F. 2d 111 (2d Cir. 1991). A two-part test: [A] bankruptcy petition will be dismissed if both objective futility of the reorganization process and subjective bad faith in filing the petition are found. In re Kingston Square Assocs., 214 B.R. 713 (Bankr. S.D.N.Y. 1997) (emphasis in original) Haynes and Boone, LLP -12-

39 The General Growth August 11, 2009 Decision The Kingston Square Assoc. Test It is the totality of circumstances, rather than any single factor, that will determine whether good faith exists. Kingston Square Assocs., 214 B.R. at 725; General Growth at 56. The Kingston Square Associates case involved a challenge to the bankruptcy filings of certain SPEs that were the product of mortgage backed securitizations. Each SPE owned an apartment complex and possessed bankruptcy remote corporate governance provisions designed to make bankruptcy unavailable to a defaulting borrower absent the affirmative consent of the mortgagee s designee on the borrower s board of directors. Given that the board of each SPE believed that it would be unable to obtain the consent of the mortgagee s designee to file for bankruptcy to thwart the mortgagee s efforts to foreclose, the debtors principal paid a law firm to solicit creditors to file involuntary chapter 11 petitions against the debtors. The Court was not required to determine the validity of the SPEs bankruptcy proof provisions, since the SPEs in that case had not observed the corporate formalities required under their documents. The collusive filings did not constitute cause to dismiss the filings or convert them to chapter 7 under section 1112(b) of the Bankruptcy Code. Id. at 737. The existence of a director s fiduciary duties might include supporting a bankruptcy filing where necessary to thwart a foreclosure action. Id. at Haynes and Boone, LLP -13-

40 The General Growth August 11, 2009 Decision Objective Bad Faith Analysis The movants objective good faith argument: the Subject Debtors Chapter 11 filings were premature, based on cases where petitions were dismissed because the debtors were not in actual financial distress at the time of their filing, the prospect of the debtor s liability was speculative, and where evidence existed that the filings were designed to obtain litigation advantage. Id. at 57. The Debtors counter: The determinations that the Subject Debtors were in financial distress was made after factual and legal analysis was conducted by the respective Debtors with their financial and restructuring advisors and legal counsel. Id. at The decisions were vetted in a series of Board meetings following substantial financial analysis, Id Haynes and Boone, LLP -14-

41 The General Growth August 11, 2009 Decision Objective Bad Faith Analysis The GGP board reviewed each Subject Debtor individually, Id. at 58-59, using at least ten factors in considering whether to file a Chapter 11 for a particular entity: The company is a borrower or guarantor under a credit facility that is currently in default and for which no forbearance has been obtained. The company is a borrower or guarantor under a credit facility that is currently in a forbearance period that can be terminated at the Lenders discretion. The default of GGP or another entity within the GGP group structure and/or a bankruptcy filing by an entity guaranteeing the company s debt triggers an event of default under the company s existing loan. The company owns a property which is subject to an existing cash trap that has been implemented. The company is a borrower or guarantor under a loan that matures within the next three to four years. The company is part of a project in which one or more subsidiaries or affiliates are under consideration for filing to facilitate a restructuring. The company is the general partner of a partnership that is under consideration for filing. The company is subject to multiple other filing considerations, including a loan which has a loan-tovalue ratio in excess of 70%. The company holds unencumbered assets and is filing to facilitate the inclusion of such assets as part of an overall corporate restructuring. The company may be part of a non-core asset disposition process that could be facilitated by a section 363 sale in bankruptcy. General Growth at 59, fn Haynes and Boone, LLP -15-

42 The General Growth August 11, 2009 Decision Objective Bad Faith Analysis The Court found that the Subject Debtors were justified in filing their Chapter 11 petitions when they did, and the procedures used by the Debtors to determine which GGP group entities would file bankruptcy petitions were reasonable. Id. at 59, The Bankruptcy Code seeks to incentivize a debtor to file earlier rather than later, so as to preserve the value of the estate. Id. at 60. The Court declined to establish an arbitrary rule that a debtor is not in financial distress and cannot file a Chapter 11 petition if its principal debt is not due within a certain period of time of the filing. Each Subject Debtor was in a degree of financial distress at the time of its filing: Four Subject Debtors had cross-defaulted to the defaults of affiliates or would have been in default as a result of the bankruptcy filings by affiliates. One Subject Debtor s loan had gone into hyper-amortization. Five Subject Debtors had mortgage debt maturing or hyper-amortizing in 2010, two in 2011 and one in The remaining seven Subject Debtors were either guarantors on maturing loans of other entities, their property was collateral for a maturing loan or the loans were otherwise in distress in the Debtors view (as evidenced by, for example, a high loanto-value ratio). Id. at Haynes and Boone, LLP -16-

43 The General Growth August 11, 2009 Decision Objective Bad Faith Analysis The Debtors conclusion that the financial market s disarray created uncertainty as to whether the Subject Debtors would be able to refinance their debt years in the future was reasonable. Id. at There was no evidence to counter the Debtors demonstration that the CMBS market, in which they historically had financed and refinanced most of their properties was dead as of the Petition Date, and that no one knew when or if that market will revive. Indeed, at the time of the hearings on these Motions, it was anticipated that the market would worsen, and there was no evidence presented showing the means of refinancing billions of dollars of real estate debt coming due in the next several years. Id. (footnote deleted). The Bankruptcy Code contains no filing requirement that a debtor be insolvent. Id. at 61. Second Circuit law did not require each Subject Debtors good faith to be examined as if it were wholly independent of the GGP group, even though the group analysis was contrary to the lenders intentions and expectations in using a bankruptcy-remote SPE structure. Nevertheless, the record also establishes that the Movants each extended a loan to the respective subject debtor with a balloon payment that would require refinancing in a period of years and that would default if financing could not be obtained by the SPE or by the SPE s parent coming to its rescue. Movants do not contend that they were unaware that they were extending credit to a company that was part of a much larger group, and that there were benefits as well as possible detriments from this structure. If the ability of the Group to obtain refinancing became impaired, the financial situation of the subsidiary would inevitably be impaired. Id Haynes and Boone, LLP -17-

44 The General Growth August 11, 2009 Decision Objective Bad Faith Analysis The fiduciary duties owed by the independent directors, officers and managers of solvent SPEs to the SPE lenders, special servicers and equity holders: The Delaware Supreme Court has rejected the notion that directors of a nearly insolvent company, operating in the zone of insolvency, owed fiduciary duties to creditors. North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, 930 A.2d 92 (Del. 2007). Since the movants did not argue that the Subject Debtors were insolvent at any time, the SPE borrowers fiduciaries properly exercised their duties in considering the interests of the SPEs equity holders over the property-level creditors because directors of a solvent corporation must consider only the interests of the entity and its shareholders in exercising their fiduciary duties. General Growth at 64. If Movants believed that an independent manager can serve on a board solely for the purpose of voting no to a bankruptcy filing because of the desires of a secured creditor, they were mistaken. Id. at 64. The Court s ruling: Consideration of the interests of the GGP group entities as a whole by the SPE fiduciaries was proper. The Subject Debtors bankruptcy filings were not premature even where their loan maturities were years away Haynes and Boone, LLP -18-

45 The General Growth August 11, 2009 Decision Competing Fiduciary Duties Difficulties arise when trying to establish how directors are to effectively protect the interests of creditors and shareholders simultaneously. The existence of fiduciary duties at the moment of insolvency may cause directors to choose a course of action that best serves the entire corporate enterprise rather than any single group interested in the corporation Geyer v. Ingersoll Publications Co., 621 A.2d 784, 789 (Del. Ch. Ct. 1992). Under Gheewalla, a creditor of a corporation that is operating within the zone of insolvency cannot bring a direct action against directors for an alleged breach of fiduciary duty. Only when a corporation becomes insolvent do its creditors take the place of shareholders as the residual beneficiaries of any increase in value. Other direct, non-fiduciary claims may be available to creditors, based on contracts between debtor and creditor Haynes and Boone, LLP -19-

46 The General Growth August 11, 2009 Decision Competing Fiduciary Duties Gheewalla Case Rationale: Recognizing that directors of an insolvent corporation owe direct fiduciary duties to creditors would create uncertainty for directors who have a fiduciary duty to exercise their business judgment in the best interests of the insolvent corporation. Gheewalla at 103. Court abandoned the concept of a zone of insolvency so that directors would have a clear guide to their duties. By its ruling, the court provided directors with clear signal beacons and brightly lined channel markers as they navigate with care, good faith and loyalty on behalf of a Delaware corporation and its shareholders. The Court also endeavored to mark the safe harbors clearly. Gheewalla at Haynes and Boone, LLP -20-

47 The General Growth August 11, 2009 Decision Subjective Bad Faith Analysis The movants subjective bad faith argument: the Subject Debtors acted in bad faith because they failed to negotiate prior to filing and because the initial independent managers of several of the SPEs were replaced shortly before the Chapter 11 filings. The Court found that the Debtors established that the filings were designed to preserve value of their estates and protect their creditors, including the movants. Id. at 69 In contrast to the Chapter 13 requirement that a consumer debtor obtain credit counseling before filing for bankruptcy, the Bankruptcy Code does not require a borrower to negotiate with its lender before filing a Chapter 11 petition. Id. at 66. The Debtors were unable to find any lender or servicer having final decisionmaking authority with whom to negotiate. Master servicers would not negotiate loan modifications until the loans approached maturity, and they would not transfer the loans to the special servicers until the loans were actually in default. Id Haynes and Boone, LLP -21-

48 The General Growth August 11, 2009 Decision Subjective Bad Faith Analysis The Court also found that the Debtors acted within their rights under the operating agreements In contrast, even if the secretive manner in which the original independent managers were fired was surreptitious. Id. at 68. The operating agreements permitted but did not require that the independent managers be supplied by a nationally recognized company which provides professional independent directors, managers and trustees. The operating documents did not require that the managers being replaced, or the lenders, be given notice of the terminations. The Debtors replaced the initial independent managers with persons who had capital markets and restructuring experience and understanding. It does not appear that these managers had any expertise in the real estate business. Id. at Haynes and Boone, LLP -22-

49 The General Growth August 11, 2009 Decision Subjective Bad Faith Analysis Lenders seeking to rely on the bankruptcy remote structure of SPEs must take measures to ensure not only the theoretical separateness of their borrowers, but also the actual separateness. In General Growth, the SPE documentation did not prevent the entire corporate group from functioning as an integrated single national owner and operator of shopping malls, including the upstream of cash from the SPEs for use on a consolidated basis in the operation of the national business. While the Court was cognizant of the rationale underlying GGP s corporate and capital structure, and that the lenders and servicers arguments resulted from industry-held transactional expectations, it cautioned that certain of those expectations may have been unreasonable or just not feasible, especially in light of the particular facts of GGP s business Haynes and Boone, LLP -23-

50 Implications of the General Growth Cases The August 11 Decision did not foreshadow how the Court would rule on other important issues that might yet be raised in the Debtors cases, including substantive consolidation and the classification and treatment of the secured, mezzanine and unsecured debt asserted against GGP Debtors. However, lenders to companies structured similarly to the GGP group holding companies with intermediate holding companies and property-level SPE subsidiaries must now consider whether or not the General Growth Decision and orders represent a developing body of law which may be used as precedent in other cases. As the real estate financing markets bottom out and lenders consider reintroducing liquidity, prospective lenders, borrowers and rating agencies will have to consider whether the results of the General Growth cases raise implications for the future of securitizations premised on the bankruptcyremote SPE structure Haynes and Boone, LLP -24-

51 Implications of the General Growth Cases The parties to CMBS transactions may consider whether modifications to existing documents are warranted, desirable and possible. Lenders and noteholders may seek to have their SPE borrowers amend organizational documents to address apparent deficiencies highlighted by the Decision. While corporate directors and officers do not have fiduciary duties to creditors until the corporations are insolvent, limited liability company managers and officers derive their fiduciary duties from the entity s organizational documents. Section of the Delaware Limited Liability Company Act allows a limited liability company to restrict or even eliminate a manager or officer s fiduciary duties to the entity s member. Some commentators have even gone so far as to suggest that Section may permit the limited liability company operating agreement to impose fiduciary duties on mangers and officers in favor of creditors regardless of whether the entity is insolvent or whether the fiduciary duties to equity have been eliminated. No court has addressed this issue Haynes and Boone, LLP -25-

52 Implications of the General Growth Cases The Decision identified issues arising from the securitization master servicer / special servicer structure, which militated against a finding that the SPEs Chapter 11 filings had been made in bad faith. Master servicers of real estate mortgage conduits (REMICs) manage the day-to-day loan administration functions and serviced the loans when not in default, while a special servicer would assume management authority for a loan in default. Only special servicers have the ability to agree to modify a loan (in some cases, with the consent of the holders of the CMBS securities issued by the REMIC). Loans would not be transferred to special servicers until the loan was in default or loan maturity was impending. Pre-petition, GGP sought permission to communicate with special servicers, but was told by master servicers that the loans had to be much closer to maturity before they would be transferred to special servicers, which was evidence of GGP s argument that it had no ability to pursue a restructuring of the property-level debt outside of a bankruptcy Haynes and Boone, LLP -26-

53 Implications of the General Growth Cases In future restructurings, master servicers would appear to benefit from being approachable in order to engage in prebankruptcy restructuring negotiations. It is likely that the tax regulations governing these structures will have to be reviewed to determine the full range of issues arising from a servicer taking a more pro-active role in pre-default restructuring negotiations. Alternatively, loan and servicing document provisions permitting borrowers to have more expeditious and direct access to special servicers, who already have the ability to engage in pre-bankruptcy negotiations, may ameliorate this problem without requiring a change in the tax laws or tax counsel analysis Haynes and Boone, LLP -27-

54 Implications of the General Growth Cases Lenders also may request that notice provisions respecting an independent manager s termination be added to operating agreements as well as loan documents, and that a member s ability to appoint and remove an independent manager be limited or further proscribed. However, lenders who consider such alternatives will have to walk the ever-fine line between imposing reasonable secured creditor rights of due notice and assuming the increased risks of liability to third parties by taking such an active role in their borrower s affairs through the inclusion of such provisions as part of their loan and collateral documentation. Lenders will need to assess the importance of pressing these points against the practical realities of whether any persons would agree to serve as a manager if their fiduciary obligations were prescribed in such a manner, especially in light of developing Delaware law on director, officer and member fiduciary duties Haynes and Boone, LLP -28-

55 Implications of the General Growth Cases Taken in conjunction with the Bankruptcy Court s other rulings in the General Growth cases, in the Decision evidence of a broader predilection by bankruptcy courts against dismissing as bad faith filings the Chapter 11 case of an SPE in circumstances similar to the General Growth cases? Will the developments in the General Growth cases invite companies structured similarly to GGP to pursue their financial restructuring in Chapter 11, regardless of whether their SPE subsidiaries are insolvent? What impact could these issues have on underwriting requirements, as well as the pricing, recourse and cash management provisions relating to both property-level and CMBS financings? 2009 Haynes and Boone, LLP -29-

56 Real Estate Bankruptcies: The Impact of General Growth Properties Unique Issues in Real Estate Bankruptcies Lorraine S. McGowen November 4, 2009

57 Topics Bankruptcy Remote Entities Commercial Single Asset Real Estate Case Bad Boy Guaranties Second-lien loans Cram-down Risks Substantive Consolidation Impact of General Growth Properties case Other Bankruptcy Issues: Treatment of Management Contracts 2

58 Bankruptcy Remoteness : What Does It Mean? The SPV s purpose is to reduce the likelihood that the borrower may become the subject of a voluntary or involuntary bankruptcy petition. Bankruptcy Remote Not Bankruptcy Proof Accomplished by: Minimizing the risk that the BRE would seek to commence a voluntary bankruptcy case Minimizing the risk that creditors of the parent/sponsor would obtain the BRE s assets to satisfy claims against the borrower 3

59 How Is It Achieved? The SPV generally is a newly formed entity whose operations are restricted to a single purpose, that of purchasing, owning, operating the Property. In theory, this restriction prevents the SPV from incurring obligations to third parties who could commence an involuntary bankruptcy case against SPV. Restrictions on the types of indebtedness that the BRE can incur. Restrictions on ability of parent or affiliate commencing or inducing an involuntary bankruptcy petition against the BRE (the so-called no petition clause) or inducing the borrower to commence a voluntary bankruptcy petition. Restrictions on the ability of the BRE to commence a voluntary bankruptcy case: the BRE S organizational documents require the consent of one or more independent directors or similar persons to commence a voluntary bankruptcy case. In theory, the independent directors owe a fiduciary duty to the SPV s creditors not to seek protection in bankruptcy. Restrictions on the types of business in which the BRE is engaged: the BRE's organizational documents prohibit the BRE from engaging in any other business activities other than those arising from the ownership or operation of the real property or project itself. 4

60 Why Do Lenders Care? Commercial Real Estate Issues Automatic stay risk Use of Cash Collateral Priming or Pari Passu Liens Sale of Property Cram-Down Risks Substantive Consolidation 5

61 What is a single asset real estate debtor? Elements of a Single Asset Real Estate Case Debtor must have real property that constitutes a single property or a single project, that is not residential real property with fewer than 4 residential units Real property generates substantially all of the gross income of the debtor Only substantial business being conducted on the property is operating the real property (and related incidental activities) 6

62 Single Asset Real Estate Issues Why does it matter? Secured creditor s rights are enhanced in a single asset real estate case: relief from the stay to enable lender to foreclose Debtor required to file a confirmable plan of reorganization within first 90 days after the filing of the bankruptcy case OR Debtor required to make monthly interest payment to the secured creditor Practice tip: 90 day period may be extended by the court for cause by order entered within the 90- day period; Additionally, debtor can extend the 90 day period by filing a motion seeking a determination that the debtor is a single asset real estate debtor. Period commences on the later of 90 days after commencement of case or 30 days after the court determines that the debtor is a single asset real estate debtor. 7

63 Examples of Single Asset Real Estate Cases Single Asset R/E Case Development of identical semidetached house Development of a single-family home development Resort development covering separate, but contiguous, parcels with a well-developed concept plan Not A Single Asset R/E Case Adjacent parcels where one was developed and leased and the other was undeveloped, with no plans to combine property Growing, replenishing and selling timber Operation of a golf course, which sold memberships, charged fees, sold merchandise Operation of a marina with ancillary services 8

64 Bad Boy Guaranties Purpose of Bad Boy Guaranty: As a source of repayment for bad boy acts or omissions, an BRE is of little worth to a lender. Thus, lenders resorted to requiring parent/sponsor to provide nonrecourse carve-out guaranty, which is a guaranty of the BRE's nonrecourse carve-out liabilities by the BRE's parent company (or by members or principal shareholders). Bad boy guaranty are aimed at preventing the borrower from taking actions: Fraud Gross negligence or willful misconduct Waste Misapplication or conversion of operating funds, or insurance or condemnation proceeds and similar funds Commencment of a voluntary or involuntary bankruptcy case involving the BRE in violation of the BRE s organizational documents Willfully interfering" with the lender's pursuit of its rights and remedies under the loan documents. 9

65 SECOND LIEN LOANS INTERRELATIONSHIP AMONG PARTIES Senior Lender Senior Loan Intercreditor Arrangements Mezzanine Lender Mezzanine Loan Property Owner/ Mortgage Borrower Owns 100% Equity Owner/ Mezzanine Borrower Property 10

66 SECOND LIEN & MEZZANINE LOANS: TENSION AMONG CREDITORS Mezzanine Lender Concerns Loan to own : right to obtain equity in bankruptcy and to take control of debtor Right to credit bid No payment subordination; cap on senior loan Enterprise value exposure (not faced by fully-secured senior lender) Subordinated Debt Concerns: Cap on senior debt Option to purchase senior debt Reservation of unsecured creditor rights 11

67 Mezzanine Lender Concerns Common Second Lien Intercreditor Provisions Lien Subordination, but not payment subordination (senior lender acknowledges that second lien is not subject to contractual payment subordination Waiver of Right to Contest Liens Agreement to Secure Loans Equally: neither will obtain additional collateral not provided to the other Standstill of Subordinated Debt Effect: Gives senior debt control over enforcement actions against collateral Trend: (i) days after event of default and acceleration by subordinated debt; (ii) extension if senior debt enforcing remedies; and (iii) waiver of right to challenge senior debt s exercise of remedies Practical Implications: Second lien lender/subordinated lender permitted to take certain acts to preserve rights that do not adversely impact the senior lender Remedies rarely exercised outside of bankruptcy; (ii) Uniform Commercial Code ( UCC ) requires good faith and commercial reasonable exercise of remedies; and (iii) senior debt not likely to let standstill expire. 12

68 SUBORDINATED DEBT CONCERNS Option to Purchase Senior Debt Effect: Allows subordinate debt to take control Trend: (i) option to purchase all senior debt at par after acceleration of senior debt; (ii) some standstill period will still usually apply for subordinated debt; and (iii) once standstill period ends, subordinated debt must exercise option and close within short period of time Practical Implications: (i) valuable right for subordinated debt; and (ii) option period may make option difficult for subordinated debt to exercise Reservation of Unsecured Creditor Rights Effect: Depending on collateral value, subordinated debt may hold unsecured deficiency claim against debtor Trend: Subordinated debt may exercise rights and remedies as unsecured creditors, subject to subordination Practical Implications: Valuable right for subordinated debt 13

69 The Reorganization Plan Process Filing a Reorganization Plan In a Chapter 11 case, the debtor has the exclusive right to file, and solicit acceptances for, a reorganization plan during the first 120 days after the commencement of the case (and 180 days to select acceptances of the plan) (period was frequently extended by bankruptcy courts). NEW LAW: Debtor s exclusive period to file a plan may not be extended beyond 18 months after the petition date (and the period for soliciting acceptances from creditors and equity-holders may not be extended more than 20 months after the petition date). A plan establishes classes of creditors and interest holders and provides for payment of cash or distribution of property ratably among the members of each class; a plan can also provide that a class of creditors or interest holder is "unimpaired," retaining all of their rights under applicable nonbankruptcy law. Generally, secured claims must be classified separately since the collateral securing each secured claim, and its relative priority, will be different. A plan can provide for the liquidation or the sale of all or substantially all assets of the debtor. 14

70 Approving a Reorganization Plan Each class of creditors or interest holders may either accept or reject the plan. To accept, a majority of voting class members holding two-thirds in amount of the claims or interests voting must vote to accept; for interests, two-thirds in amount of the interests voting must vote to accept. No "quorum" requirement. A class that receives nothing is presumed to have rejected the plan. A class that is unimpaired is presumed to accept the plan; however, a plan must be accepted by at least one impaired class of creditors. In order for a class of unsecured claims under a Chapter 11 plan to be unimpaired (and therefore deemed to have voted in favor of the plan), such class must be paid in cash in the full amount of its claim including post-petition interest. If payment of post-petition interest is not provided for in the plan, the class is deemed impaired and, therefore, entitled to vote on the plan. 15

71 Unimpairment of Secured Claims A secured claim is not impaired (and, therefore, secured creditor can not vote in respect of plan) if the plan leaves unaltered the legal, equitable and contractual rights of the secured creditor. If a plan provides for a secured creditor to be paid in cash in the full amount of the allowed claim on the plan's effective date, the secured claim will be deemed unimpaired. Additionally, if the debtor has never defaulted on its obligations and proposes to assume the pre-petition obligation according to the original terms, the claim is unimpaired. Even when a secured claim has been accelerated as a result of the debtor's default, the plan may reverse a contractual or legal acceleration and reinstate the original maturity date of the obligation without impairing the claim, provided that the plan provides for: curing any default (except a default conditioned on bankruptcy or insolvency); compensating for any damages caused by the secured creditor's reasonable reliance on the right of acceleration reaffirming the original terms of the agreement; and does not otherwise alter the legal, equitable or contractual rights to which the secured creditor is entitled 16

72 Confirmation of Plan To confirm a reorganization plan, each of the tests set forth in Section 1129 must be satisfied. Some of the important requirements are as follows: The bankruptcy court must find that the plan is feasible -- that confirmation of the plan will not be followed by the liquidation of the debtor or the need for further financial reorganization, unless such liquidation or reorganization is provided for in the plan itself. The Plan must be fair Each creditor that does not accept the plan must receive at least as much as the creditor would receive if the debtor were liquidated under Chapter 7 on that date (the "best interests" test). The plan must provide for cash payments to holders of priority unsecured claims. 17

73 Cram Down If a class of creditors or interest holders rejects the plan, the plan can still be confirmed if the plan meets more stringent requirements that are intended to preserve strict priority in right of payment; this procedure is called "cramdown." Holders of secured claims must retain their liens on the pledged property (or the proceeds of sale if sold under Section 363) and must receive deferred cash payments totaling the allowed amount of the secured claim and valued, as of the effective date of the plan, at not less than the value of the creditor's lien. Absolute Priority Rule : Holders of unsecured claim must be paid in full or junior classes receive nothing. Holders of interests must receive the greatest of their liquidation preference, redemption price (if any) or the value of their security, or junior classes receive nothing. 18

74 Cram Down Risks in CMBS Transactions Plan provides for sale of the property (but lenders can credit bid) Plan can bind restructuring on dissenting creditors (avoid the contractual voting requirements under senior or junior loan facilities) Stripping down mortgaged-debt Providing the indubitable equivalent while altering the terms of the mortgage debt, borrower can cram down a plan over the mortgage lender s objection if the plan provides lender will retain its lien up to the value of the lender s interest in the collateral and will receive periodic payments equal to the present value of the secured claim. In cramming down the mortgage loan, the borrower can: Changes the maturity date Changes the interest rate or amortization schedule Changes to the covenants and events of default 19

75 Substantive Consolidation Ensuring the BRE's Separate Identity A bankruptcy-remote BRE must be designed, and in fact operate, as an entity with its own corporate identity, separate from the parent/sponsor. Failure to satisfy either requirement could cause a bankruptcy court in the parent/sponsor's bankruptcy case to disregard the BRE's separate identity and subject the BRE's creditors and assets to the risks of the parent/sponsor's bankruptcy case, thereby defeating the BRE's purpose. Two critical factors" in substantive consolidation analysis are: whether creditors dealt with the entities as a single economic unit or 'did not rely on their separate identity in extending credit,' or whether the affairs of the debtors are so entangled that consolidation will benefit all creditors. (One court has described the test as whether the eggs consisting of the ostensibly separate companies are so scrambled that we decline to unscramble them 20

76 Factors Considered For Substantive Consolidation : BRE should have separate officers, directors, and shareholders, in whole or at least in part. BRE should pay its own expenses, including professional fees, from its own bank accounts. BRE should establish and maintain separate books, records, bank accounts. BRE should have separate assets. The BRE s bank account should be maintained in the name of the BRE. BRE should have separate liabilities. Invoices and other statements of account from third parties must be addressed and mailed directly to the BRE. BRE should have separate offices, separate telephone number, and separate stationery. BRE should have adequate capitalization, financing, working capital. Lack of intercompany guarantees of payments of indebtedness, or mutual guarantees or payments of indebtedness of third parties, or cross-collateral agreements. Books and records of each company are accurately and properly kept in accordance with nonarbitrary standards. 21

77 Factors Considered For Substantive Consolidation Proper regard for and observance of the formalities of corporate organization e.g., directors' meetings, minutes. No commingling of funds. No commingling of assets. The parent/sponsor and BRE should be engaged in different businesses, or perform different functions in the same business. Lack of intercompany transfers or exchanges of assets. Lack of intercompany loans. Separate financial statements issued or to the extent the financial statements are consolidated with the parent/sponsor, that such financial statements contain a footnote stating that the BRE is a separate legal entity, the assets of which are not available to pay creditors of the parent/sponsor or its affiliates. Separate tax returns filed and the BRE should have its own tax identification number. If consolidated or combined federal or state tax returns are filed, the BRE and its parent should be parties to a written tax sharing agreement, pursuant to which the BRE pays its allocated share of the taxes (or obtains its allocated share of any refunds). 22

78 Impact of General Growth: Open Questions Are the BREs proper debtors in the bankruptcy case? Will the bad boy guaranties spring into full recourse? Are the BREs single asset real estate debtors? What structural changes will be wrought in the CMBS world? Will the debtors seek to substantively consolidate all or some of the General Growth debtors and non-debtors 23

79 Other Bankruptcy Issues Rejecting property management/administrative services agreement. Who will operate the Property: If the parent/sponsor rejects the administrative services agreement, the rejection constitutes a breach of the agreement entitling the BRE to assert a prepetition damage claim (usually unsecured) in the parent/sponsor's bankruptcy case. The parent/sponsor's and the BRE's rights and obligations under the agreement terminate and the BRE may contract with another entity to maintain the Property. Time for assumption or rejection. The parent/sponsor will be entitled to a reasonable time to make an informed judgment on whether to assume or reject the agreement. Any party to the agreement, however, may ask the bankruptcy court to order the parent/sponsor to determine within a specified period of time whether to assume or reject the agreement. As a practical matter, the court will be more likely to expedite the parent/sponsor's decision to assume or reject the agreement if the parent/sponsor is derelict in performing its duties under the agreement and thereby harming the BRE's creditors. 24