ACC Real Estate Committee Quick Legal Hits SPE Financings Current Issues and Practices

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1 ACC Real Estate Committee Quick Legal Hits SPE Financings Current Issues and Practices Presented by: William D. James

2 Goal of Presentation To give you the information necessary to manage SPE transactions To identify issues that commonly arise in practice McGuireWoods LLP 2

3 Main Features of SPE Loans Property is owned by a Special Purpose Entity (SPE). Also referred to as a Single Purpose Entity by some lenders SPE serves as the borrower Loan is non-recourse to the SPE, as owner and borrower Guaranty is provided by a parent company, resulting in limited elements of recourse (known as the non-recourse carve-outs which typically include environmental matters and improper conduct) Example: Freddie Mac CME Program McGuireWoods LLP 3

4 Purpose of SPE Structure Purpose is to protect the lender by using a Property owner/ borrower that is bankruptcy remote Example: Parent company has two sibling subsidiaries named Sub-A and Sub-B Sub-B acquires the Property and becomes the borrower Later, a bankruptcy filing is made by the parent company and/ or Sub-A Is Sub-B beyond the jurisdiction of the bankruptcy court? McGuireWoods LLP 4

5 Type of Entity Corporation: Traditional model, with SPE provisions in the public formation filing (for example, the Certificate of Incorporation in Delaware) LP or LLC: SPE provisions are usually in the private governing agreement (partnership agreement or LLC operating agreement) Why the difference? Change in practice as SPE financings with LP or LLC borrowers became more common over time McGuireWoods LLP 5

6 Additional Requirements When the loan amount is above a certain threshold (lender-specific, usually $15-25 million), and when the loan will be securitized (or is treated as if it might be securitized later), you should expect: Requirement for an independent director or independent manager whose consent is needed before the SPE can file for bankruptcy protection Requirement for a non-consolidation legal opinion from counsel to borrower (a reasoned opinion citing bankruptcy case law, often pages long) Requirement for a second layer of remoteness a second SPE, formed to serve as the new parent company or manager of the primary SPE McGuireWoods LLP 6

7 Basic SPE Documents Loan application mentions SPE structure in a general or summary manner Each lender has its own specific written criteria Deed of Trust, Mortgage or similar document will have detailed SPE requirements matching lender criteria Organizational documents of SPE will have detailed SPE requirements matching lender criteria McGuireWoods LLP 7

8 Types of SPE Provisions Limited purpose clause for SPE (generally restricted to owning and operating the Property) Restrictions on organic changes (mergers, asset sales, etc.) Separateness covenants (often a list of 20 or so) Must be conformed to the deal, but very little room to negotiate the substance of SPE provisions, which are generally standardized McGuireWoods LLP 8

9 Common Problems Failure to receive or to inquire about the current, lender-specific form of SPE provisions Failure to determine at an early stage whether additional requirements will apply (e.g., independent director, non-con opinion, second layer of SPE protection) Failure to conform SPE language for a second layer SPE, if required (related SPE is not a borrower, does not own the Property, etc.) Disconnect between SPE language in (i) Deed of Trust, Mortgage, etc., as handled by outside real estate attorneys vs. (ii) entity documents, as prepared by outside business attorneys *** Company in-house counsel has a unique opportunity to manage the process and to prevent these problems McGuireWoods LLP 9

10 Specific Drafting Examples Lender s Form of Separateness Covenant: The Company shall file its own tax returns separate from those of any other Person and shall pay any taxes required to be paid under applicable law If the SPE/Company is a corporation, may need to add at end: except to the extent that the Company is part of a consolidated group for federal income tax purposes (or similar language) If the SPE/Company is an LLC, may need to add at end: except to the extent that the Company has a sole member and is a disregarded entity for federal income tax purposes (or similar language) McGuireWoods LLP 10

11 Specific Drafting Examples (continued) Lender s Form of Separateness Covenant: The Company shall not permit any Affiliate or constituent party independent access to its bank accounts If an Affiliate is Serving as Property Manager, may need to add at end:, except for any Property Manager for the Property acting in accordance with the Property Management Agreement (or similar language) McGuireWoods LLP 11

12 Special Cases Recycled SPE: The SPE is usually a newly-formed entity. It is theoretically possible to use an existing entity (known as a recycled SPE ) but difficult in practice. For a recycled SPE, the parent company may be required to certify that the entity has always operated as if the separateness covenants were in place since inception. Springing Member LLC: When the SPE is a sole member LLC, you should expect that the lender will require (i) a Delaware LLC, with (ii) a special or springing member. The springing member is a party who is named at the outset and who automatically jumps in as the replacement member if the original member is dissolved (to avoid any implication that a bankruptcy trustee could take control). McGuireWoods LLP 12

13 Trends Trend is expansion of non-recourse carve-outs in parent company guaranty. Formerly, carve-outs were limited to environmental matters and fraud. Now, the list may also include willful contractual breaches or defaults. Trend is tighter restrictions on who can qualify as an independent director (if required). It was always sufficient to engage a national service provider in this capacity. Now, given the need for true independence, this may be necessary as a practical matter. McGuireWoods LLP 13

14 Sample Structure Chart (Before SPE Loan) Parent Company 100% Original Sub LLC 100% Property McGuireWoods LLP 14

15 Sample Structure Chart (After SPE Loan) Parent Company (and Guarantor) 100% SPE Manager Corp. 100% Original Sub LLC 0.01% 99.99% SPE Owner LLC 100% Loan Lender Property McGuireWoods LLP 15

16 McGuireWoods Speaker William D. James Bill James has over 20 years of experience in a wide range of debt and equity transactions. His practice includes all major areas of partnership, joint venture and LLC law. He has also represented REIT clients on general corporate and transactional matters. McGuireWoods LLP 16

17 Questions or Comments? McGuireWoods LLP McGuireWoods LLP 17