BANKRUPTCY REMOTENESS NONRECOURSE CARVE OUTS, NONCONSOLIDATION AND THE MEANING OF
LIFE
Harriet Alexson, Bohm Wildish, LLP
Peter Munoz, Reed Smith LLP
Edward Wender, Venable LLP
1
BANKRUPTCY
REMOTENESS
Keeping the Borrower
“separate” from other
entities. Lender
underwrote the
Borrower and is
willing to take the risk
of Borrower’s
bankruptcy. Borrower
is on its own island.
2
BASIC PRINICIPLES OF
BANKRUPTCY
REMOTENESS
IMPOSE PROCEDURAL
BARRIERS TO DECLARING
BANKRUPTCY.
REQUIRE THE BORROWER TO
BE SEPARATE FROM OTHERS
[IN THEORY PROPERTY CAN
STAND ON ITS OWN].
IMPOSE COSTS ON
PRINCIPALS OF THE
BORROWER IF THEY DARE TO
DO IT.
3
• DOES NOT MEAN THAT THE BORROWER WILL NOT
FILE BANKRUPTCY – THE INTENT IS TO PROTECT
THE LENDER EVEN IF BANKRUPTCY IS FILED.
4
HOW REMOTENESS IS ACHIEVED
• RECOURSE PROVISIONS AND GUARANTIES THAT CREATE SPRINGING
LIABILITY IF CERTAIN EVENTS OCCUR OR ACTIONS ARE TAKEN.
• SPE REQUIREMENTS INCORPORATED INTO THE BORROWER’S
ORGANIZATIONAL DOCUMENTS – LIMIT OPERATION OF THE
BORROWER – DESIGNED TO PREVENT SUBSTANTIVE CONSOLIDATION.
• REQUIREMENT FOR INDEPENDENT DIRECTORS TO APPROVE
INSOLVENCY ACTIONS (NOT REQUIRED IN SMALL LOANS).
5
NON-RECOURSE
CARVE OUTS
• INCENTIVIZE BORROWER TO
PROTECT THE LOAN COLLATERAL.
• PROVIDE INCENTIVE FOR
BORROWER AND ITS PRINCIPALS
TO AVOID CERTAIN BEHAVIOR.
• PROTECT THE LENDER FROM
ACTS THAT IMPAIR COLLATERAL.
• DISCOURAGE BANKRUPTCY AND
OTHER CONTESTS TO THE
EXERCISE OF REMEDIES.
6
NON-RECOURSE
CARVE OUTS
TWO TYPES OF CARVE OUTS
LOSS CARVE OUTS –
GUARANTORS AND
BORROWER RESPONSIBLE
FOR LOSSES INCURRED BY
LENDER AS A RESULT OF
CERTAIN EVENTS.
FULL RECOURSE CARVE OUTS
– GUARANTORS LIABLE FOR
ENTIRE LOAN IF CERTAIN
EVENTS OCCUR.
7
CARVE OUTS THAT
PROTECT COLLATERAL
Indemnification for Losses as a result of:
• fraud or intentional misrepresentation;
• gross negligence or willful misconduct;
• the breach of any representation,
warranty, covenant or indemnification
provision in the Environmental
Indemnity Agreement or in the
Mortgage concerning environmental
laws, hazardous substances and
asbestos and any indemnification of
Lender with respect thereto in either
document;
• the removal or disposal of any portion
of the Property after an Event of
Default;
8
OTHER LOSS EVENTS
• Waste (generally intentional waste);
• the misapplication or conversion by
Borrower, Principal or Guarantor of (A) any
Insurance Proceeds paid by reason of any
Casualty, (B) any Awards received in
connection with a Condemnation, (C) any
Rents following an Event of Default or (D) any
Rents paid more than one (1) month in
advance;
• any security deposits, advance deposits or
any other deposits collected with respect to
the Property which are not delivered to
Lender upon a foreclosure of the Property;
• the intentional breach of the representation
by Borrower that on the Closing Date, all
Improvements at the Property were in
material compliance with applicable laws;
• failure to pay charges for labor or materials
or other charges or judgments that can
create Liens on any portion of the Property;
9
OTHER POSSIBLE LOSS
EVENTS
• a breach of separateness
covenants;
• any litigation or other legal
proceeding related to the Debt
filed by, or any other act or
omission by, Borrower, Principal,
Guarantor or any Affiliated
Manager that delays, opposes,
impedes, obstructs, hinders,
enjoins or otherwise interferes
with or frustrates the efforts of
Lender;
10
FULL RECOURSE
EVENTS BANKRUPTCY
• Borrower or Principal filing a
voluntary petition under the
Bankruptcy Code or any other
Federal or state bankruptcy or
insolvency law;
• the filing of an involuntary petition
against Borrower or Principal
under the Bankruptcy Code or any
other Federal or state bankruptcy
or insolvency law in which
Borrower, Principal or Guarantor
colludes with, or otherwise assists
such Person, or solicits or causes to
be solicited petitioning creditors
for any involuntary petition against
Borrower or Principal from any
Person;
11
OTHER FULL RECOURSE EVENTS
• Borrower or Principal consenting to or
acquiescing in or joining in an
application for the appointment of a
custodian, receiver, trustee, or
examiner for Borrower or Principal or
any portion of the Property;
• Borrower or Principal making an
assignment for the benefit of
creditors, or admitting, in writing or in
any legal proceeding, its insolvency or
inability to pay its debts as they
become due;
• if the first (1st) full Monthly Interest
Payment Amount is not paid when
due;
• if Borrower fails to maintain its status
as a Special Purpose Entity;
• if Borrower fails to obtain Lender’s
prior written consent to any
Indebtedness or voluntary Lien
encumbering the Property, other than
as expressly permitted pursuant to the
Loan Documents; or
• if Borrower fails to obtain Lender’s
prior written consent to any Transfer
as required by this Agreement or the
Mortgage.
12
OTHER FULL RECOURSE EVENTS
• Borrower or Principal filing an answer consenting to or otherwise
acquiescing in or joining in any involuntary petition filed against it, by
any other Person under the Bankruptcy Code or any other Federal or
state bankruptcy or insolvency law;
• following any Casualty or Condemnation, Borrower’s inability to
rebuild the Improvements at the Property as substantially existed on
the Closing Date in compliance with Legal Requirements;
13
EVEN MORE RECOURSE EVENTS
• the failure to pay Taxes or Insurance
Premiums in accordance with the
terms of the Loan Documents or the
failure to maintain the Policies
required pursuant to the terms of the
Loan Documents in full force and
effect;
• the forfeiture by Borrower of the
Property, or any portion thereof,
because of the conduct or purported
conduct of criminal activity by
Borrower, Principal or Guarantor or
any of their respective agents or
representatives in connection
therewith;
• if Borrower (A) fails to permit on-site
inspections of the Property, (B) fails
to provide financial information or (C)
fails to appoint a new property
manager upon the request of Lender
as permitted under this Agreement,
each as required by, and in
accordance with, the terms and
provisions of this Agreement or the
Mortgage.
14
SEPARATENESS
COVENANTS – SPE
REQUIREMENTS
SPE COVENANTS ARE
DESIGNED TO KEEP THE
BORROWER SEPARATE
AND ALONE FROM
OTHER ENTITIES – TO
CREATE A SPECIAL
PURPOSE VEHICLE
15
SPE REQUIREMENTS
WHAT TO EXPECT
• REQUIREMENTS FOR SPECIAL PURPOSE ENTITY THAT ARE
EITHER IN THE DEFINITION OF A SPECIAL PURPOSE ENTITY
OR IN A STAND ALONE EXHIBIT.
• LENDER WILL REQUIRE INCORPORATION OF PROVISIONS
INTO THE BORROWER’S (AND ITS GENERAL PARTNER’S, IF A
LIMITED PARTNERSHIP) ORGANIZATIONAL DOCUMENTS.
16
SEPARATENESS COVENANTS
• SEPARATENESS COVENANTS FALL INTO THE FOLLOWING GENERAL
CATEGORIES:
• Limiting the activities of the Borrower to owning and operating a specified
Property.
• Preventing the Borrower from lending its credit to others.
• Preventing the Borrower from using the credit of others.
• Preventing the Borrower from intermingling its affairs with affiliates.
• Ensuring that the Borrower is not being propped up or propping up affiliates
with sweetheart deals.
• Operating as a separate entity.
17
GENERAL REQUIREMENTS
• BORROWER (AND GP) MUST BE ORGANIZED AND OPERATED FOR THE
SOLE PURPOSE OF OWNING THE REAL ESTATE BEING FINANCED.
• BORROWER (AND GP) MUST ADOPT SEPARATENESS COVENANTS
NO COMMINGLING OF ASSETS.
MAINTENANCE OF SEPARATE FINANCIAL RECORDS.
NO JOINT CREDIT (LENDING OR BORROWING CREDIT).
OPERATIONAL SEPARATENESS (PAY ITS OWN BILLS - SEPARATE STATIONARY –
ALLOCATION OF EXPENSES).
• DEBT LIMITATIONS.
• FOR LARGER LOANS, REQUIRE INDEPENDENT MANAGERS OR DIRECTORS.
•
•
•
•
18
GOAL IS TO BE THE
TREE ON THE LEFT
19
EXAMPLES OF SEPARATENESS COVENANTS
• not commingle its funds and other assets with those of any other
Person, except as expressly permitted under the Program Documents.
• conduct its own business in its own name and hold all of its assets in
its own name and in such a manner that it will not be costly or
difficult to segregate, ascertain or identify its individual assets from
those of any other Person.
• pay its debts and liabilities (including employment and overhead
expenses) from its assets as the same become due.
20
MORE COVENANTS
• maintain and prepare financial reports, financial statements, books and records
and bank accounts separate from those of any other Person, except that the
Company’s financial position, assets, liabilities, net worth and operating results
may be included in the consolidated financial statements of an Affiliate, provided
that such consolidated financial statements contain a footnote indicating that the
Company is a separate legal entity and that it maintains separate books and
records.
• maintain an arm’s length relationship with its Affiliates and the Member and not
enter into any contract or agreement with any general partner, member,
shareholder, principal, guarantor of the obligations of the Company, or any
Affiliate of the foregoing, except upon terms and conditions that are intrinsically
fair to the Company, commercially reasonable and substantially similar to those
that would be available on an arm’s-length basis with Persons that are not
Affiliates of the Company.
21
MORE COVENANTS
• not buy or hold any evidence of Indebtedness issued by an Affiliate.
• maintain and utilize separate stationery, invoices and checks bearing
its own name, a separate mailing address, and a separate telephone
number.
• allocate fairly and reasonably for any overhead for shared office
space.
• not hold out its credit or assets as being available to satisfy the
obligations of others.
• not make any loans or advances to, or pledge its assets for the benefit
of, any other Person (except as provided in the Program Documents).
22
DEBT LIMITATION
• with respect to Borrower, incur any debt, secured or unsecured, direct or
contingent (including guaranteeing any obligation), other than the Debt, except
for trade payables in the ordinary course of its business of owning and operating
the Property, provided that such debt (A) is unsecured, (B) is not evidenced by a
note, (C) is due not more than sixty (60) days past the date incurred and is paid
when due and (D) does not at any time exceed two percent (2%) of the
outstanding principal amount of the Note and, with respect to Principal, incur any
debt secured or unsecured, direct or contingent (including guaranteeing any
obligations), except for trade payables in the ordinary course of its business of
owning an interest in Borrower and serving as a manager of Borrower, provided
that such debt (I) is unsecured, (II) is not evidenced by a note, (III) is paid when
due and (IV) does not at any time exceed Ten Thousand and No/100 Dollars
($10,000).
23
CAPITAL AND SOLVENCY
• maintain adequate capital for the normal obligations
reasonably foreseeable in a business of its size and
character and in light of its contemplated business
operations.
• become insolvent or fail to pay its debts and liabilities
from its assets as the same shall become due.
24
EVEN MORE COVENANTS
• fail to maintain its records, books of account and bank records separate and apart
from those of the members, general partners, principals and affiliates of
Borrower or of Principal, as the case may be, the affiliates of a member, general
partner or principal of Borrower or Principal, as the case may be, and any other
Person or fail to maintain such books and records in the ordinary course of its
business.
• enter into any contract or agreement with any member, general partner, principal
or affiliate of Borrower or of Principal, as the case may be, Guarantor or
Indemnitor, or any member, general partner, principal or affiliate thereof, except
upon terms and conditions that are intrinsically fair, commercially reasonable and
substantially similar to those that would be available on an arms-length basis
with third parties other than any member, general partner, principal or affiliate of
Borrower or of Principal, as the case may be, Guarantor or Indemnitor, or any
member, general partner, principal or affiliate thereof.
25
LENDING CREDIT
• own, form or acquire any subsidiary or make any investment in, any Person, other
than Principal's investment in Borrower.
• guaranty or become obligated for the debts of any other Person or hold out its
credit as being able to satisfy the debts of another Person, except if a Principal is
a general partner of Borrower, such an entity may be under state or
commonwealth law liable for the debts of Borrower in its capacity as a "general
partner“.
• make any loans or advances to any third party, including any member, general
partner, principal or affiliate of Borrower, or of Principal, as the case may be, or
any member, general partner, principal or affiliate thereof, nor buy or hold
evidence of indebtedness issued by any other Person (other than cash or
investment grade securities).
26
EVEN MORE COVENANTS
• fail to file its own tax returns, nor file a consolidated federal income tax return
with any other entity, unless required by law.
• fail to hold itself out to the public as a legal entity separate and distinct from any
other Person, fail to conduct its business solely in its own name, mislead others
as to the identity with which such other party is transacting business, or suggest
that Borrower or Principal, as the case may be, is responsible for the debts of any
third party (including any member, general partner, principal or affiliate of
Borrower, or of Principal, as the case may be, or any member, general partner,
principal or affiliate thereof).
27
AND MORE
• fail to pay the salaries of its own employees (if any) from its own
funds.
• fail to maintain a sufficient number of employees in light of its
contemplated business operations.
• fail to allocate fairly and reasonably any overhead expenses that are
shared with an affiliate, including paying for office space and services
performed by any employee of an affiliate.
• pledge its assets for the benefit of any other Person, other than in the
case of Borrower, in connection with the loan secured hereby.
28
FINANCIAL STATEMENTS
• fail to maintain separate financial statements and accounting records,
showing its assets and liabilities separate and apart from those of any
other Person, provided, however, that Borrower's assets may be
included in a consolidated financial statement of its Affiliates
provided that (a) appropriate notation shall be made on such
consolidated financial statements to indicate the separateness of
Borrower and such Affiliates and to indicate that Borrower's assets
and credit are not available to satisfy the debts and other obligations
of such Affiliates or any other Person, and (b) such assets shall be
listed on Borrower's own separate balance sheet.
29
AND MORE
• fail to use separate stationery, invoices and checks bearing its own
name.
• acquire the obligations or securities of any member, general partner,
principal or affiliate of Borrower or of Principal, as the case may be,
Guarantor or Indemnitor, or any member, general partner, principal or
affiliate thereof.
• fail to maintain its assets in such a manner that it will not be costly or
difficult to segregate, ascertain or identify its individual assets from
those of any other entity.
30
AND MORE
• with respect to Borrower, have any obligation to indemnify its partners,
officers, directors or members, as the case may be, or have such an
obligation only if it is fully subordinated to the Debt and will not
constitute a claim against it in the event that cash flow in excess of the
amount required to pay the Debt is insufficient to pay such obligation.
• fail, to the fullest extent permitted by law, to consider the interests of its
creditors in connection with all actions if such entity is a corporation.
• have any of its obligations guaranteed by any member, general partner,
principal or affiliate except Guarantor or Indemnitor.
31
INDEPENDENT DIRECTOR REQUIREMENT
• fail at any time to have at least one (1) duly appointed member of the board of
directors or board of managers (an "Independent Director") who is not at the
time of initial appointment, or at any time while serving as a director or
manager, as applicable, of General Partner, and who has not been at any time
during the preceding five (5) years: (A) a stockholder (or other equity holder),
director (with the exception of serving as the independent director of General
Partner), officer, employee, partner, attorney or counsel of Borrower or any
affiliate thereof; (B) a customer, supplier or other Person who derives any of its
purchases or revenues from its activities with Borrower, Guarantor, Indemnitor
or any affiliate of either of them; (C) a Person controlling or under common
control with any such stockholder, partner, customer, supplier or other Person; or
(D) a member of the immediate family of any such stockholder (or other equity
holder), director, officer, employee, partner, customer, supplier or other Person.
32
INDEPENDENT DIRECTOR’S ROLE
• allow or cause General Partner to take any action requiring the unanimous vote
of its Board of Directors unless the Independent Director shall participate in such
vote; or
• take for itself or cause any other entity to take any of the following actions
without the unanimous consent of its partners or members, as applicable, and
the unanimous affirmative vote of the Board of Directors of General Partner
(including the Independent Director): (A) file or consent to the filing of any
bankruptcy, insolvency or reorganization case or proceeding, (B) institute any
proceedings under any applicable insolvency law or otherwise seek any relief
under any laws relating to the relief from debts or the protection of debtors
generally, (C) seek or consent to the appointment of a receiver, liquidator,
assignee, trustee, sequestrator, custodian or any similar official for itself or any
other entity, (D) make an assignment of its assets for the benefit of its creditors
or an assignment of the assets of another entity for the benefit of such entity's
creditors, or (E) take any action in furtherance of the foregoing.
33
OTHER RELATED LLC AGREEMENT
PROVISIONS
• PROVISIONS THAT PREVENT AMENDMENTS TO THE LLC AGREEMENT
THAT WILL STRIP OUT OR CHANGE THE BANKRUPTCY REMOTE
PROVISIONS.
• SUBORDINATE INDEMNIFICATION PROVISIONS TO REPAYMENT OF
THE LOAN.
• IN LARGER LOANS, HAVE INDEPENDENT DIRECTORS/MANAGERS
WHOSE APPROVAL IS REQUIRED FOR CERTAIN ACTIONS.
34
ENFORCEMENT OF
GUARANTIES
READ AND WEEP.
GUARANTORS GET NO
SYMPATHY FROM
COURTS – CARVEOUTS
ARE ENFORCED AS
WRITTEN.
35
DEFENSES TO LIABILITY THAT HAVE FAILED
• In re Inn at Woodbridge 2015 WL 1013585 (D. N. J. 2015) is typical.
• BREACH OF NON-RECOURSE CARVE-OUTS NOT CONTESTED.
VARIOUS ARGUMENTS TO AVOID ENFORCEMENT DENIED.
• NOT A BREACH OF COVENANT OF GOOD FAITH AND FAIR DEALING
(IMPLIED COVENANT CANNOT OVERRIDE EXPRESS TERMS OF A
CONTRACT).
• NOT AGAINST PUBLIC POLICY.
• NOT UNREASONABLE PENALTY.
36
CASE LAW
• Wells Fargo Bank N.A. v. Cherryland
Mall L.P., 295 Mich. App. 99, 812 N.W.2d 799 (2011).
VIOLATION OF SPE COVENANTS LED TO FULL RECOURSE.
SPE COVENANTS PROVIDED:
Mortgagor is and will remain solvent and Mortgagor will pay its debts
and liabilities (including, as applicable, shared personnel and overhead
expenses) from its assets as the same shall become due.
HELD: Full Recourse (subsequently addressed by legislation upheld in
Borman, LZLC. V. 18718 Borman, LLC 2014 WL 943181
37
HELLER FINANCIAL INC. V. LEE
2002 WL 188591 (N. D. ILL. 2002)
• RECOURSE FOR BREACH OF COVENANT THAT THE BORROWER
WOULD NOT GRANT OR PERMIT THE FILING OF ANY LIEN OR
ENCUMBRANCE ON THE PROJECT.
• THIRD PARTY HOTEL MANAGER MANAGED THE PROJECT.
• TAX LIENS FILED.
• MECHANICS LIENS FILED.
• NO LIEN BONDED.
• GUARANTORS CLAIMED NO KNOWLEDGE OF LIENS.
• HELD LIABLE – NOT UNENFORCEABLE PENALTY
38
BLUE HILLS OFFICE PARK, LLC V. J. P. MORGAN
CHASE BANK
477 F. Supp. 2nd 366 (D. Mass, 2007)
• Borrower got paid $2,000,000 to dismiss a zoning appeal relating to
an adjacent property – kept the money and did not tell the Lender.
• Borrower failed to pay real estate taxes.
• Alleged settlement constituted transfer of the Mortgaged Property to
trigger recourse – HELD Zoning Appeal Settlement was part of the
Mortgaged Property.
• Guarantors Liable.
39
REPORTING REQUIREMENTS
• U.S. BANK N. A. V. GREEN MEADOW SWS LLC, ET AL (OHIO, 2013 AND
UPHELD IN 2014)
• FULL LIABLITY FOR VIOLATION OF A REPORTING REQUIREMENT (TWO
LENDER NOTICES AND THIRTY DAYS’ TO CURE).
• NOTICE FAILED TO INCLUDE C/O ADDRESS.
• HELD LIABLE FOR FULL RECOURSE – FAILURE TO SEND C/O NOT FATAL.
40
FILING A BANKRUPTCY PETITION OR AIDING
(even if the petition is unauthorized and dismissed)
• 111 DEBT ACQUISITION HOLDINGS, LLC V. SIX VENTURES LTD, ET AL. 413
Fed. Appx. 824
(6TH Cir., 2011)
• One of the Guarantors caused a bankruptcy petition to be filed for the
borrower.
• Full recourse for filing or aiding in the filing of a bankruptcy petition
• Summary judgment for lender affirmed
• Guarantor who filed did not have the authority to file (needed other
Guarantor’s consent) and petition was dismissed.
• See also 8375 Honeytree Boulevard Holdings, LLC V. Starman et. al. (Mich.
2012)
41
RAYS OF HOPE FOR
GUARANTORS
THERE ARE A FEW CASES WHERE
LIABILITY HAS BEEN DENIED
JLM FINANCIAL INVESTMENTS V
AKTIPIS (U. S DT. CT, N, D,., ILL,
2013) and CP III Rincon Towers v.
Cohen (Dt. Ct. S. D. N. Y., 2014)
13 F. Supp. 3rd 307
Recourse was tied to imposition
of “voluntary liens” - held
mechanics liens were not
voluntary liens.
Rincon court also held that
mechanics liens did not violate
the transfer restrictions .
42
Wells Fargo Bank, N. A. v. RLJ Lodging Trust
2016 WL 427487 (N. D. Ill. 2016)
• Non-recourse loan. Borrower sought to do a deed in lieu of
foreclosure.
• Lender filed foreclosure action.
• Borrower filed an answer, including affirmative defenses and denials.
• Borrower dismissed affirmative defenses etc. but delayed foreclosure
sale by three months.
• Loan documents provided recourse to Guarantor if Borrower in a
material way interfered with Lender’s foreclosure action.
• Court held fact question as to whether the delay was material.
43
GENERAL GROWTH PROPERTIES
In re General Growth Properties, 409 B.R. 43 (Bankr. S.D.N.Y. 2009)
• MANY “BANKRUPTCY REMOTE SPES” FILED BANKRUPTCY
• INDEPENDENT DIRECTOR (FROM A SERVICE PROVIDER) WAS
REPLACED PRIOR TO AUTHORIZATION BY ANOTHER PERSON WHO
SATISFIED THE DEFINITION OF INDEPENDENT DIRECTOR – NO NOTICE
TO LENDER.
• BANKRUPTCY WAS FILED TO PROTECT THE PARENT COMPANY OF THE
ENTITIES.
• WHEN APPROPRIATE, THE BANKRUPTCY REMOTE ENTITIES WORKED
OUT EXTENSIONS OR MODIFICATIONS.
44
GENERAL
GROWTH
LENDER’S COUNSEL
PANICKED WHEN
GENERAL GROWTH
AND MANY
SUBSIDIARY SPES
FILED FOR
BANKRUPTCY.
45
LENDERS LOST CONTROL
BUT:
• COURT RESPECTED THE SEPARATENESS OF THE PROPERTY OWNERS.
• PROPERTY OWNERS WITH DEFAULTS OR PENDING DEFAULTS DUE TO
MATURITY NEGOTIATED EITHER LOAN AMENDMENTS/EXTENSIONS
OR DEED IN LIEU OR FORECLOSURES.
• LENDERS WERE PROTECTED.
46
EFFECT OF GENERAL GROWTH CASE
• INDEPENDENT DIRECTORS MUST COME FROM RECOGNIZED
PROVIDERS.
• MUST GIVE LENDER NOTICE TO REPLACE INDEPENDENT DIRECTORS.
• BOARD OF DIRECTORS/MANAGERS MAY BE REQUIRED TO CONSIDER
THE INTERESTS OF CREDITORS IN ACTING.
• LENDERS ARE RELUCTANT TO CUT OR ELIMINATE BACK SPE
COVENANTS.
47
PRACTICE SUGGESTIONS
FOR BORROWER’S
COUNSEL
READ RECOURSE CARVEOUTS CAREFULLY.
IF A VIOLATION OF SPE
PROVISIONS IS A
RECOURSE CARVE OUT –
READ SPE PROVISIONS
CAREFULLY.
48
CHECKLIST
• REVIEW LIMITATIONS IN INCURRENCE OF INDEBTEDNESS TO MAKE
SURE THAT THEY CAPTURE ALL EXPECTED DEBT - CONSIDER
REQURING THAT THE COVENANT DOES NOT REQUIRE ADDITIONAL
CAPITAL CONTRIBUTIONS.
• DETERMINE IF ANY OF THE PROVISIONS HAVE BEEN OR WILL BE
VIOLATED
• FOR EXAMPLE – CHECK TO SEE IF ANY SUBIDIARIES (TYPICALLY PROHIBITED).
• IF THERE IS A JOINT BORROWER – THERE IS JOINT CREDIT (BUT THIS SHOULD
BE A PERMITTED EXCEPTION).
• IF THERE IS A JOINT BORROWER THERE MAY BE COMMINGLING AMONG
BORROWERS.
• THERE ARE ALMOST ALWAYS SOME GUARANTIES.
49
THINGS TO WATCH FOR AS BORROWER
COUNSEL
• DETERMINE IF MECHANICAL ITEMS WILL BE COMPLIED WITH –
TYPICALLY BANKRUPTCY REMOTE ENTITIES ARE REQUIRED TO
ALLOCATE SHARED OFFICE SPACE, PAY ALLOCABLE SHARE OF
COMMON EXPENSES AND MAINTAIN SEPARATE STATIONARY
(GENERALLY THESE ARE MANDATORY).
• MAINTAINING RECORDS SO THAT ASSETS AND LIABLIITIES OF THE SPE
CAN BE ASCERTAINED WITHOUT DIFFICULTY IS AN ABSOLUTE
REQUIREMENT.
50
THINGS TO WATCH FOR AS BORROWER
COUNSEL
• DETERMINE IF VIOLATION OF THE SEPARATENESS COVENANTS CAN
TRIGGER RECOURSE IN FINANCING.
• IF A VIOLATION CAN TRIGGER RECOURSE, READ THE SEPARATENESS
RESTRICTIONS CAREFULLY.
• SHOULD NOT PROMISE TO REMAIN SOLVENT, CURRENT PRACTICE IS TO
REQUIRE THAT THE BORROWER COVENANT TO INTEND TO REMAIN SOLVENT.
• COVENANTS THAT REQUIRE THE BORROWER TO PAY ITS OBLIGATIONS FROM
ITS OWN FUNDS SHOULD BE LIMITED SO THAT “nothing in this clause shall be
interpreted to mean that the holder of any partnership interest, member
interest, or shareholder in the Special Purpose Entity shall have any obligation
to make additional capital contributions beyond their initial capital
contributions.”
51
• BORROWER SHOULD COVENANT TO INTEND TO REMAIN SOLVENT.
• LIMITATIONS ON DEBT, MAINTENANCE OF ADEQUATE CAPITAL,
PAYMENT OF EXPENSES FROM OWN FUNDS, PAYMENT OF TAXES AND
THE LIKE SHOULD BE QUALIFIED BY (A) NOT REQUIRING THE
PRINCIPALS TO MAKE ADDITIONAL CAPITAL CONTRIBUTIONS,
AND/OR (B) SO LONG AS CASH FLOW FROM THE PROPERTY IS
SUFFICIENT.
• GUARANTORS SHOULD SEEK TO BE SURE RECOURSE IS TRIGGERED BY
THEIR ACTIONS OR ACTIONS WITHIN THEIR CONTROL.
• GUARANTORS (WITH MONEY) SHOULD CONTROL BANKRUPTCY
FILINGS.
52
• REVIEW STRUCTURE OF TRANSACTION TO ENSURE THAT THE
TRANSCTION DOES NOT CONTAIN ITEMS THAT WOULD CONSTITUTE
VIOLATIONS OF THE SPE COVENANTS.
• CO-BORROWERS.
• CONTRACTS WITH AFFILIATES THAT ARE FAVORABLE TO THE BORROWER BUT
NOT ON ARMS-LENGTH TERMS.
53
• REVIEW SPE PROVISIONS TO ENSURE NONE REQUIRE SPECIAL ACTION
BY YOUR CLIENT FOR COMPLIANCE.
• FOR EXAMPLE, A COVENANT TO KEEP WRITTEN MINUTES OF BOARD
MEETINGS IS A LIKELY CULPRIT TO BE VIOLATED.
• LIMIT RECOURSE FOR SPE VIOLATIONS TO SITUATIONS WHERE
SUBSTANTIVE CONSOLIDATION OCCURS (TO THE EXTENT POSSIBLE).
• REVIEW TRANSFER PROVISIONS CAREFULLY – PARTICULARLY TO
MAKE SURE THAT INDIRECT TRANSFERS DO NOT TRIGGER LIABILITY
(UNLESS YOUR CLIENT CAN CONTROL SUCH TRANSFERS).
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OTHER TIPS
• SEEK TO LIMIT IMPOSITION OF LIENS TO VOLUNTARY LIENS (OR
PROVIDE A CURE PERIOD TO BOND OFF MECHANICS LIENS).
• PROVIDE FOR PERIOD IN WHICH TO GET BANKRUPTCY PROCEEDINGS
DISMISSED BEFORE LIABLITY IS INCURRED (HOWEVER, TIME IS LIKELY
TO BE SHORT AND DISMISSALS ARE NOT EASY TO OBTAIN).
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RECYCLED ENTITIES
• “RECYCLED” MEANS ANY ENTITY WITH A PAST – EVEN IF ITS PAST
WAS JUST OWNING THIS PROPERTY.
• REQUIRES ADDITIONAL REVIEW OF SEPARATENESS COVENANTS SO
THAT ANY KNOWN PAST VIOLATIONS ARE NOTED AND DISCLOSED.
FOR EXAMPLE
• NOTE ANY OTHER PROPERTY THAT MAY HAVE BEEN OWNED.
• NOTE PRIOR DEBT.
• ADD REP THAT PRIOR DEBT HAS BEEN REPAID.
• DISCLOSE PRIOR GUARANTIES.
• IF NO TRANSFER AND RECORDATION TAX OR OTHER COST ISSUES –
CONSIDER TRANSFERRING PROPERTY TO A NEW ENTITY.
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SUBSTANTIVE CONSOLIDATION
• ALLOWS A DEBTOR IN BANKRUPTCY TO COMBINE ITS ESTATE WITH
THE ESTATE OF EITHER ANOTHER DEBTOR OR (EVEN WORSE) A
SOLVENT AFFILIATE SO THAT THE ENTITIES ARE TREATED AS ONE
WITH COMMON CREDITORS.
• RATING AGENCIES AND LENDERS REQUIRE NONCONSOLIDATION
OPINIONS TO DOCUMENT THAT STRUCTURE IS INTENDED TO AVOID
THE RISK.
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NONCONSOLIDATION OPINIONS
• REASONED OPINIONS – DISCUSS LAW (WHICH IS BASED IN EQUITY
AND GENERAL BANKRUPTCY POWER) AND APPLY GENERAL
PRINCIPLES TO THE FACTS.
• PAIRINGS – THE OPINION IS BASED ON PAIRINGS. GENERALLY FOR
AN LLC THE BORROWER IS ONE SET AND THE OWNERS OF 50% OR
MORE OF THE BORROWER AND RELATED PROPERTY MANAGERS AND
GUARANTORS (WHO TYPICALLY CONTROL MANAGEMENT OF THE
BORROWER) ARE THE OTHER SET (THE “OTHER PARTIES”).
• IN AN LP, THE GP AND THE BORROWER ARE ONE SET OF THE
PAIRINGS.
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• BAD FACTORS
• COMMINGLING OF ASSETS
• GUARANTIES
• TYPICAL NON-RECOURSE CARVE OUT PROVISIONS WILL NOT PREVENT
RENDERING A NONCON OPINION.
• GUARANTIES OF PRINCIPAL CAN AFFECT OPINION – MUST BE LIMITED
BUT NOT HARD AND FAST RULE (10-25% OF TOTAL LOAN WITH BURN OFF
PROVISIONS).
• GUARANTIES OF UNLIMITED FINANCIAL OBLIGATIONS CAN BE A
PROBLEM.
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• RECOURSE PROVISIONS THAT PROVIDE FOR OPEN-ENDED RECOURSE
• OPINION GIVERS WILL READ THE RECOURSE PROVISIONS AND RELATED
COVENANTS.
• OPINION GIVERS MAY REQUEST CHANGES TO COVENANTS –
PARTICULARLY COVENANTS INTENDED TO DEAL WITH A PARTICULAR RISK
IN THE PARTICULAR DEAL.
• LENDERS MAY ACCEPT OPINIONS THAT ASSUME THAT PARTICULAR
COVENANTS ARE NOT APPLICABLE OR WILL NOT RESULT IN SUBSTANTIVE
CONSOLIDATION RATHER THAN CHANGE THE LOAN DOCUMENTS.
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• OPINION “it is our opinion that, under present reported decisional
authority and statutes applicable to federal bankruptcy cases, and in a
properly presented case, if any of the Other Parties were to become a
debtor(s) in a case under the Code, regardless of which of the
approaches or standards the court would elect to follow, a court
would not order substantive consolidation of the assets and liabilities
of Borrower with those of any of the Other Parties.”
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Speakers’ contact information
• Harriet Alexson, Bohm Wildish, LLP, 695 Town Center Dr., Suite 700,
Costa Mesa CA 92626 714.384.6500
• Peter Munoz, Reed Smith, 101 Second Street, Suite 1800, San
Francisco, California 94105 415.659.5964
• Edward Wender, Venable LLP, 750 E. Pratt Street, Suite 900, Baltimore,
Maryland 21202
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