Reported by Cameron Weil and Dustin W. Lauermann

Special Purpose Entities in Commercial Real Estate Transactions

Corporate structures in commercial real estate transactions can often be very complex and involve layers of entities. Special purpose entities that are bankruptcy remote (“SPEs”) are frequently used in commercial real estate loans to limit certain risks associated with a bankruptcy filing involving a borrower or its property. This applies to loans originated by CMBS (commercial mortgage-backed securities), agency (Fannie Mae and Freddie Mac), and certain other lenders. Lenders typically care about bankruptcy risk related to either (i) the borrower’s actions, such as property operation, actions by or with respect to the borrower or its assets or liabilities that could lead to consolidation with other entities in bankruptcy, or the filing of voluntary bankruptcy, and (ii) a related party’s or parent entity’s actions that could taint the subsidiary or affiliated borrower.

Different lenders have different requirements when it comes to their SPE borrowers.  Most lenders, however, require many of the same general concepts driven by bankruptcy court decisions. Generally, the entity must be formed for a limited purpose (such as owning and operating only the real estate collateralized for the loan) and contain “separateness covenants”, which ordinarily require the owners of an entity to operate their subsidiary as a separate legal entity. 

Additionally, to qualify as a bankruptcy-remote SPE, an entity will also often be required to have “independent directors” or “independent managers” (which we will call, “Independent Directors” for ease), and “Springing Members,” both of whom are appointed and named in an entity’s operating agreement. An Independent Director’s primary purpose is to approve such entity’s bankruptcy filing, thus limiting a borrower’s ability to take actions that are commonly associated with bankruptcy-related matters (e.g., filing a voluntary bankruptcy petition, consenting to the appointment of a receiver, making an assignment for the benefit of creditors, or admitting in writing its inability to pay debts). In the event that a non-SPE member ceases to be a member of the limited liability company, the inclusion of Springing Member provisions in the entity’s operating agreement and appointment of a Springing Member ensures that the Springing Member automatically becomes a member of the entity without the need for any further act; in turn, this allows the entity to continue conducting its business in lieu of being forced to dissolve.

Corporate Transparency Act Considerations for Special Purpose Entities

There are a number of considerations that lenders and borrowers should think about when using SPEs in transactions, including the following:

First, the Springing Member should have no current or contingent ownership interest, management rights or responsibilities in the SPE entity, and should only be considered a member if there is no other member of the limited liability company. This will help the argument that the Springing Member does not need to be listed in a BOI report at closing.  However, if the Springing Member later steps in and has a vote in “major decisions” or otherwise meets the criteria for ownership or substantial control, an amendment to the BOI report will be required, identifying such Springing Member.  Similarly, if an Independent Director is required, the entity should seek additional guidance from counsel to determine whether the Independent Director’s control of the entity’s ability to file for bankruptcy, together with any other rights of the Independent Director, constitutes “substantial control” of the entity for CTA purposes.  If it is determined that the Independent Director’s level of control rises to that level, the Independent Director will likely need to be disclosed in an initial or updated BOI report.

Second, in order to minimize the likelihood of civil and/or criminal penalties, among other things, the parties should clarify (either in the operating agreement or engagement letter) who has the obligation to file the updated BOI report in the event that the Springing Member becomes the sole member of the company. This is particularly important when a corporate service company acts as either a Springing Member or an Independent Director and also provides BOI report-filing services under completely separate engagements.

Last, given the potential liability related to filing (or not filing) a BOI report, many service providers now either specifically disclaim any liability related to the CTA in their engagement letters or require an entity to indemnify them for such liability. When the service provider is serving as a Springing Member or an Independent Director and also providing BOI report-filing services, the borrower should be cautious about waiving liability to or indemnifying a service provider with respect to the CTA to ensure that the borrower is not civilly or criminally liable for the service provider’s failure to comply with the CTA.  In particular, a waiver of liability for CTA-related matters should be limited only to the Springing Member and Independent Director services in question, and such waiver should not be so expansive as to include other services being separately provided by the same corporate services provider.

Read full report: https://www.seyfarth.com/news-insights/the-corporate-transparency-act-considerations-for-special-purpose-entities-in-commercial-real-estate-transactions.html