Protecting Lenders In Structured Financing Transactions: The Utility Of 'Bankruptcy-Remote' Entities Following In Re GGP Properties, Inc.

In 2009, Judge Allan L. Gropper of the U.S. Bankruptcy Court for the Southern District of New York issued several remarkable rulings in the bankruptcy In re GGP Properties, Inc.1 ("GGP"). Participants in structured credit markets initially expressed their "grave concern" regarding the potential "catastrophic impact" of the GGP rulings.2 While the ultimate effects of the rulings remain unsettled, they do demand that lenders reconsider the limits of protection manufactured through the use of "bankruptcy-remote" special purpose entities in structured-financing transactions.

Background

Borrowers regularly use special purpose entities ("SPEs") to increase access to structured credit markets. The advantages of financing through an SPE are built into the operating documents, which typically include separateness covenants and limited recourse provisions that seek to make the SPE "bankruptcy-remote" to protect lenders from becoming entangled in insolvency proceedings in separate areas of an SPE's Company.

GGP was a publicly-held shopping mall owner, and the second-largest mall operator in the United States. Most of its real estate properties were held by individual SPE subsidiaries, who directly owed the debt for financing agreements on the properties but in a structure that kept the assets separate from credit risk elsewhere in the Company. This enabled lenders to have their loans secured by the relatively predictable cash flows from specific real estate assets.

GGP had historically satisfied its capital funding needs through commercial mortgages, relying on the market for commercial mortgage-backed securities ("CMBS"). GGP's debt was typically secured by SPE-owned shopping center properties. GGP's CMBS funding model impelled it to regularly refinance SPE-held debt before exploding repayments scheduled near maturity became due.

Notable Rulings

Judge Gropper made two critical rulings that immediately reverberated across the credit markets: first, that the well-capitalized, solvent SPEs were included in GGP's voluntary bankruptcy filing, and second, that GGP's debtor-in-possession ("DIP") financing facility could be secured by excess rents generated by the SPE subsidiaries. Collectively, these rulings undermined the previously assumed effectiveness of SPEs' structure to isolate its assets from affiliated entities.3

Although the GGP rulings addressed credit in the CMBS market, the implications of the rulings cast doubt on what were thought to be...