On April 16, General Growth Properties, Inc. and certain of its
affiliates ("GGP") filed for Chapter 11 bankruptcy in the
United States Bankruptcy Court for the Southern District of New
York. GGP operates a national network of approximately 200 shopping
centers. To the surprise of many, most of GGP's
property-specific SPE subsidiaries ("SPE Debtors") also
filed for bankruptcy.
On April 17, Judge Allen Gropper consolidated the Chapter 11 cases
for procedural purposes only. Subsequently, GGP filed motions
seeking authorization to continue using an existing centralized
cash management system to use cash flow from its shopping centers,
including those owned by the SPE Debtors, and to obtain
debtor-in-possession ("DIP") financing.
Several of the SPE Debtors' mortgage lenders ("SPE
Lenders") filed objections to GGP's motions and filed
motions to dismiss the bankruptcies of their SPE Debtors on the
grounds that such entities are solvent, adequately capitalized and
have sufficient cash flow to pay their current obligations,
including debt service. Some SPE Lenders also raised concerns about
the legal separateness of the SPE Debtors, and the impact that
their inclusion in GGP's bankruptcy case might have on the
future of structured finance transactions.
On May 14, 2009, Judge Gropper entered an order granting GGP's
motions to use net cash flow generated from properties encumbered
by secured debt, and approved a $400 million DIP loan from a group
of lenders. In granting the motions, Judge Gropper stated that
those measures were "necessary to prevent substantial harm to
the Debtors' estates that would otherwise result if the Debtors
fail to obtain the [DIP] financing contemplated herein to preserve
the Debtors' assets and continue their operations."
However, Judge Gropper also ordered that the SPE Lenders were
entitled to adequate protection of their interests in their
respective prepetition collateral. Judge Gropper specifically
ordered, among other things, that to the extent of the diminution
in value of their prepetition collateral (as determined by the
court), the SPE Lenders are entitled to postpetition perfected
first priority liens on funds in GGP's main operating account
and intercompany claims among the Debtors based upon the
property-specific net cash that flows into the Debtors'
centralized cash management system.
Judge Gropper's ruling has been positively received by the CMBS
community, and has been viewed as affirming the sanctity of single
purpose entities. The GGP case is not over, and several questions
remain unanswered, but following are some thoughts and observations
to keep in mind:
The issue of whether the SPE Debtors could or should be
substantively consolidated was not before the court. The various
filings were procedurally consolidated only. The value of the
non-consolidation opinions that populate the loan closing binders
in countless real estate finance transactions has not been called
into question.
All of the "bells and whistles" that real estate lenders
and their counsel have been requiring to ensure bankruptcy
remoteness remain effective deterrents against the risks that they
were designed to mitigate. That is, those bells and whistles are
intended to prevent a solvent parent entity from causing its
insolvent SPE to file for bankruptcy protection as a defensive
maneuver to stave off a foreclosure. Specifically, the threat of
personal recourse to a solvent parent entity being triggered by the
voluntary or collusive bankruptcy filing at the SPE level should
continue to be an effective deterrent. And the independent
directors of an insolvent SPE owe a fiduciary duty to the creditors
of the SPE, chiefly its mortgage lender, and the downside of
breaching those fiduciary duties is significant. The GGP case
turned the assumed fact pattern on its head—here a
financially troubled parent dragged many solvent SPEs into
bankruptcy. The recourse trigger against a parent that already is a
debtor in a bankruptcy proceeding has absolutely no deterrent
value, and the independent directors of the solvent SPE have a
fiduciary duty to the equity holders, which in this case would be
an insolvent GGP entity that would benefit from the inclusion of
the SPEs in the bankruptcy case.
The reality is that real estate lenders, while relying in the
abstract on the separateness and bankruptcy remoteness of
property-level SPEs, did not use—and likely could not
have used—structure to mitigate the risks that have been
highlighted in the GGP case. In short, proper structuring can make
the borrower entities bankruptcy "remote," but not
bankruptcy "proof." While the risks highlighted in the
GGP case are more pronounced when the borrower is an SPE subsidiary
of a REIT or other large, corporate owner of real estate, lenders
undoubtedly will continue to make loans to such SPEs, but with some
additional mitigating measures.
Clearly, the creditworthiness of the ultimate parent will be much
more relevant and will require more underwriting due diligence.
Excessive leverage at the parent level, especially when the parent
level income is tied almost exclusively to the performance of a
narrow sector of the real estate market, might render the parent
susceptible in the event of a significant economic downturn.
Increased focus on this risk eventually may impact the pricing of
the subsidiary's debt.
In the case of a REIT or large corporate sponsor, a related factor
to consider will be the timing of mortgage debt maturities in its
portfolio of property specific SPEs. GGP often utilized five-year
debt, and its portfolio had maturity concentrations. One way to
mitigate that risk is to employ the "hyper-amortization"
loan structure, in which the loan has an anticipated repayment date
of five to 10 years after the initial closing, but does not
technically mature for some greatly extended period. This structure
allows the borrower to avoid a maturity default, but provides that
excess cash flow after the anticipated repayment date be swept to
the lender and used to repay outstanding principal. The
hyper-amortization structure is not perfect (and the cash sweep
feature after the anticipated repayment date presents other
potential issues), but may become more common in the wake of the
GGP case.
Property-level cash management, which often was waived or
structured as "springing" in the case of institutional
sponsors, will likely become more prevalent. One of the issues in
the GGP case was the fact that property-level cash flows were
commingled in a parent-level operating account, which facilitated
the argument that the DIP lenders should be granted a first
priority lien on those cash flows. Segregation of property-level
cash flow through the use of lender controlled accounts, with only
excess cash flowing to the commingled operating account, likely
will become common.
Many of the SPE Lenders were REMIC trusts ("CMBS
Lenders"). One criticism that GGP had of the CMBS Lenders was
that they could not get any response to their request for relief
with respect to looming maturities for which refinancing was not
available. Whether or not those suggestions were accurate, they
highlight a difficult issue that CMBS Lenders will face when
dealing with parent-level financial stress. When a particular SPE
owns a property that is performing well, under a Pooling and
Servicing Agreement, a master servicer will have no authority to
modify the loan, or to transfer the asset to the special servicer.
Since the loan must be in default (or imminent default) for the
special servicer to have any significant latitude in modifying the
loan or otherwise addressing the parent-level stress, the current
CMBS structure will be an impediment even if the servicer is
sympathetic. One possible patch might be to include parent-level
financial covenants so that parent-level financial stress can be an
express event of default, which would allow the special servicer to
engage the borrower prior to a parent bankruptcy filing.
In the next chapter in this evolving story, on June 17, 2009, Judge
Gropper will hear the motions of the various SPE Lenders to dismiss
the bankruptcy cases of the SPE Debtors for cause as bad faith
filings. The arguments in support of those motions fall into two
general categories. The first category of arguments suggest that
there was no financial justification for the bankruptcy filings,
and that the filings result in no benefit and only burdens to the
SPE Debtors. The second category turns on the authority for the
bankruptcy filings under the organizational documents of the SPE
Debtors and applicable state law, the propriety of actions taken on
the eve of bankruptcy to replace independent managers of the SPE
Debtors, and the failure to adhere to the other governance and
contractual documents of the SPE Debtors. There is case law
addressing motions to dismiss related to both categories, and it is
clear that the courts have required rather egregious conduct to
support a bad faith filing determination. Here, if Judge Gropper
were to find that the bankruptcy filings of the SPE Debtors were
made without requisite authority under the organizational and
governance documents and applicable state law, the court could
determine the motions to dismiss without addressing the allegations
of bad faith.
The shockwaves have subsided, but the GGP case is providing a
formidable test to many things the lenders, especially lenders
involved in the securitization market, hold sacrosanct. The damage
so far has been minimal, but the case has exposed some chinks in
the armor that will need to be considered when real estate lending
resumes.
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