The U.S. Bankruptcy Court for the Southern District of New York recently declined to dismiss the Chapter 11 petitions of several subsidiaries of General Growth Properties, Inc. (GGP) demonstrating that special purpose entities (SPEs), designed to avoid bankruptcy, can be subject to bankruptcy proceedings despite having strong cash flows, no debt defaults and "bankruptcy remote" structures.
GGP, the second largest mall operator in the U.S., filed a bankruptcy petition in April 2009, and shortly thereafter 166 SPE borrowers that were affiliates of GGP also filed bankruptcy petitions. While GGP's bankruptcy had been widely expected, the concurrent bankruptcy petitions of the SPEs had not. Mortgage lenders and borrowers have closely watched the GGP bankruptcy because of concerns that the SPEs bankruptcies, if allowed to stand, could call into question the utility of the bankruptcy remote structures used throughout the real estate finance industry -- going so far as to suggest that, unless dismissed, the SPE bankruptcy filings could have a catastrophic impact on Commercial Mortgage Backed Securities (CMBS) lending.
The SPEs, which owned the malls operated by GGP, had collectively borrowed approximately $1.83 billion from lenders, secured by one or more malls. Certain lenders asked the Court to dismiss the SPEs bankruptcy petitions arguing, among other things, that the SPEs had filed in bad faith because they were not insolvent at the time of the filings and had bankruptcy remote structures. The Court focused on the functionality of the SPE in GGP's overall business. The weaknesses in the SPE structure exposed by the GGP ruling was the requirement under Delaware law that independent directors must consider not only the interests of the creditors, but also the interest of the shareholders.
In this instance, the shareholders included GGP as the ultimate parent entity. Although the SPEs did not have loans maturing for up to three years and none were in immediate danger of defaulting, the Court held that it was not premature or in bad faith for the SPEs to file bankruptcy because, with the unprecedented collapse of the real estate market and serious uncertainly about when (and if) CMBS financing would be available, GGP had little choice other than to reorganize the entirety of the GGP enterprise capital structure through a bankruptcy filing. Therefore, it was appropriate to file bankruptcy at an early point to preserve the value of the group because GGP and each SPE would not otherwise be able to successfully restructure its debt when it came due.
The Court noted that the fundamental protections that the lenders negotiated and that the SPE structure represents are still intact, including protection against the substantive consolidation of project-level debtors with any other entities. However, this ruling serves as a timely reminder to lenders that "bankruptcy remote" does not mean "bankruptcy proof."