On April 16, 2009 and April 22, 2009, General Growth Properties, Inc. (“GGP”) and certain of its subsidiaries (the “Debtors”), including many subsidiaries structured as special purpose entities (the “SPE Debtors”), filed voluntary petitions for relief under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the Southern District of New York (the “Court”). Subsequent to the Court entering orders approving first-day motions authorizing the Debtors to continue using the prepetition centralized cash management system, obtain debtor-in-possession financing and use cash collateral, certain lenders and special servicers filed motions to dismiss (the “Motions”) the Chapter 11 filings of certain SPE Debtors (the “Subject Debtors”) on the grounds that the filings were in bad faith. On Aug. 11, 2009, Judge Allan L. Gropper (“Judge Gropper”) entered a memorandum of opinion (the “Opinion”) denying the motions to dismiss, finding, in part, that the independent managers1 of the Subject Debtors had a prima facie duty to act in the interests of the entity and its shareholders (as opposed to the SPE lenders), and that a decision to file for Chapter 11 protection may be in good faith when based on “consideration of the interests of the group as well as the interests of the individual debtor.”

Opinion at 30.

SPEs Generally As discussed in the Opinion, the organizational or transactional documents of an SPE often require the appointment of one or more independent managers whose consent is required for the SPE to undertake certain material acts, including the filing of a voluntary bankruptcy petition. In addition to separateness covenants, which provide comfort to lenders that the SPE will act as an independent entity, SPE documents generally also contain restrictions on additional indebtedness as well as on the business activities that the entity may conduct. Such elements are intended, in part, to make SPEs “bankruptcy remote” and, as intended by the Movants, to “insulate the financial position of each of the Subject Debtors from the problems of its affiliates, and to make the prospect of a default less likely.” Opinion at 28.

Motions to Dismiss The Movants argued that the Chapter 11 filings of the Subject Debtors were premature as some loans to the Subject Debtors are not scheduled to mature for several months and that “the Debtors had a good faith obligation to delay a Chapter 11 filing until they were temporally closer to an actual default.” Opinion at 24. In considering whether the filings were in good faith, the Movants urged the Court to “consider only the financial circumstances of the individual Debtors,” arguing that “consideration of the financial problems of the Group in judging the good faith of an individual filing would violate the purpose of the SPE structure.”

Opinion at 27.

In response to the Movants’ claims that the filings were premature, Judge Gropper noted in the Opinion that the Bankruptcy Code does not require debtors to be insolvent prior to filing for bankruptcy protection and, in fact, is intended to “incentivize a debtor to file earlier rather than later, so as to preserve the value of the estate.” Opinion at 26. In response to the Movants’ argument that the Court should consider “only the financial circumstances of the individual Debtors” rather than the interests of the larger corporate structure, Judge Gropper noted that the Movants were aware “that they were extending credit to a company that was part of a much larger group, and that there were benefits as well as possible detriments from this structure. If the ability of the Group to obtain refinancing became impaired, the financial situation of the [SPEs] would inevitably be impaired.” Opinion at 28.

The operating agreements of certain of the Subject Debtors provided support for Judge Gropper’s finding that the independent managers acted properly in voting to file for Chapter 11 protection. The independent manager provisions in those agreements provided that the independent managers “shall consider only the interests of the Company, including its respective creditors, in acting or otherwise voting” on certain matters, including the filing of any bankruptcy petition. Opinion at 31. The operating agreements also provided, however, that “in exercising their rights and performing their duties…any Independent Manager shall have a fiduciary duty of loyalty and care similar to that of a director of a business corporation organized under the General Corporation Law of the State of Delaware,” which provides that directors must consider the interests of shareholders in exercising their fiduciary duties. Opinion at 31.

Citing the testimony of a representative of one of the Movants, Judge Gropper noted in the Opinion that the lenders seemed to believe that the independent managers “were meant to be devoted to the interests of the secured creditors.” Opinion at 8. Judge Gropper noted, however, that Delaware law provides that “the directors of a solvent corporation are authorized—indeed, required—to consider the interests of the shareholders in exercising their fiduciary duties.” Opinion at 32. While a recent decision of the Delaware Supreme Court, North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, 930 A.2d 92 (Del. 2007), held that “directors of an insolvent corporation have duties to creditors that may be enforceable in a derivative action on behalf of the corporation,” Judge Gropper noted that the Gheewalla court “rejected the proposition of several earlier Chancery cases that directors of a Delaware corporation have duties to creditors when operating in the ‘zone of insolvency.’” Opinion at 32. Because the Subject Debtors “were and are solvent,” Judge Gropper found that the “Movants therefore get no assistance from Delaware law in the contention that the Independent Managers should have considered only the interests of the secured creditor when they made their decisions to file Chapter 11 petitions, or that there was a breach of fiduciary duty on the part of any of the managers by voting to file based on the interests of the Group.” Opinion at 33.

Judge Gropper similarly found no support for the Movants’ argument that the termination and replacement of the independent managers shortly before the commencement of the bankruptcy cases constituted bad faith and grounds for dismissal. In testimony before the Bankruptcy Court on the Motions, Thomas Nolan, President and COO of GGP, explained that the decision to replace the independent mangers on the boards of some of the SPE Debtors was made following discussions with financial, restructuring and legal advisors with the goal of appointing independent managers with restructuring experience, specifically in real estate, who had worked through prior market cycles. Moreover, the relevant corporate documents of the Subject Debtors did not prohibit termination and replacement of the independent managers, and Judge Gropper found that the Debtors had complied with the requirements of such documents in terminating and replacing the independent managers. Had the relevant organizational or transactional documents of the Subject Debtors required lender consent to replace the independent managers, the outcome may have been different.  

Conclusion

Though denying the Motions, Judge Gropper noted in the Opinion that “the fundamental protections that the Movants negotiated and that the SPE structure represents are still in place and will remain in place during the Chapter 11 cases,” including protection against substantive consolidation. Opinion at 42. Judge Gropper further noted that “[t]here is no question that a principal goal of the SPE structure is to guard against substantive consolidation” but that the issue of substantive consolidation is distinguishable from the question raised in the Motions of whether the independent managers of an SPE act properly in considering the interests of the larger corporate structure in voting to file for Chapter 11 protection. The Opinion should serve as a caution to lenders that independent managers are not in place to protect only the interests of lenders, and that any provisions in the organizational or transactional documents of an SPE which provide that independent managers have a fiduciary duty of loyalty and care similar to that of a director of a corporation under Delaware corporate law may further shift the duties of independent managers away from lenders.