March 20, 2022
The concept of a single purpose entity is often present in the purchase and financing of commercial real estate. A lender may require its borrower to be a single purpose entity in order to lessen the lender’s bankruptcy risk in the event that the borrower or any of its parent entities file for bankruptcy, and also to ensure that no other businesses of the borrower adversely affect the property that is the subject of the loan. A single purpose entity is often advisable from the owner’s and investor’s perspectives as well, in order to isolate potential liabilities in a single entity and protect the subject real estate from downturns in other portfolio properties.
What, then, is a single purpose entity, how are they structured, and what advantages do they provide?
A single purpose entity, or SPE, is frequently a limited liability company or s-corporation that is formed for the single purpose of holding a specific parcel of commercial real estate. The SPE owns no other assets and is subject to no other liabilities, and the real estate it owns serves as collateral for the lender. Often, the SPE contracts with an affiliated company which serves as the manager of the property and handles matters such as tenant leases and day-to-day business operations of the property.
The purpose of the SPE is expressly limited under its governing documents to owning only the specific parcel of commercial real estate. By so limiting the purpose of the SPE, the number of creditors that might be involved in any bankruptcy proceeding affecting the SPE is also essentially limited to the lender that is financing the purchase of the subject real estate.
A single purpose entity is often required under its governing and loan documents to keep its assets separate from those of its parent and other entities, to maintain separate books and records from other related entities, and to not commingle its cash and other liquid accounts with those of other entities.
In addition, the SPE’s loan documents usually limit its third-party indebtedness to just the underlying purchase loan, plus unsecured trade payables and possibly equipment leases. Single purpose entities are also generally prohibited from guaranteeing obligations of other entities or pledging their assets as collateral for the debts of another person or entity.
Single purpose entities are sometimes required by their lenders to have a springing member in order to protect against dissolution. Upon the occurrence of any event that causes the last remaining member of the SPE to cease to be a member, the springing member “springs” into place as a new member, thus allowing the SPE to continue its existence without facing the prospect of dissolution due to having no members.
In order to further distance the single purpose entity from any possible bankruptcy, lenders might require a single purpose entity to have one of more independent managers or directors, and the approval of such an independent manager or director is necessary in order for the SPE to file a bankruptcy petition. A manager or director is considered independent only if that person does not have any direct or indirect ownership interest in or business dealings with the SPE. Certain national service companies are available to provide independent manager services for an annual fee.
Lenders may look for additional bankruptcy protection by requiring the SPE to deliver a satisfactory non-consolidation opinion of counsel at the time of the loan closing. The non-consolidation opinion is given by an independent outside law firm selected by the SPE and approved by the lender, and such firm examines and analyzes the structure of the subject single purpose entity for the purpose of its opinion. This opinion is addressed to the lender and is intended to conclude that, in the event that one or more equity owners of the SPE were to file a bankruptcy petition, the bankruptcy court would not consolidate the property that is owned by the SPE with the properties of its parent or other affiliated entities and, therefore, the property of the SPE would not be made available to pay the creditors of its affiliated entities.
While lenders often require the borrower to be a single purpose entity, the SPE structure provides its own advantages to real estate owners and investors. By separating ownership of the subject real estate from the ownership of other properties and assets, that real estate is shielded from the downtown or bankruptcy of such other investments. Also, by owning just a single parcel of real estate, the SPE structure simplifies current and future purchases, financings, and sales of the property by eliminating unrelated and intertwined contractual obligations and interests.
In summary, it is often advisable for a lender to require that the owner of commercial real estate be structured as a single purpose entity. In addition, a single purpose entity structure can be worthwhile for commercial real estate owners and investors as an important method of asset and liability management and protection.