Single Purpose LLC: Everything You Need to Know
A single purpose LLC holds a title to real estate in which the lender who provided financing holds a mortgage but does not have any other liabilities or assets.3 min read
2. Requirements to Become a Single Purpose LLC
A single purpose LLC is a limited liability company that holds a title to real estate in which the lender who provided financing holds a mortgage but does not have any other liabilities or assets.
About the Single Purpose LLC
There are times when the lender requires a single-purpose entity (SPE) structure to insulate the collateral, which is the property with the mortgage. The structure protects the property from claims by creditors as well as restricting the business activities. This results in protection to the lender and the owners of the SPE from things like third-party claims attempting to target the property as a source of recovery to satisfy debts.
An SPE will often contract with a second company to take care of business such as:
- Managing the property.
- Handling the leases of tenants.
- Managing the operation of the business.
- Incurring all liabilities associated with managing the commercial real estate.
There's also the option of hiring a third-party management company to fulfill the necessary roles.
A key feature of an SPE has to do with special bankruptcy circumstances. If the SPE files for bankruptcy, the lender will have a much easier time proceeding with foreclosure since there's only one lender. As the sole lender, he or she has the only vote involved with bankruptcy issues, such as providing approval for reorganization plans for the SPE under Chapter 11.
When more creditors are involved, they could most likely force the lender into a situation where he or she may have to submit to a plan of reorganization despite the fact that the lender has a first-position mortgage on the property. The reorganization plan may not be in the best interests of the lender due to various plays being made by the other creditors during the bankruptcy proceeding.
Lenders also have the authority to require the SPE to be what is termed "bankruptcy remote." This means that the LLC must have the approval of an independent person in the manager or director role of the entity in order to have the authority to file bankruptcy.
In most cases, for a director or manager to be independent requires that they have no direct or indirect ownership interest in the business whether at the time the person is deemed independent and for a period of several years prior to their becoming involved with the LLC.
Requirements to Become a Single Purpose LLC
For an SPE to be recognized as legal the basis for the ownership and operation of a specific piece of commercial property, a fundamental element to include is a clearly stated purpose clause. There are variations to the provisions of a purpose clause, but it must achieve a level of clarity regarding the existence of restrictions on the activities that the SPE can take.
Include the purpose clause as part of a public document for the entity, such as the formation documents, that is filed at the office of the Secretary of State. If this is not possible, the purpose clause should be included as part of the loan documents as part of the loan agreement.
A set of covenants should also be required to clarify the separation between the SPE and other affiliates or entities. The covenants could include:
- Prohibiting comingling of assets.
- Prohibiting guaranteeing obligations of other entities.
- A requirement for tor the SPE to maintain a separate tax identification number.
- Maintaining a separate bank account.
A lender may require additional restrictions on other types of actions that a general purpose entity may undertake, such as incurring additional debt or the right to seek bankruptcy protection voluntarily. While there are common elements associated with an SPE, there is no set or uniform qualification criteria for an SPE.
Depending on the nature of the covenants and restrictions, it can be expected that the costs to comply with SPE requirements can become a burden. This is basically the case when the SPE secures an independent manager to maintain bankruptcy remoteness.
Generally, it is advisable for the lender providing the financing to ask that the business entity that owns the property become an SPE. Likewise, the SPE structuring by the owners of the entity is often advisable and used by business people as a form of protection for assets and liabilities.
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