Key Takeaways

  • A single purpose entity (SPE) or single purpose LLC is used primarily in real estate finance to isolate risk and protect lenders.
  • SPEs are designed to hold a single asset, typically real estate, and shield it from unrelated liabilities.
  • Lenders often require SPEs to be "bankruptcy remote" to reduce the risk of delays or complications during foreclosure.
  • Compliance with SPE structuring includes covenants, purpose clauses, and sometimes independent directors.
  • SPEs are frequently used in CMBS and other commercial financing structures to satisfy underwriting standards and investor protections.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.

Common Uses of a Single Purpose Entity

Single purpose entities are commonly used in structured finance transactions, particularly for commercial real estate acquisitions. Lenders prefer this structure because it restricts the entity from engaging in unrelated business activities that could expose the asset to external liabilities. SPEs are also frequently used in securitized loans like Commercial Mortgage-Backed Securities (CMBS), where they meet legal isolation requirements for rating agencies and investors.

A few examples of when a single purpose entity may be required:

  • Acquiring income-producing commercial property
  • Structuring mezzanine or bridge financing deals
  • Participating in loan securitization programs
  • Isolating liability in joint ventures or syndicated investments

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.

SPEs and Bankruptcy Remoteness Explained

Bankruptcy remoteness is a foundational principle behind the creation of a single purpose entity. It ensures that the entity is less likely to become entangled in bankruptcy proceedings initiated by a parent company or other affiliates.

To enhance bankruptcy remoteness:

  • The LLC should include provisions preventing voluntary bankruptcy filings without the consent of an independent director.
  • The SPE should not guarantee debt for any other party.
  • Operating agreements often contain language that explicitly states the entity's goal of maintaining solvency and independence.

These safeguards are critical for lenders who want predictable access to the collateral securing their loan without interference from unrelated financial turmoil.

SPE Structuring Best Practices

To ensure an SPE meets lender and legal requirements, several best practices should be followed beyond the purpose clause and covenants:

  • Independent Director/Manager Requirement: Appointing an independent manager who cannot be influenced by the parent company is key to bankruptcy remoteness. This person must not have had material relationships with the borrower or affiliates for a specified period.
  • No Commingling: Maintain books, records, accounts, and funds separately from other entities.
  • Limited Purpose Clause: The operating agreement should strictly define the LLC's scope of activity to owning and operating a specific asset.
  • No Cross-Collateralization or Cross-Default Provisions: Avoid agreements that tie the SPE’s obligations to those of another entity.
  • Annual Solvency Certification: Lenders may request periodic certification affirming the SPE's solvency to support asset protection claims.

These steps help the SPE qualify as a legally separate entity, reducing the risk that a bankruptcy court would consolidate it with other affiliated entities.

Frequently Asked Questions

1. What is the purpose of a single purpose entity (SPE)? A single purpose entity is created to own and operate a single asset—typically commercial real estate—to protect that asset from unrelated liabilities and bankruptcy risks.

2. Why do lenders prefer SPEs in real estate financing? Lenders favor SPEs because they isolate collateral, reduce legal risk, and simplify foreclosure or asset recovery if the borrower defaults.

3. What makes a single purpose entity “bankruptcy remote”? Bankruptcy remoteness is achieved through structural measures like appointing an independent director, restricting the ability to file for bankruptcy, and prohibiting obligations to third parties.

4. Are SPEs required by law? While not legally mandated in all cases, many lenders and institutional investors require an SPE structure as a condition for financing.

5. What’s the difference between an SPE and a regular LLC? An SPE is a type of LLC with specific restrictions on its activities and obligations to ensure legal and financial separation from other entities.

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