General Growth’s bankruptcy shakes the foundations of the commercial real estate market, and the financing documents that hold it up. The bankruptcy plot touches on a wide range of issues, from the sacredness of corporate entities to director independence to the prevalence of Delaware entities. The GGP plot, thus far, ends at a place that is a happy one for developers and a cautionary one for lenders. Before getting into the specifics, it’s worth noting the overall impact: commercial real estate and its financing structures will never be quite the same.

As background, complex entity structuring pervades the commercial real estate market, from large mall owners such as Simon Property Group and General Growth to more regional investor-developer types, such as Tishman Speyer and the Bonaventure Group. Motivating this are both structuring factors and financing drivers.

From a structuring perspective, commercial real estate holding companies typically have asset organizational charts as complex as an ultra-modern family tree, with different sets of parents, abundant offspring, and multiple sets of grandparents. This structure originates in the need for 3 things: investment facilitation; capital structure layering; and liability reduction. A note as to the latter: liability-shy real estate developers work to mitigate environmental, financial and other legal liability via LLC formations intended to protect the mother-ship or personal family financials from each property’s unique set of risks.

REITS in particular continue to work in a very complex way, as seen most recently in the documents of IPO’ing Americold Realty Trust. These real estate companies bundle together many assets, often set up with asset-specific entities (Special Purpose Entities or SPEs for short) and, with several driving factors, have instituted complex financing strategies. Lender-driven financing approaches required a special purpose entity (most often an LLC) for each asset. The result of this can be seen in ARTs own filing, which holds over 2,000 commercial loans relating to its many subsidiaries. Suffice it to say that, with the innovations of GGP, legal issues are heating up, even for refrigeration REIT ART. From a legal perspective, REITs have until now tended to be formed in Maryland, due to favorable tax laws.

These long-held tenets look set to change, following decisions in General Growth’s bankruptcy. Borrowers that are newly formed SPEs may now end up several miles up Interstate-95 in Delaware, taking advantage of state corporate laws designed to limit the surprises that lenders of these familial enterprises may face going forward.

General Growth's April 2009 historic “family-filing” for bankruptcy, rattled many a cage. The filing placed the real estate giant and its mall subsidiaries into Chapter 11, shaking up investors and lenders throughout its capital stack, to say nothing of the entire real estate finance market. The parent company filed, leaving the SPE’s out of bankruptcy at the time. Until then, investors in each one of GGP’s mall transactions had figured their investment was insulated from a parent company's bankruptcy.

The sheer size of General Growth ensured that its bankruptcy was ground-shaking. It owns and manages over one hundred shopping centers in 44 states in the United States. General Growth’s capital structure included approximately $18.27 billion in debt, partly secured by mortgages on the individual properties of the company. They are the second largest shopping mall owner in the country, second to Simon Property Group. On April 16, 2009, General Growth and many of their domestic subsidiaries filed for Chapter 11 in U.S. Bankruptcy Court for Southern District of New York. When kicked into Chapter 11, General Growth became the largest real estate company to declare Chapter 11 protection.

As noted above, the GGP plot, thus far, ends at a place that may be happy for developers, but is decidedly less so for lenders. The upshot of the bankruptcy thus far is that bankruptcy-remote cash flows are remote no longer. Instead, SPE value was allowed to be put in one bucket, that of the parent. General Growth’s new and improved Chapter 11 cash management system may allow for each of the Operating Properties to collect cash receipts in a property-specific lockbox…but then swiftly transfers such receipts to a centralized GGP-Parent cash management account from which cash disbursements are funded. This is magic to the ears of developers everywhere. On a contrary viewpoint this would give heartburn to commercial real estate lenders, their attorneys, and commercial real estate debt investors.

The relationship of the SPE to its broader corporate family, and the role of independent directors in the governance of the SPEs (each of which was a LLC) are both revolutionized in the GGP case. Consolidation of remote entities is the core issue in GGP operations, its bankruptcy and its impact on the market. GGPs approach to consolidation of its once-independent subsidiaries flouted prior thinking about the independence of its subsidiaries. While Bankruptcy Judge Gropper has clearly held back from substantive consolidation, this may appear to be semantics to many real estate lawyers looking “merely” to get deals done in this newly uncertain environment.

It turns out that the allegedly-independent directors for independent SPEs must also consider the interests of parent company shareholders (i.e. those of parent company, General Growth), according to bankruptcy court Judge Gropper. Along with this, and contrary to thinking prior to April 2009, LLC independent managers are not precluded from authorizing a bankruptcy filing as part of their fiduciary duties. In fact, LLC managers may look to the entire family enterprise in analyzing whether a bankruptcy filing is prudent.

While this makes it clear how broad the impact of GGP may be, in fact, these issues are even broader as they touch on a broader set of Delaware corporate laws, for all LLCs. With a view to securitization, SPE independent directors and their fiduciary duties are also broadly impactful, affecting things as far afield as securitizable assets that even include David Bowie’s royalty streams.

Furthermore, the current General Growth bankruptcy reorganization plan notes that a forward-looking requirement that the debtors become Delaware limited liability companies and thus able to limit their directors’ fiduciary duties pursuant to section 18-1101 of the Limited Liability Company Act of Delaware. The nature of the LLC was not called into question in GGP; what was questioned are the lawyer-drafted lender covenants that did not adequately restrict the firing of independent directors. While it may seem random courts are pulling in DE-specific corporate law with regard to bankruptcy proceedings, many skilled attorneys have been including Delaware-mandated SPE provisions including non-real estate situations, such as Franklin Covey’s SPE regarding securitized intellectual property.

The loan documents that proved troublesome in GGPs case are likely to drive a facelift to future loan documents to prevent some of the GGP-like events from repeating themselves. In particular, lenders and their counsel are likely to require in the loan documents a prohibition on altering managers or directors of Special Purpose Entities. Lenders will require provisions that govern the ability of the member to replace independent directors or managers. Moreover, the provisions that define the scope of the independent directors’ or managers’ fiduciary duties will point to state statutory guidance proscribing the state of LLC formation and rights and obligations of independent directors.

A second lender’s document is also likely to change: non-consolidation opinion letters can be expected to increase and address GGP-related scenarios. As primer, non-consolidation opinion letters are typically delivered by borrower's counsel to lender and addressing issues relating to substantive consolidation in bankruptcy. Consider American Casino’s letter of credit which had, as a condition of the credit, the delivery of a satisfactory non-consolidation opinion that was to be delivered first to a lender in form and substance reasonably satisfactory to lender.  

The NY bankruptcy court held back from making any decision on substantive consolidation, though this may be seen as semantics in practice. In the eyes of many real estate lawyers one familial bucket has clearly been created, with funds commingled with another family member. In legal terms, however, the court drew a very bright line between substantive consolidation from the pragmatic issue of whether the board of a bankruptcy remote SPE can take steps that get to the same goal. In particular, what was weighed is whether part of a corporate group can consider the interests of the broader group along with the interests of the individual debtor when making a decision to file a bankruptcy case. While these appear similar issues, the NY bankruptcy court distinguished the scenarios. Judge Gropper clearly stressed that he had not substantively consolidated the SPEs with other entities.

To understand the momentous nature of the decisions in GGP thus far, consider the structures that used to define the commercial real estate world. The relationship between Real Estate asset and the entity was typically a 1:1 relationship, with the entity structure thought to define both the legal risk and the financial structure. Underpinning this, there was a fundamental understanding throughout the CMBS market that the corporate entity that held one real estate transaction was truly bankruptcy remote. The importance of this can’t be under-stated, as it was thought to mean that the entity was completely independent of its parents, allowing its cash flows to be dedicated to paying debt service on a particular property.

As a result, lenders were willing to loan funds to these SPEs, on a non-recourse basis, with the follow on step of issuing securities backed by the SPE. Holders of securities expected the structure would ensure they would be paid even if the parent company went bust. The airtight nature of this understanding was thought to allow independent risk tranches with correlating debt tranches.

As to the financing structure, the typical structure for an individual real estate asset/SPE looking something like this. Keep in mind that financing strategies are all about risk and its allocation, by tranche. A typical real estate development project would get a bank loan of 60% of the fair market value of a property – from a risk-perspective, this is one of the safest positions, enjoying a primary security interest via mortgage. Other layers beyond this first piece of debt would typically break out into two additional debt pieces: a “B-Piece” (with secondary security interest), and an unsecured debt or mezzanine debt piece. In these riskier debt positions, the valuation of risk (and its correlating yield) drove the securitization market.

In GGP’s case, the Court found that the lenders did not contend that they were unaware that they were extending credit to a company that was part of a much larger enterprise. In fact, the lenders acknowledge that there were benefits, as well as possible detriments, from GGP’s ownership and structure. Among the benefits, the Court reasoned that each lender was aware that if the individual mall entity was unable to refinance, then the ability of the overall group of LLCs to obtain refinancing would be impaired.

Prior to GGPs bankruptcy, the accepted wisdom around bankruptcy remoteness had required independent managers for each bankruptcy remote entity. However, GGP tested those boundaries. As it was getting ready to file for bankruptcy and recap via its subsidiaries, it replaced the managers of 90% of their entities. Adding insult to injury was the image of rent-a-cops when it surfaced that their independent managers came from Corporate Service. Co, a staffing company that supplies independent directors. These directors were fired and replaced as quickly as their temp agency placed them, and because the financing agreements were silent on this issue the action of replacing directors did not amount to bad faith on the part of General Growth.

Prior to General Growth’s watershed case, the case law pointed in a seemingly different, yet seemingly reconcilable, direction, that basically enforced boundaries rather than taking them down. Take for example a bankruptcy remote entity known as Central European Industrial Development Company (“Ceidco”), to which Lehman Brothers was the lender. The debtors moved the Court to substantively consolidate their cases in an attempt to outflank the lender, Lehman Brothers, as the sole creditor of Ceidco. Lehman filed a motion to dismiss and the Court granted it.

In its reasoning, the court indicated, “it would not be equitable for this court to ignore the …wishes of Lehman and the Debtors by disregarding the corporate structure the parties so carefully created by agreement”. Also, the Court pointed to incomplete parent ownership of the sub, which is a factor against substantive consolidation. Both the Court in Lehman/Ceidco, and in General Growth honored the agreements and the proverbial meetings of the minds, as General Growth’s debacle was driven by silence, and Lehman’s corporate documents and ownership structure clearly spelled out what familial assets belong in what bucket.

On a macro-level, going forward this will impact how rating agencies analyze commercial real estate debt. Securitization agreements are subject to confirmation from the rating agencies that the modifications and waivers set forth in the plan will not result in the qualification, downgrade, or withdrawal of the ratings currently assigned to the applicable certificates. Most importantly, lenders will demand that covenants exist prohibiting borrowers from firing and replacing independent directors without lenders running into lender liability concerns for exerting too much control. Lender documents will point towards choice of state law for SPE formation. Lenders will clarify and limit fiduciary duties of directors to the furthest extent possible.