Forrest Pearce, Bankruptcy-remote Special Purpose Entities and a Business?s Right to Waive Its Ability to File for Bankruptcy

• Publication year: 2011

BANKRUPTCY-REMOTE SPECIAL PURPOSE ENTITIES AND A BUSINESS’S RIGHT TO WAIVE ITS ABILITY TO FILE FOR BANKRUPTCY

INTRODUCTION

In 2009, General Growth Properties, Inc. (General Growth), a real estate investment trust that managed hundreds of shopping centers throughout the United States, filed for chapter 11 bankruptcy.1 General Growth did not directly own or manage any of its individual properties.2 Rather, it created hundreds of subsidiaries (special purpose entities) to own and manage each individual piece of real estate.3

General Growth was structured this way because of the manner in which it financed its operations. Each special purpose entity (SPE) received a mortgage loan secured by a piece of property owned by that SPE.4 Many of the banks lending to the individual SPEs were active in the commercial mortgage-backed securities (CMBS) market.5 These banks pooled the mortgages that they received from General Growth with similar commercial mortgages and sold securities to investors that represented the collective rights to payment on those mortgages.6 A crucial aspect of CMBS financing is that the individual mortgagors have a low risk of default.7 Lenders based their decision to invest in General Growth on whether the activity of any particular SPE was likely to cause it to become insolvent. Thus, the SPE was an attempt by these banks,

1 In re Gen. Growth Props., Inc., 409 B.R. 43, 54 (Bankr. S.D.N.Y. 2009).

2 Id. at 47–48.

1. Id. at 49.

2. Id. at 50.

3. Id.

4. See Patrick D. Dolan, Lender’s Guide to the Securitization of Commercial Mortgage Loans, 115 BANKING L.J. 597, 597 (1998). Note that a similar structure to the type of SPE discussed in this Comment,

   sometimes called a special purpose vehicle (SPV), is used during the securitization process. To securitize a pool of mortgages, the loan originator must transfer the pooled mortgages to a separate entity, which then issues the securities. When using the term SPE, this Comment is not discussing that entity. For discussion of the impact of substantive consolidation on that type of SPV, see generally Peter J. Lahny IV, LL.M Thesis, Asset Securitization: A Discussion of the Traditional Bankruptcy Attacks and an Analysis of the Next Potential Attack, Substantive Consolidation, 9 AM. BANKR. INST. L. REV. 815 (2001); Michael J. Cohn, Note, Asset Securitization: How Remote Is Bankruptcy Remote?, 26 HOFSTRA L. REV. 929 (1998).

5. See generally Georgette C. Poindexter, Subordinated Rolling Equity: Analyzing Real Estate Loan

   Default in the Era of Securitization, 50 EMORY L.J. 519, 543–47 (2001).

   along with General Growth, to minimize the risk that any individual SPE would find itself in bankruptcy.8

   
   

   To make General Growth’s SPEs more attractive to CMBS lenders, the SPEs were designed to be “bankruptcy-remote.”9 There were various provisions included in the loan documents of the SPEs that were meant to ensure that each SPE would only engage in business related to one property, not incur additional indebtedness, and to file for bankruptcy must acquire the approval of an independent director that represented the lender’s interest.10 When General Growth filed for bankruptcy, however, it pulled all of its subsidiaries into bankruptcy with it, including many SPEs that were not in financial distress and had not defaulted on their loans.11 General Growth’s intent was to use the cash flow from some of these healthy SPEs to help pay

   for its reorganization, which would “preserve value for the [d]ebtors’ estates and creditors.”12 The Bankruptcy Court for the Southern District of New York denied motions by these SPEs’ debtors to dismiss those cases from bankruptcy for filing in bad faith.13

   
   

   The General Growth bankruptcy raises two serious issues about the theory of bankruptcy law. First, where does the right to file for bankruptcy come from? It is clear that not every firm is given the right to the protections offered by the Bankruptcy Code whenever it pleases. For example, there are

   requirements that a petition be filed in good faith14 and that a firm have a

   
   

6. William McInerney, From Bankruptcy-Remote to Risk-Remote; Reframing the Single-Purpose Entity in CMBS Finance, N.Y. L.J., Aug. 23, 2010, at 9, available at http://www.cadwalader.com/assets/article/ 082310McInerneyNYLJ.pdf.

7. Gen. Growth, 409 B.R. at 49 n.15.

8. Id. at 49.

9. The Prudential Insurance Co. of America’s & Prudential Retirement Insurance & Annuity Co., a Connecticut corp. f/k/a CIGNA Life Insurance Co.’s: (I) Objection to Debtors’ Motion Requesting (A) Entry

   of (i) Interim & Final Orders (a) Authorizing the Debtors’ Use of Cash Collateral & Granting Adequate Protection Therefore Pursuant to Sections 361 & 363 of the Bankruptcy Code & Bankruptcy Rule 4001, & (b) Modifying the Automatic Stay, & (ii) a Final Order Authorizing Borrowing With Priority Over Administrative Expenses & Secured by Liens on Property of the Estates Pursuant to Section 364(c) of the Bankruptcy Code,

   & (B) Scheduling a Final Hearing on Each Requested Final Order & (II) Request for (A) Determination that Certain Debtors are Single Asset Real Estate Debtors, (B) Adequate Protection, (C) Segregation & Accounting for Its Cash Collateral, (D) Entry of an Order Recognizing the Establishment of All Prerequisites for a Section 507(b) Claim, & (E) Granting Relief from the Automatic Stay or Dismissing Cases of Certain Debtors for Cause at 3, In re Gen. Growth Props., Inc., 412 B.R. 122 (Bankr. S.D.N.Y. 2009) (No. 09-11977 (ALG)) [hereinafter Prudential Insurance Company’s Objection].

10. Gen. Growth, 409 B.R. at 69 (internal quotation marks omitted).

13 Id. at 56–70.

1. See Robert J. Keach, Solvent Debtors and Myths of Good Faith and Fiduciary Duty, AM. BANKR. INST. J., Dec./Jan. 2005, at 36, 36.

   
   

   legitimate chance at reorganization.15 The SPEs in In re General Growth Properties, Inc. were allowed to enter bankruptcy even though some were not in financial distress and were not in default on any obligations.16

   
   

   Second, why is a firm not allowed to waive the right to file for bankruptcy? There is a clear rule in bankruptcy law that a waiver of bankruptcy eligibility is not enforceable.17 However, most courts that discuss the issue do not give a clear reason why such a waiver is not enforceable.

   
   

   This Comment will argue, in four parts, that the SPE presents a limited situation in which bankruptcy courts should enforce a waiver of bankruptcy eligibility. Specifically, it will argue that a firm’s promise not to file for bankruptcy should be enforceable if that firm is not insolvent. Part I will review the three doctrines that led the In re General Growth court to deny the

   motions to dismiss the SPEs’ cases from chapter 11.18 Part II will analyze the

   
   

2. In re Landing Assocs., Ltd., 157 B.R. 791, 812 (Bankr. W.D. Tex. 1993).

3. Gen. Growth, 409 B.R at 64 (“There is no contention in these cases that the Subject Debtors were insolvent at any time.”).

4. Klingman v. Levinson, 831 F.2d 1292, 1296 n.3 (7th Cir. 1987) (“For public policy reasons, a debtor

   may not contract away the right to a discharge in bankruptcy.”); Nw. Bank & Trust Co. v. Edwards (In re Edwards), 439 B.R. 870, 874 (Bankr. C.D. Ill. 2010) (“For public policy reasons, the right to a discharge in bankruptcy may not be contracted away.”); Double v. Cole (In re Cole), 428 B.R. 747, 752 (Bankr. N.D. Ohio 2009) (“[I]t is not unusual for parties to insert language into contracts whereby one party agrees to waive their right to discharge through bankruptcy . . . . [W]hatever one party’s reliance on the efficacy of such an agreement, they are not, as a matter of public policy, enforceable.”); Simmons Capital Advisors, Ltd. v. Bachinski (In re Bachinski), 393 B.R. 522, 533 (Bankr. S.D. Ohio 2008) (“[A] prepetition waiver of discharge entered into in a nonbankruptcy case is unenforceable.”); Marra, Gerstein & Richman v. Kroen (In re Kroen), 280 B.R. 347, 351 (Bankr. D.N.J. 2002) (“[T]he court is impelled to evaluate the mixed fact/law question of the attorney’s purported justifiable reliance on an oral representation, pre-petition, waiving discharge in bankruptcy. The fundamental point here is that such waivers are void, offending the policy of promoting a fresh start for individual debtors.”); In re Madison, 184 B.R. 686, 690 (Bankr. E.D. Pa. 1995) (“[A]n agreement not to file bankruptcy is unenforceable because it violates public policy.”); Freeman v. Freeman (In re Freeman), 165 B.R. 307, 312 (Bankr. S.D. Fla. 1994) (“An agreement to waive the benefit of a discharge in bankruptcy is void, as against public policy.”); Alsan Corp. v. DiPierro (In re DiPierro), 69 B.R. 279, 282 (Bankr. W.D. Pa. 1987) (“[T]he court gives no significance to the portion of the [j]udgment [e]ntry determining that said [j]udgment shall not be dischargeable in bankruptcy. A debtor cannot contract away the right to a bankruptcy discharge in advance of the bankruptcy filing.”); Markizer v. Economopoulos (In re Markizer), 66 B.R. 1014, 1018 (Bankr. S.D. Fla. 1986) (“An agreement to waive the benefit of a discharge in bankruptcy is wholly void, as against public policy.”); Artinian v. Peli (In re Peli), 31 B.R. 952, 956 (Bankr.

   E.D.N.Y. 1983) (“Agreements waiving the right to file a petition in bankruptcy violate public policy and will not be given effect.”); In re Tru Block Concrete Prods., Inc., 27 B.R. 486, 492 (Bankr. S.D. Cal. 1983) (“It is a well settled principal that an advance agreement to waive the benefits conferred by the bankruptcy laws is wholly void as against public policy.”); Johnson v. Kriger (In re Kriger), 2 B.R. 19, 23 (Bankr. D. Or. 1979) (“It is a well settled principle that an advance agreement to waive the benefit of a discharge in bankruptcy is wholly void, as against public policy.”).

5. Gen. Growth, 409 B.R 43.

   SPE structure and the In re General Growth decision in detail. Part III will review the scholarly literature on contracting around bankruptcy, giving particular attention to two arguments commonly advanced as reasons that a firm should not be able to waive its right to bankruptcy...