By: Serge Filatov
The real estate market in the Bay Area and San Jose is booming. With interest rates still low, many real estate investors are taking advantage of cheap debt and either taking out new loans for projects or refinancing existing debt.
One of the common items that I see in commercial real estate loan transactions is the requirement that the borrower be a single purpose entity (an “SPE”) and that it agree to numerous provisions designated to ensure that it remains separate. A single purpose entity is an entity that exists for one purpose. In our context, an SPE is set up for the sole purpose of owning and operating a property, and for no other purpose. By making the entity so narrowly focused, the lender is trying to put protections in place to make sure that the borrower is not pulled into or consolidated with a bankruptcy caused by the problems of affiliates of the borrower.
To ensure a borrower is and remains an SPE, the lender will often impose numerous covenants on the borrower. Below are some examples of the type of covenants a borrower must often agree to:
- maintain accounts separate from any other person or entity
- maintain separate books and records from any other person or entity
- not commingle assets with those of any other person or entity
- pay for all liabilities out of the borrower’s own funds
- maintain a sufficient number of employees in light of borrower’s contemplated business
- not acquire debt or equity of another entity
- hold itself out at all times as a separate entity
- maintain adequate capital in light of its contemplated business
- not create or incur any indebtedness other than the loan and unsecured trade debt or operating expenses
The list can go on and on…
As the borrower, you need to review the SPE language carefully to make sure that it accurately portrays how you will run your business.
For example, will you really maintain a sufficient number of employees to run your business or are those employees really employed by an affiliate? If so, will you need to put in place a services contract between the entities?
If you do not end up operating your business like you have stated, an event of default under the loan can occur and the lender could have recourse against the borrower or any guarantors. Therefore, thinking through these issues is important and a knowledgeable attorney can help you meet the SPE requirements while still allowing you to conduct your business as normal.
The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.