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In the recent heyday of real estate and structured finance, the use of “bankruptcy-remote” special purpose entities (“SPEs”) as borrowers was a fundamental underwriting requirement by lenders, and a critical factor considered by ratings agencies, to shield lenders and their collateral from the potentially adverse impact of bankruptcy filings by their borrowers’ parents and affiliates. Conventional mortgage and commercial mortgage-backed securities (“CMBS”) financings, in particular, required borrowers to be structured as “bankruptcy-remote” entities to support the intent by all parties involved in the financings to insulate debt to specific properties. In this manner, parties sought to minimize credit risks to mortgagees or owners of notes collateralized by specific real estate assets or groups of mortgages in the event of financial distress by a corporate parent or affiliates owning multiple real estate properties through SPE structures. However, despite the best intentions of their creators, the SPEs were only bankruptcy remote and not bankruptcy proof. The parties to these financings tacitly recognized that federal bankruptcy law would not permit a borrower to negotiate away its right to file a bankruptcy petition. Similarly, a lender could not neutralize the court’s role as the arbiter of whether a borrower could be a Chapter 11 debtor or its assets could be subject to the Chapter 11 cases of its direct or indirect parent or affiliates.
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Originally published in the November/December 2009 issue of Pratt's Journal of Bankruptcy Law. Reprinted with permission.