The American Bankruptcy Institute describes a Special Purpose Entity (SPE) as an entity formed concurrently with, or immediately prior to, the closing of a financing transaction…to isolate the financial assets from the potential bankruptcy estate of the original entity, the borrower, or originator. When   a lender requires the creation of a “special purpose entity,” (“SPE”) the loan will probably relate to real estate and Delaware law will control.  In this regard, the lender will usually require the borrower’s documents to contain some or all of the terms and conditions discussed below.


The Five Elements of SPE Coverage

  1. Restricted to One Asset.  Most important is that the loan documents and SPE documents will require that the borrower’s sole assets be the real estate and personal property incidental to ownership of the real estate.  The one exception will be for a mezzanine borrower whose sole purpose would be limited to owning the equity interest being pledged as collateral for the loan.  The lender’s goal in restricting the SPE’s assets is to limit the number of creditors involved in any bankruptcy proceeding filed by the borrower.

  2. Prohibition of Incurring Additional Debt. Next, more often than not, the borrower is prohibited from incurring additional debt with perhaps an exception related to equipment leases and/or unsecured trade payables (with a cap), and payable within a certain period of time.  Other covenants may include limiting the number of the borrower’s creditors, prohibiting the borrower from guaranteeing the debts of any other entity, or pledging assets as collateral for the debts of any other entity.

  3. Limitations on Ability to Dissolve.  Occasionally, the lender will limit the borrower’s ability to dissolve.  In this regard, Delaware Law allows for a “springing member” provision or a “special purpose” provision.  These springing members “spring” or automatically become special members upon the occurrence of any event, usually an event of default, that causes the last remaining member of the borrower (or the special purpose member) to cease being a member of the borrower or ceases from being a special purpose member.  This provision allows the lender to control the borrower and prevent dissolution until a new member can be appointed pursuant to the terms of the borrower’s operating agreement. 

  4. Covenants to Prevent Commingling and Ensure Separateness.  Also, generally there are covenants prohibiting the borrower from co-mingling its assets with the assets of its holding company or any other entities, requiring the borrower to maintain separate books and records to ensure that the borrower’s assets are separate and apart from its holding company or any other entity.  These covenants are inserted to prevent the borrower or its creditors from arguing that the holding company or related entities are an alter ego or are one and the same as the borrower, and to prevent the substantive consolidation of the borrower with the holding company or related entity in the event the borrower files bankruptcy.

  5. Appointment of Independent Directors.  Finally, in order for the borrower to file bankruptcy, which requires the consent of its directors, the lender may require the appointment of one or more independent directors.  Once appointed, the independent director(s) must confirm that a bankruptcy filing is in the best interest of the borrower as a condition for filing bankruptcy,  

Though it is important for the lender to require one or more of these five elements, a bankruptcy court, which sits as a court of equity, can disregard one or more of these elements.  That said, setting up the SPE with one or more of these elements will provide the lender with necessary leverage when negotiating a deal with its borrower. 


By Published On: July 9, 2021Categories: BankruptcyTags:


Avatar of Bill Siegel
William L. (Bill) Siegel is a Shareholder and Section Head of the Cowles and Thompson Bankruptcy and Creditors’ Rights Practice Group as well as a member of the Corporate and Business Practice Group. His experience includes representing individuals and business entities in their corporate and transactional affairs, including drafting and negotiating agreements of all types, and representing individuals and business entities in disputes that may arise in litigation in State and Federal Courts. He also represents debtors, creditors, Trustees, and Committees in bankruptcy matters in Chapter 7 liquidations and Chapter 11 reorganizations. His clients include small and medium-sized businesses, start-up technology companies, and partnerships. He frequently publishes articles and content regarding trends in bankruptcy law, the economy, commercial real estate, and retail-related matters.