In an important ruling issued on Wednesday, May 13, 2009 Bankruptcy Judge Allan L. Gropper in the Southern District of New York approved a $400 million debtor-in-possession facility for General Growth Properties, Inc., which filed the largest real-estate Chapter 11 case in U.S. history. In connection with approving the financing, Judge Gropper permitted affiliated debtors to use excess cash collateral from bankruptcy-remote special purpose entities which, to the surprise of many market participants, were included in the Chapter 11 proceedings.
General Growth Properties, Inc. (the "Company") is a publicly held shopping mall operator headquartered in Chicago. By the time of its bankruptcy filing on April 16, 2009, it was the second largest shopping mall operator in the U.S., owning more than 200 malls in 44 states, with approximately $27 billion in debt outstanding. Approximately $15 billion of its debt is in the form of collateralized mortgaged-backed securities ("CMBS"), making the Company the largest borrower in the CMBS market.1
In connection with seeking approval of the Company's proposed debtor-in-possession facility (the "DIP Facility"), the Company also sought use of cash collateral from separately organized subsidiary bankruptcy-remote special purpose entities ("SPEs"), which were, to the surprise of many market participants, included in the Company's Chapter 11 proceedings. The property owned by each of these SPEs was intended to secure only the obligations of the pre-petition lenders to the SPE owning the property (the "SPE Lenders"). Arguing that the value of the collateral in certain of the SPEs is sufficient to protect the interests of the SPE Lenders, the Company proposed that excess cash collateral from rents be made available to support the DIP Facility. In exchange, as adequate protection, the Company and the SPE Lenders consensually agreed, among other things, that (i) each of the SPE Lenders would receive a perfected first-priority post-petition lien on (a) the respective SPE's claims against the Company resulting from the consolidation of their cash collateral in the Company's centralized cash management system and (b) the cash in the centralized cash management system itself; (ii) each of the SPE Lenders would receive a perfected post-petition lien on properties securing a separate pre-petition facility with Goldman Sachs Mortgage Company (the "Goldman Facility") junior to the liens securing the DIP Facility and the Goldman Facility; and (iii) the Company would continue to pay interest at the applicable non-default rates and to maintain the properties, including the payment of taxes and other operating expenses, in accordance with their pre-petition agreements.
Several pre-petition agents for the SPE Lenders (the "Pre-Petition SPE Agents") filed objections to the Company's proposed DIP Facility on behalf of the SPE Lenders. The Commercial Mortgage Securities Association and the Mortgage Bankers Association also filed an amici curiae brief (the "Amici Brief") with the court addressing the implications of the proposed use of cash collateral on commercial real estate finance.
Objectors Assert Profound Potential Implications for Securitization Market
The Amici Brief and the Pre-Petition SPE Agents' objections each observed that initially the Company benefited from preferable financing terms available through the use of the SPEs and, in the proposed DIP Facility, now sought to ignore the very factors - separateness and securitization - that allowed that initial structure. They argued that the Company's motion proposed de facto substantive consolidation of the bankruptcy cases contrary to the purpose for which the Company established the SPEs.
Court Allows Use of Cash Collateral, Finding SPE Lenders "Adequately Protected"
Pursuant to section 362(c)(2) of chapter 11 of title 11 of the United States Code (the "Bankruptcy Code"), a debtor's use of cash collateral is predicated on lender consent or a finding by the Court under section 363(e) of the Bankruptcy Code that the lenders are being provided with "adequate protection" - protection against the diminution of the value of their collateral resulting from the use of cash collateral. Judge Gropper found that the SPE Lenders' interests were adequately protected, pursuant to section 361 of the Bankruptcy Code, against the diminution of their interests - even given the risks inherent in cash flows from shopping mall rents - by, as the Debtors had proposed, providing replacement liens on the Company's and the SPEs' assets, continuing to pay interest and maintaining the properties.
Judge Gropper distinguished the use of cash collateral from "substantive consolidation," explicitly stating, "we are not substantively consolidating any estates [and are] only deciding the matters before the Court today." Although it was originally contemplated that the DIP lenders would receive second liens on the SPEs' properties, the final DIP Facility did not include such provisions and so Judge Gropper did not need to reach the legitimacy of this aspect of the initial proposal.
Pending Motion to Dismiss the Cases of the SPEs
The Pre-Petition SPE Agents also moved to dismiss the SPEs' Chapter 11 cases as not warranted, questioning whether the SPEs' cases had been commenced in "good faith." Although the Amici Brief cited "rumors in the market" that the Chapter 11 filings took place because the SPEs' independent directors were replaced in possible contravention of their organizational documents, the motions to dismiss did not rely on or confirm such allegations. Rather, the Pre-Petition SPE Agents argued only that the filings were inappropriate because the SPEs: were not insolvent or in danger of becoming so, were not facing the imminent maturity of their facilities and did not directly benefit from Chapter 11 bankruptcy protection. The Pre-Petition SPE Agents seek dismissal of the cases for "cause" pursuant to section 1112(b) of the Bankruptcy Code. A hearing on the motions to dismiss is scheduled for May 27, 2009.
Judge Gropper's ruling is viewed by many market participants as inconsistent with the protections thought to be provided to SPE creditors by the creation of "bankruptcy-remote" financing vehicles. Even though the proposal to cross-collateralize the DIP financing with SPE assets was withdrawn, both the commencement of the SPEs' Chapter 11 proceedings and Judge Gropper's ruling suggest SPE assets may, in certain circumstances, be invaded for the benefit of affiliated entities in furtherance of the goal of reorganization of the sponsoring enterprise. This ruling, while not surprising as a legal matter in light of the judge's determination regarding adequate protection of the SPE Lenders, is inconsistent with the market's expectations regarding the treatment of SPEs in the event of a bankruptcy of the sponsoring enterprise.
The Amici Brief expressed concern regarding "the catastrophic impact such a precedent, if it stands, could have on the CMBS market, as well as on structured finance and the broader capital markets that rely on the same underlying principles of asset isolation in the architecture of securitization." Judge Gropper disagreed that his decision created any "systemic risk."
The ruling in General Growth is likely to cause market participants and rating agencies to review market practice relating to SPE structures. Among other things, market participants may revisit the organizational documents used by SPEs to make it less likely that the SPEs will be able to file for bankruptcy.
It also remains to be seen how courts may apply the General Growth precedent in situations involving SPEs holding other types of assets. There is reason to think that, while a court might permit a debtor to use cash collateral of an SPE in a case like General Growth, where the cash is generated by operating assets owned by the SPE, a court might be more reluctant to invade cash collateral generated by securities or other more traditional financial assets.
In re General Growth Properties, Inc., Case No. 09-11977 (ALG) (Bankr. S.D.N.Y. Apr. 16, 2009).