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August 12, 2009

REIT and Real Estate Restructurings and Bankruptcies –

Observations from the Front Lines

Yesterday’s ruling in the bankruptcy of General Growth Properties (GGP) makes clear that “bank-
ruptcy remote” special purpose entities (SPEs) are not “bankruptcy proof.” The ruling denied motions to
dismiss the bankruptcy filings of SPE subsidiaries of General Growth, rejecting the mortgage lenders’ and
CMBS special servicers’ arguments that the bankruptcy filings were made in bad faith because there was
no imminent threat to the financial viability of the SPEs, that the relevant debt was not yet in default, and
that the SPEs’ independent directors improperly considered the interests of General Growth as the equity-
holder of the SPEs, in addition to the interests of the creditors of the SPE borrowers, in authorizing a bank-
ruptcy filing.

For better or worse, the GGP ruling may herald a trend towards bankruptcy filings by highly struc-
tured commercial real estate enterprises which today find themselves vastly over-levered. Indeed, GGP
stands for the proposition that the protections against bankruptcy that were built into CMBS and similar
structures are surmountable in certain circumstances: independent directors whose consent is needed for a
bankruptcy filing can be replaced and can properly take into account the interest of the overall enterprise
and the parent equityholder of an SPE; springing bankruptcy guarantees may be of little help if the guaran-
tors themselves are insolvent or bankrupt or are protected or indemnified by some of the creditors (as pro-
posed in the Extended Stay bankruptcy); and many of the “separateness covenants” applicable to SPEs of-
fer little protection against a consolidated bankruptcy filing of their sponsor and do little to prevent the on-
going use of SPE cash during a bankruptcy (although there is no reason, yet, to think that they will not pro-
tect against “substantive consolidation”).

Further fueling potential bankruptcies, many of the highly structured, multi-tranche capital stacks
that were set up in the last few years present significant barriers to consensual restructuring outside of
bankruptcy. For one, master servicers and special servicers are often constrained in their ability to modify
loans because of restrictions under the relevant pooling and servicing agreements and adverse tax conse-
quences under applicable REMIC tax rules. Matters are further complicated by intricate webs of consent
rights and cross-default provisions that run to various tranches of debt, as well as conflicting incentives and
divergent views of value among the many levels of creditors. Even the simple act of jettisoning a property
through a deed-in-lieu-of-foreclosure transaction may be complicated by conflicting transfer restrictions.

Given the novelty of some of these issues, it is not yet clear how the coming wave of real estate re-
structuring and bankruptcies will play out. While this round went to GGP and against the SPE and CMBS
lenders, it remains to be seen where the balance struck by the GGP court between creditors’ rights and the
interests of equityholders leads when thorny issues such as cramming down secured lenders to extend ma-
turities and alter pricing and other terms to the benefit of equity are presented to the court, or how negotia-
tion and settlement discussions – both in formal bankruptcy proceedings and in consensual non-bankruptcy
restructurings – will play out in the post-GGP era. The prospect of SPEs being included in consolidated
bankruptcy proceedings will also raise issues not addressed in GGP, such as whether solvent SPEs will par-
ticipate in an enterprise’s DIP financing, potentially structurally subordinating mezzanine lenders. Another
twist may be the bypassing of the intricate consent and control mechanics in pooling and servicing agree-
ments, with CMBS certificateholders working independently of their servicers.

Whether or not consistent with the expectations of creditors and debtors, the GGP ruling is consis-
tent with the general tendency of bankruptcy courts to be pragmatic and to place substance over form. As
the GGP court concluded: “These Motions [to dismiss] are a diversion from the parties’ real task, which is
to get each of the [debtors] out of bankruptcy as soon as feasible. The [secured lenders] assert talks with
them should have begun earlier. It is time that negotiations commence in earnest.”

Adam O. Emmerich
Robin Panovka
Eric Rosof

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