Financing Focus

Restructuring Rights

CTL borrowers must preserve their Chapter 11 reorganization options.

Credit tenant lease, or CTL, financing can be an attractive alternative to traditional real estate loans. Owners and developers with investment-grade tenants can take advantage of CTL financing to obtain long-term, fixed-rate loans up to the full value of the real estate. CTL financing offers real estate owners and developers the opportunity for better terms and faster execution for construction, acquisition, and refinance loans.

A potential disadvantage for the owner/developer, however, may be the lender’s ability to essentially eliminate the right to restructure the loan in a Chapter 11 reorganization. This article focuses on what the owner/developer can do to preserve this right.

In a CTL financing transaction, the lender relies on the tenant’s creditworthiness and the cash flows from the underlying lease, which is typically long-term (15 to 30 years) and carries no landlord obligations. The nominal borrower is a special purpose entity formed solely to hold the property and pass the rental payments through to the lender. The loan is generally fully amortizing over the term of the lease with payments designed to track the rental income. The loan is nonrecourse and backed by a first mortgage on the real estate and a pledge of the income stream.

The Right to Reorganize

Reorganization under Chapter 11 is a powerful tool for any borrower to have in its arsenal. As shown by the successful reorganization of General Growth Properties, which restructured more than $15 billion in project-level mortgage debt, even a massive developer consisting of more than 100 “bankruptcy remote” SPEs can benefit from the protections and powers afforded Chapter 11 debtors.

A bankruptcy filing automatically stays all enforcement actions against the debtor and its property, according to the U.S. Bankruptcy Code. The stay provides much needed breathing room during the reorganization. The code also permits rejection of a lease if it has fallen below market and imposes a strict cap on early termination damages.

Yet, one of the lender’s goals in structuring the CTL loan through an SPE is to prevent the loan from being impacted by a bankruptcy filing by or against the borrower. The use of separate borrowing entities, however, may not preclude the developer’s right to include an SPE’s assets and liabilities within a joint plan of reorganization.

But lenders will not stop there, and neither should the borrower if it hopes to preserve its rights. The developer must take certain steps if it ever hopes to reorganize through bankruptcy. Most importantly, it must retain the SPE’s right to file a bankruptcy petition and preserve the SPE’s property interest in the rents.

Step 1: Retain the Right to File. First and foremost, the developer must be able to get the SPE through the bankruptcy courtroom door. CTL lenders, like traditional real estate lenders, may attempt to strip the SPE of its ability to file a bankruptcy petition. A common strategy is to include provisions in the SPE’s formation documents that require independent managers, chosen by the lender, to authorize a bankruptcy filing.

But the GGP case illustrates that such impediments may not be insurmountable. The bankruptcy court found that GGP did not act in bad faith by replacing the lender’s chosen managers; and the managers’ fiduciary duties to act in the interest of its parent shareholder overrode the express requirement that the managers consider only the interest of the SPE and its lender.

The bottom line is that bankruptcy remote is a relative term. A savvy borrower may be able to anticipate potential weaknesses in the lender’s anti-bankruptcy provisions and assess the ability to circumvent them before signing off on the loan.

Step 2: Protect the Income Stream. Next, the developer must protect the rental income stream by avoiding a “true” absolute assignment of the rents. Although nearly every commercial mortgage purports to contain an absolute assignment, many times bankruptcy courts treat these assignments as merely additional collateral. As a result, the rents become property of the bankruptcy estate and potentially includable in the borrower’s plan of reorganization.

A savvy CTL lender may attempt to take advantage of the CTL loan’s payment structure in an effort to fully divest the SPE of the rents by requiring the tenant to pay the rents directly to the lender. Whether this is sufficient to remove the rents from the SPE’s bankruptcy estate depends on the state where the property is located and the specific language used in the assignment. It is critical that the owner/developer consult local counsel with experience in both real estate and bankruptcy.

CTL financing is an excellent option for owners/developers who can avail themselves of it. That benefit may also have risk for the unwary. Of course, the right to pull the SPE into bankruptcy may be meaningless if the developer is unable to effectuate a successful reorganization. A developer considering Chapter 11 reorganization must consult an experienced and creative attorney.

Jeffrey M. Reisner is a partner and Michael P. McMahon is an associate of Irell & Manella, LLP, in Los Angeles. Contact them at and


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