Special Delaware Bankruptcy Remote Opinions

Introduction

Delaware limited liability companies, and, in particular, special-purpose bankruptcy-remote limited liability companies, are used in many financing transactions throughout the United States. While the structure of the limited liability companies and the types of legal opinions that are required can vary depending upon the type of transaction, there are certain features common to many of these transactions.

There are usually one or more single-member Delaware limited liability companies in the ownership chain for these transactions. The limited liability company agreements of these companies typically include (i) a narrow purpose; (ii) covenants limiting the activities of the limited liability company, as well as covenants aimed at respecting the separate legal entity status of the limited liability company; (iii) restrictions on the ability to (a) dissolve the limited liability company, (b) sell all or substantially all of its assets, (c) amend its limited liability company agreement, and (d) to engage in similar activities; and (iv) in some transactions, a requirement that the limited liability company always have at least one or two independent managers whose consent is required for the limited liability company to file a voluntary bankruptcy petition or otherwise consent to bankruptcy-related matters.

As a general matter, the types of opinions required in these transactions fall into three categories: (i) nonconsolidation and/or true sale opinions, (ii) traditional formation, power and authority, and enforceability opinions (and occasionally U.C.C. perfection opinions), and (iii) opinions that are often referred to as “bankruptcy-remote LLC opinions” or “rating agency opinions.” The rating agency criteria in connection with this type of transaction are not addressed in this article but are discussed in some detail at the websites of certain of the statistical rating agencies.

The SPE LLC Borrower Transaction

One common form of transaction using special-purpose bankruptcy-remote limited liability companies is a loan transaction involving a property owned by a single-member Delaware limited liability company (an “SPE LLC Borrower Transaction”). For reasons discussed below, lenders and rating agencies have often expressed a preference for using Delaware limited liability companies in this type of transaction. In its basic form, the SPE LLC Borrower Transaction involves a newly formed, single-member Delaware limited liability company, which has a limited purpose and other bankruptcy-remote features (an “SPE LLC”), and borrows funds in order to obtain or refinance a single property.

Many practitioners are familiar with the traditional real estate loan opinions that are required in an SPE LLC Borrower Transaction (e.g., opinions concerning the due formation of the borrower; the power and authority of the borrower to execute, deliver, and perform the loan documents; and enforceability opinions with respect to the loan documents).^. Many opinion givers are also familiar with the nonconsolidation opinions that may be required in this type of transaction. However, there is a third category of legal opinions that is often required in this type of transaction that may be unfamiliar to the attorneys involved: the bankruptcy-remote LLC opinions or rating agency opinions. While these opinions are often required in an SPE LLC Borrower Transaction, it is worth noting that these same opinions are also frequently required in various other limited liability company financing transactions, whether in the commercial mortgage securitization market, in other structured finance transactions, or even in portfolio loan transactions.

Bankruptcy-remote LLC opinions primarily address two points: (i) if the SPE LLC has at least one independent manager, the vote required for the SPE LLC to file a voluntary bankruptcy petition, and (ii) the continuation of the existence of the SPE LLC without dissolution in the event of the bankruptcy or dissolution of its sole member. The first point involves both federal and state law considerations; the second point involves only state law considerations.

The Vote Required to File a Voluntary Bankruptcy Petition

In an SPE LLC Borrower Transaction, there may be a requirement that the SPE LLC at all times has one or two independent managers whose consent is required for the limited liability company to file a voluntary bankruptcy petition. From a lender’s standpoint, such a requirement gives the lender some degree of assurance that before the borrower files for bankruptcy, its owners or principals must convince an independent person that filing is in the best interests of the company. Lenders often seek comfort with respect to this requirement by requesting a legal opinion concerning the enforceability of this consent requirement.

This legal opinion has two components. The first component relates to the law that a federal bankruptcy court will choose when determining whether or not a person has authority to file a voluntary bankruptcy petition on behalf of the SPE LLC. This is normally a reasoned opinion, examining both statutes and existing case law, and stating that, as a matter of federal law, a federal bankruptcy court will look to the state law governing the SPE LLC’s internal affairs, and not federal law, to determine what persons have the authority to file a voluntary bankruptcy petition on behalf of the SPE LLC. For an SPE LLC that is a Delaware entity, the governing law would be Delaware law. As a reasoned opinion, this analysis of federal law can be very complex, but the opinion statement is simple; Delaware law governs the determination of what persons or entities have authority to file a voluntary bankruptcy petition on behalf of the SPE LLC.

The second component of this opinion relates to the enforceability of the consent provision of the limited liability company agreement under applicable Delaware state law that requires the consent of all independent managers in order for the SPE LLC to file a voluntary bankruptcy petition. In summary, this opinion provides that, if properly presented to a Delaware court, a Delaware court applying Delaware law would conclude that, in order for a person to file a voluntary bankruptcy petition on behalf of the SPE LLC, the consent of some identified person (e.g., the independent manager of the LLC) is required, and such consent requirement in the limited liability company agreement is an enforceable provision under the laws of the State of Delaware. In other words, the lender has some comfort that an independent person will have to determine that a bankruptcy filing is in the best interests of the SPE LLC.

Delaware is often the preferred jurisdiction of formation of a limited liability company for which the foregoing opinions are to be rendered. The reasons for this preference may include the traditional reasons relating to the preferred use of Delaware business entities -- such as well-developed corporate law precedent, a responsive legislature, and courts that are well versed in business matters. Additionally, certain aspects of the Delaware Limited Liability Company Act (the “DLLC Act”) are helpful in connection with these opinions. The DLLC Act permits great flexibility in connection with the management structure of a Delaware limited liability company. It also permits a member or manager to delegate its rights and powers to manage and control the limited liability company. Importantly, it is the policy of the DLLC Act “to give maximum effect to the principle of freedom of contract and to the enforceability of limited liability company agreements.” Finally, the DLLC Act permits contractual modification of a member’s or manager’s fiduciary duties. Moreover, the Delaware Supreme Court has stated that the DLLC Act is a default statute, and the Court has applied the principle of enforcing the applicable limited liability company agreement, except to the extent that it is inconsistent with a mandatory provision of the DLLC Act. The combination of all of these factors may provide the lender with a satisfactory level of assurance concerning the enforceability of contractual provisions requiring the consent of an independent manager for the filing of a voluntary bankruptcy petition on behalf of a Delaware limited liability company.

An SPE LLC is typically managed by the member; however, various other management structures are also sometimes employed (e.g., management by a separate manager or management by a board of managers). For purposes of the required legal opinions, the critical provision of the limited liability company agreement, which overrides any inconsistent provision in the limited liability company agreement, is one providing that the SPE LLC may not, among other things, file a voluntary bankruptcy petition unless all independent managers unanimously consent to the filing.

Continuing the Existence of the SPE LLC

The second focus of bankruptcy-remote LLC opinions relates to continuing the existence of the SPE LLC without dissolution upon the bankruptcy or dissolution of its sole member. With respect to a single-member limited liability company borrower in particular, lenders often seek comfort through a legal opinion that, under the law and documents governing the limited liability company, the bankruptcy or dissolution of the sole member will not, by itself, cause a dissolution of the limited liability company.

Delaware is often the preferred jurisdiction of formation to the extent that there is concern with respect to continuing the existence of the limited liability company upon the bankruptcy or dissolution of its sole member. This preference may again be due to certain aspects of the DLLC Act. With respect to the bankruptcy of a member, the default rule under the DLLC Act is that the bankruptcy event with respect to a member will cause the member to cease to be a member of the limited liability company. But this is a default rule that is subject to modification by the terms of the limited liability company agreement for an SPE LLC, and the relevant provisions of the agreement are intended to override the default rule.

However, the SPE LLC in these transactions is typically a single-member company; therefore, if there is no member, the company itself may dissolve. While it is possible to provide in the limited liability company agreement of an SPE LLC that the bankruptcy of a member, in and of itself, will not cause the member to cease to be a member of the SPE LLC, a separate issue arises if the member ceases to exist. However, various mechanisms are permitted under the DLLC Act to avoid such a dissolution. Among these, the DLLC Act provides that the limited liability company agreement may obligate the personal representative of the last remaining member to continue the limited liability company and admit the personal reperesentative or the nominee or designee of the personal reperesentative. In addition, the DLLC Act, as well as the underlying principle of freedom of contract, permits a Delaware limited liability company agreement to have one or more persons agree to spring in as members and continue the entity without dissolution upon the sole member ceasing to be a member. Often, the independent managers of the SPE LLC will also be so-called “springing members.” If the sole member ceases to be a member (other than in certain circumstances), the limited liability company agreement provides that the “springing members” are automatically admitted as members; however, typically they are not obligated to make capital contributions, do not receive a limited liability company interest, and have no voting rights in their capacity as “springing members.”

As described above, lenders often seek comfort in the form of a legal opinion that, under the DLLC Act and the applicable limited liability company agreement, the bankruptcy or dissolution of the sole member of an SPE LLC will not, by itself, cause dissolution of the SPE LLC, and these provisions of the DLLC Act allow an SPE LLC to be organized in a way to avoid such a dissolution.

Other Opinions

Certain other legal opinions are often also rendered as part of the bankruptcy-remote LLC opinions. These opinions include (i) a general enforceability opinion with respect to the limited liability company agreement of the SPE LLC itself, (ii) an opinion that, under the DLLC Act, the limited liability company is a separate legal entity that continues in existence until its certificate of formation is canceled, and (iii) an opinion concerning the rights of a judgment creditor of the sole member of the limited liability company. The DLLC Act supports each of such opinions.

Conclusion

The special bankruptcy-remote opinions given with respect to an SPE LLC in an SPE Borrower LLC Transaction are specialized opinions requiring careful analysis of the governing limited liability company agreement for its compliance with the requirements of Delaware law as well as careful analysis of the federal bankruptcy laws implicated in such opinions. For this reason, these opinions are usually given only by lawyers experienced in dealing with these laws.