Bankruptcy remoteness, and what breaks it

Graduate · enrolled learners

This lesson opens with General Growth Properties, 2009.

What happened

General Growth Properties was a large owner of shopping malls that financed them through bankruptcy-remote special-purpose entities: each mall sat in its own single-purpose entity, with an independent director whose consent was needed to file for bankruptcy, a structure designed so that the mall could not be dragged into the parent company's bankruptcy and lenders to that mall would be protected. In April 2009 General Growth filed for Chapter 11 and included dozens of these supposedly remote entities in the filing, even ones that were current on their debt, and the bankruptcy court allowed them to stay in bankruptcy, reasoning that the group's overall financial distress could justify it and that the independent directors could weigh the group's interests, not only the single entity's. The market was shocked, because these structures had been treated as reliably remote. No investor was wiped out here, and the entities were eventually reorganized, which is why the recorded loss is zero, but the assumption that bankruptcy remoteness was absolute was broken, and lenders who had priced the risk as near zero found it was not.

The decision point

Bankruptcy remoteness is a design that lowers the chance that an SPV is pulled into its sponsor's bankruptcy, through structural features, a single purpose, restrictions on incurring other debt, an independent director whose consent is needed to file, separateness covenants, but it lowers the chance, it does not eliminate it. General Growth is the case that proved the difference: entities engineered to be remote, and treated by the market as reliably so, were nonetheless brought into the parent's bankruptcy and kept there, because a court accepted that group-wide distress and the independent directors' consideration of the group could justify it. Remoteness is therefore a matter of degree, resting on features that reduce risk but can be overcome by a determined sponsor, a sympathetic court, or a group-wide failure. So the decision when structuring or relying on a tokenized asset is to assess the actual strength of the SPV's remoteness, how independent the director truly is, how tight the separateness covenants are, how the relevant law treats such filings, rather than assuming remoteness is a binary that is simply achieved, because a token whose safety rests on the SPV being untouchable by the sponsor's bankruptcy is resting on a probability, not a certainty, as General Growth's lenders discovered.

Orientation and Year One are open: anyone can read them without an account. From Year Two onward the lessons are for enrolled learners, because progress through the later years only means anything if it is tracked against a record.

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