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COMMERCIAL FINANCE 701: Practical issues with multi-tiered entity structures

Commercial Finance 701 is a continuing series on commercial loans written exclusively for the Mississippi Business Journal. This series is geared to lenders, developers, investors and transactional attorneys.


It is quite common – even vogue nowadays – for the ownership structure of a commercial project to include a chain of entities.  Even in a relatively straightforward commercial project, the resulting organizational chart can be convoluted.   (See Chart 1).

The older ones among us grew up with corporations as the standard fare, which invariably included shareholders, a board of directors, and the typical officers.  Later a host of officer acronyms (CEO, CFO, & COO) and several new or revitalized entities (LLC, LLP, PLLC, PLLP & LLLP) arrived on the scene.  The nontraditional structures offered customizable governance.   One can no longer find comfort in the familiarity of a good ol’ corporation and must read the organizational documents of these newfangled entities to understand the power and control arrangement.  An LLC manager might be omnipotent or powerless, depending on a few key words in the operating agreement.

Justifications for the formations are usually associated with tax avoidance, succession planning, investor accommodation, and risk mitigation.  Clark Luke, a Watkins & Eager tax attorney, addressed some of these issues in “Business Entity Selection:  Choose Wisely or Pay Later” (Mississippi Business Journal, July 24, 2015).

In commercial loans, tiered structures come with some practical issues:

Organizational Documents. In preliminary discussions, it is likely (1) the entity structure isn’t complete, or (2) the Borrower doesn’t think the entity gradations are relevant.   Once the loan process gathers steam, the lender receives the Borrower’s organizational documents and, may, for the first time, learn that the principal is NOT really the owner of the Borrower.  Instead, it may be the Borrower is actually owned by a never-before-mentioned entity not listed on any financial statements. The principal might express genuine surprise that the lender even cares about that “paper” entity, as it really doesn’t do anything and was merely created by a lawyer for some obscure legal reason.  Legally, however, that understated entity owns the Borrower, controls management, can grant a lien on equity rights, and is entitled to the Borrower’s profits.

Family, Friends & Investors.   As the parties meander down the tiered entity structure, eventually you find the true ownership.   Sometimes it turns out the “principal” is not alone.   There may be family, friends and other “investors” with ownership interests.  Who has the rights and power to make decisions?  Can an investor take over management?  Can any of the equity owners sell (or lose) their interests to a third party?  What happens if there is an involuntary transfer (death, tax liens, judgments, bankruptcy, etc.)?   It is not uncommon for organizational documents to require amendment prior to a loan closing to satisfy a lender.

Guaranties.   While the early discussions with the Borrower might have contemplated a 100% guaranty solely from the principal, that discussion preceded a disclosure of the ownership structure.  Lenders reasonably require the owners of a project to have a financial stake in the Borrower through the life of a loan.  A guaranty keeps them at the table.  Guaranties may also be required from each entity in the chain of ownership.

A principal might bring investors to the deal to help meet the HVCRE equity requirements (See “Basel III, high volatility & realty loans,” Mississippi Business Journal, May 15, 2015).  Passive investors, those just bringing money and otherwise playing no role in construction or management, are hardly enamored with the idea of providing guaranties.  A bank, however, wants assurance that it has guaranties from current and future controlling ownership interests.

Lien Searches.  Just as a lender will obtain lien searches on the Borrower and the guarantors, the lender will often search liens on all entities in the organizational structure.  Obtaining these lien searches (tax, judgment, UCC) is a more onerous task if the entities are formed in multiple states.  Searches are typically run, on a county level where the property, principal offices of the Borrower, and guarantors are located, and, on a state level, where entities are organized.  The more entities, guarantors and jurisdictions involved, the more searches.

Company Certifications, Resolutions & Good Standing Certificates.  The lender will require each entity provide a company certification (as to organizational documents and relevant factual matters), along with detailed authorizing resolutions.  The more entities, the more resolutions to be drafted, executed and reviewed.   Good standing certificates from the applicable states (of organization and qualification) are necessary.  None of this is particularly burdensome, but it does involve some paper and legal hours.

Opinions.   A complex organizational structure limits any flexibility a bank has to waive or limit costly legal opinions. The bank needs assurance that each entity exists, is in good standing, has authorized the transaction, and the officers are duly appointed and empowered to carry out the transaction.   Multiple entities formed in varying jurisdictions may necessitate legal opinions from counsel in multiple states.

Other Complications.    We’ve merely hit the high points.   Lien and credit issues are amplified for entities engaged in unrelated, non-project activities.  The use of disregarded entities, tenants-in-common, and trusts provide additional fodder.  It is hard to have a simple loan closing when you have a complex ownership structure.

CONCLUSION.   The Borrower’s ownership structure is best disclosed and addressed early in the process.  A tiered structure has its place in many transactions, and legal counsel and tax advisors can advise as to the pros and cons of the weighty issues.  A small part of the weighing should include an appreciation for the practical issues discussed above. The proper balance is difficult to discern, particularly without the benefit of hindsight.    Albert Einstein, who ranked 9th in Forbes’ 2015 Top Earning Dead Celebrities list, nailed it when he said:  “Make everything as simple as possible, but not simpler.”

» Ben Williams and Molly Jeffcoat Moody  are attorneys engaged in an active commercial law practice at Watkins & Eager PLLC.   Ben and Molly are both recognized by Chambers USA and Best Lawyers in America.   Ben was selected as Best Lawyer’s 2016 Project Finance Lawyer of the Year in Jackson, Mississippi.   Additional information is available at www.watkinseager.com.


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