The Guarantor’s Defense — Part 3: What the SPE Covenants Actually Say

Part 3 of a 5-part series on defending against carve-out guaranty claims in commercial real estate.

Single-purpose entity covenants appear in virtually every institutional commercial real estate loan. They are often presented as routine. They are not. These provisions impose ongoing behavioral obligations on the borrowing entity throughout the life of the loan. Violations do not require fraud or intent. Many occur under financial pressure, when sponsors are trying to keep a property alive. And in a bad boy guaranty structure, a technical SPE violation can convert a non-recourse loan into full personal recourse. Most guarantors cannot recite what their SPE covenants require. That is the problem.

What SPE Covenants Typically Require

Institutional SPE covenants commonly require the borrower entity to: maintain its existence as a separate legal entity; keep separate books, records, and bank accounts; avoid commingling its assets with those of any other person or entity; maintain adequate capital; pay its own liabilities out of its own funds; not incur indebtedness other than the permitted loan; not make loans to or invest in other entities; observe all corporate or LLC formalities; not merge, consolidate, or dissolve without lender consent; maintain at least one independent manager and require that manager’s consent for certain actions; and not file for bankruptcy without the required vote of the independent manager. These are not aspirational guidelines. They are contractual obligations with enforcement teeth.

Where Violations Most Commonly Occur

In practice, SPE violations arise from decisions made under financial pressure, not from deliberate misconduct.

Intercompany cash transfers. When a project runs short of cash, sponsors often move money between related entities. Those transfers — even when made with the intent to preserve the property — may violate the prohibition on intercompany loans, commingling, or unauthorized debt.

Shared services and expenses. Related entities often share staff, office space, vendors, insurance, or management infrastructure. If the allocation of those costs is not properly documented, lenders argue that the separateness requirement has been violated.

Unauthorized debt. Vendor obligations that go unpaid for extended periods can be characterized as unauthorized debt. Unsecured credit extended by a related party — even informally — may constitute a prohibited loan.

Independent manager failures. Many loan documents require an independent manager whose consent is needed for major decisions. If the required independent manager was never properly appointed, resigned without replacement, or was not consulted on material decisions, that is a structural violation.

Related-Party Transactions and the Disclosure Obligation

Related-party transactions are one of the most underappreciated exposure areas in distressed CRE guaranty litigation. When a project struggles, sponsors frequently provide informal financial support from related entities — cash advances to cover operating shortfalls, deferred management fees, shared vendor relationships. Each of these can be characterized as an unauthorized loan or an SPE covenant violation. What looks like a sponsor trying to save a deal can later be framed as a series of undisclosed insider transactions that violated the separateness structure of the loan.

Practical Checklist

If you are managing a distressed commercial real estate asset with a bad boy guaranty, these questions identify the most common exposure points: Are there unsecured cash advances from related parties that have not been disclosed to the lender? Are project bank accounts separate from related entity accounts? Is the property manager affiliated with the borrower, and if so, are management fees properly disclosed? Has the independent manager been properly appointed and maintained? Have there been any transfers of ownership interest without lender consent? Are financial reporting obligations current? Have vendor obligations gone unpaid in a manner that creates informal debt? Are insurance proceeds held in a segregated account?

SPE covenants are not boilerplate. They impose real, ongoing obligations. Understanding exactly what those covenants require — and auditing compliance before the lender does — is one of the most valuable things a guarantor can do during a distressed period.

Next in the series: Negotiating the Guaranty Before You Sign.

Matthew M. Clarke is a shareholder at Kelley Clarke, PC and Chair of Litigation. He represents guarantors, borrowers, and investors in commercial real estate disputes. This article is for informational purposes only and does not constitute legal advice.