Why Springing Member Provisions Are Often Required for Bankruptcy Remote Entities

What this is: A springing member is an individual or company that serves as a placeholder, with no ownership interest, management rights or responsibilities, and remains in place only so long as there is no other member.  

What this means: As you might expect, it gets a little more complex when it comes to drafting operating agreements.

In our previous discussion on the nuances of drafting provisions for independent directors or managers, we identified 2 key lender requirements in real estate finance transactions (including commercial mortgage-backed securities loans): 

1. Lenders may require the formation of a bankruptcy remote entity (BRE), also referred to as a single purpose entity (SPE). This limits certain risks associated with a borrower’s bankruptcy filings and isolates a lender’s collateral from insolvency and bankruptcy risks. Most lenders favor the formation of a Delaware Limited Liability Company (DLLC) to satisfy this requirement. 
2. Lenders may require appointment of an independent director or manager who is not affiliated or associated with the borrower. 

Purpose of Springing Members 

Section 18-101(6) of the Delaware Limited Liability Company Act (DLLC Act) requires a DLLC to have at least one member. A springing member serves as a safeguard against dissolution of a DLLC for lacking any members. 

In a transaction where a large lender is loaning millions of dollars to a DLLC SPE purchasing real estate, the lender will want to be certain that a standby person, a springing member, is named in the DLLC’s Limited Liability Operating Agreement, especially if it is a single purpose entity operating agreement. In the event that the DLLC’s single member is terminated (which would otherwise trigger dissolution of the DLLC), the springing member (like the name implies) 'springs' into the membership role and prevents the entity from dissolving, per Section 18-801(a)(4)b of the DLLC Act.  

A simple springing member definition would be an individual or company that serves as a placeholder, with no ownership interest, management rights or responsibilities, and remains in place only so long as there is no other member. As you might expect, it gets a little more complex when it comes to drafting operating agreements. 

Below is a short (but not complete) excerpt of language regarding springing members that you may find in a DLLC Operating Agreement to be reviewed by legal counsel and agreed to by all parties: 

“Single Purpose Entity Provision: Springing Member. Upon the occurrence of any event that causes the Sole Member to cease to be a member of the Company ... the Springing Member shall, without any action of any Person and simultaneously with the Sole Member ceasing to be a member of the Company, automatically be admitted to the Company as a member of the Company and shall continue the Company without dissolution.” 

While the springing member is a very limited role, it’s another layer of protection for lenders. It will ensure that the DLLC they have loaned money to remains active and in good standing (maintaining a registered agent and paying Delaware’s annual franchise tax by June 1) and is not at risk of being dissolved if the DLLC’s sole member is no longer in place. 

Experience (Still) Matters 

Springing member requirements from lenders are not necessarily complex, but there is nuance to their fulfillment. When selecting a service company to serve as your independent manager/springing member, it helps to work with experienced professionals who understand this limited but important role and can quickly and seamlessly coordinate the designation of a springing member for the DLLC SPE in your transaction. 

Have additional questions about springing members or other topics referenced in this post? Get in touch or ask in the comments below. We’re happy to help!

This article is provided for informational purposes only and should not be considered, or relied upon, as legal advice.