The term ‘Bankruptcy remote’ may be defined as the impact of bankruptcy of any one organization within a group on other sister companies. The insolvency status of one of the group companies should not in any way adversely affect the other companies in the group.
As most companies operate as limited liability concerns, they will be legally bankruptcy remote from one another within a group. However, professionals adept in financial structuring will refer to bankruptcy remote as the extra steps needed to insulate group companies from any possible adverse repercussions.
Orphan Structure
They generally advocate employing what is known as ‘orphan structure’ to wean away the ownership of the bankrupt company from the group. This step is usually resorted to when the delinquent company may mean liability to the group – particularly when it comes to environment legislation or tax liabilities.
Mortgage Lenders
Interestingly, mortgage lenders who are into commercial lending may insist that the properties offered as collateral security be placed in special LLC (Limited Liability Company) which are bankruptcy remote from their owners. This is a necessary precaution if the lender has to confiscate the property in the event of default of loan repayment.
It is a fact that many mortgage lenders had bad experience during the recent real estate recession. The purpose of any bankruptcy remote structure is to minimize the two possible risk factors - the risk that the borrower will volunteer a bankruptcy petition and the risk that creditors of the borrower will drive the borrower into an involuntary bankruptcy.
Other Factors
It needs to be stated that the actual enforceability of bankruptcy remote structures is oftentimes difficult. A bankruptcy court may not accept a structure that aims to prohibit bankruptcy. Thus, a lender must be aware of the potential risk despite the most impeccably drafted bankruptcy remote structures.
The fact also remains that borrowers will resent any interference by a lender into their functioning and will oppose any bankruptcy remote structure that bestows the lender with controlling rights. It is therefore necessary that both the parties should mutually agree to the contents of a bankruptcy remote structure.
Of course, it is in the lender’s interest that some form of bankruptcy remote structure is included in all lending transactions to lessen bankruptcy risks. But the lender should also remember that any bankruptcy remote device, however imaginatively crafted, will not be a foolproof guarantee against a borrower's bankruptcy but only a means to reduce the risk factor.
