When lenders lend millions to Delaware single purpose entities buying real estate, lenders often require that a springing member be identified in the operating agreement as a standby person to prevent the LLC from dissolving when its members may otherwise leave.
What Is a Springing Member?
Springing members can be an indispensable addition to an operating agreement for Single Purpose Entities (SPEs) and Delaware Limited Liability Companies that hold assets used as security for loans from large lenders. Lenders frequently require that these SPEs operate under bankruptcy remoteness laws like Delaware Statutory Trust Act to avoid personal bankruptcy risks associated with holding these loans as collateral for personal bankruptcy risks.
Although a DST or SPE with a springing member is often the ideal way to secure debt, its bankruptcy-remote nature can present certain concerns. LLC laws require at least one member, so if any member leaves an LLC must dissolve. To prevent this from happening, an operating agreement should include language stating that upon termination of any remaining member a person designated in said operating agreement as “springing member” will become part of it and join.
What Does a Springing Member Do?
Springing members are prepared and available at any moment to step into an LLC as needed following events that could affect its existence, such as death or bankruptcy. Without one member on board, an LLC would likely no longer be able to conduct business operations, enforce contracts, settle matters amicably, sell assets and distribute distributions effectively.
Lenders of large structured finance transactions usually mandate that an LLC’s operating agreement include provisions to prevent it from dissolving due to lack of members, though many owners voluntarily name springing members without being forced by law to do so.
Before becoming a special member, a springing member does not possess any interest in the profits, losses, capital or distributions from Company assets. Furthermore, no capital contributions must be made and they cannot bind the company legally.
How Does a Springing Member Work?
Springing members are widely used in real estate entities known as Single Purpose Entities (SPEs), also known as Delaware Limited Liability Companies. Such entities typically rely on one member to manage all aspects of business operations; should that person pass away or become otherwise incapable, the LLC will dissolve. To prevent this from occurring, their operating agreement typically designates someone as an “SPE Springing Member”, who will become part of membership as soon as the old member leaves.
Loan providers tend to appreciate this provision being added into an LLC agreement because it makes the entity bankruptcy remote, protecting their interests should borrowers file for bankruptcy protection while isolating collateral from other liens or claims. First seen in commercial mortgage-backed securities market over twenty years ago, lenders quickly learned that loans with this provision were given higher ratings by credit ratings agencies.
What Is a Noneconomic Member?
Noneconomic members are individuals or entities designated in an LLC operating agreement as the replacement members should any current ones cease being members for any reason, such as their death. Unlike springing members, however, noneconomic members don’t receive any economic stake in the company.
An investor or lender often requires the inclusion of noneconomic members into an operating agreement of a Delaware Limited Liability Company or Single Purpose Entity in order to avoid dissolution due to insufficient members. This is especially important when lending millions of dollars directly into real estate projects using these vehicles; lenders want their interests protected while protecting DLLC SPE properties that they loan money into.
Although noneconomic members do not hold an economic stake in the company, they are sometimes referred to as such because they do not receive any distributions of profits, losses and capital of DLLC SPEs as per usual. Instead, compensation for their services as noneconomic members of these enterprises is provided on an annual basis.
