The entity that acquires, maintains, manages and ultimately sells the real estate is called the “syndicator” or “sponsor”. These terms will be used interchangeably. A typical syndication combines the money of individual investors with the management of the sponsor, and has a three-phase cycle: origination (planning, acquiring property, satisfying registration and disclosure rules, and marketing); operation (sponsor usually manages both the syndicate and the real property); and liquidation or completion (sale or disposition of the property).
In most deals, the sponsor will provide a limited financial investment but bring to the table valuable expertise and the ability to locate the investment opportunity. The investors will provide most of the capital, but will not be involved in daily operations. The investor essentially has made a passive investment.
The sponsor typically has a smaller percentage ownership interest in the combined entity, but will provide the following:
• Locate and negotiate the purchase of the property;
• Perform initial legal and tax diligence;
• Obtaining bank financing;
• Manage the affairs of the partnership;
• Arrange for management of the property;
• Communicate with the investors;
• Make day to-day operating decisions; and
• Negotiate the final disposition of the property.
Even though sponsors may use legal structures that provide limited liability, they may be required to sign personal guarantees for any debt taken out on the syndication. This is a very common practice as banks and financial institutions are aware of the limited liability afforded to LLCs, so they often want a party who they can personally hold liability for the debt if things go wrong.
Another common practice aside from a personal guarantee, is the use of so called “bad boy” clauses or carve-outs. So even if the sponsor does not personally guarantee the loan, they may still not be immune from personal liability. Accordingly, a non-recourse loan can have provisions within the loan agreement that essentially transfers personal liability to the sponsor for certain acts or behaviors.
Not only can the sponsor be held liable as a result of a bad boy clause, other individuals or entities that provide limited guarantees or indemnification can be liable as well. Some of the more typical clauses include the following:
• Losses pertaining to any fraud or misrepresentation of the sponsor;
• Losses relating to theft or defalcation of tenant rents or security deposits;
• Specific performance for actions under the loan documents;
• Ability to foreclose and obtain title to any additional collateral;
• Ability to enforce any environmental indemnification;
• Losses regarding the maintenance of insurance of the collateral; and
• Issues pertaining to insolvency or bankruptcy.
While the list above represents some of the typical carve outs, each lender may have specific provisions or covenants. These can also be tailored to the economics of the loan and the strength of the sponsor. The stronger and more experienced the sponsor and the lower the loan to value the more leverage the sponsor has as it relates to negotiating specific bad boy provisions.