Special Purpose Companies
A Special Purpose Company (SPC) is a company that is set up for a specific goal, for instance to isolate a specific risk.
There are many situations that warrant the use of a Special Purpose Company. In the following paragraphs, we will give some examples to illustrate how beneficial it would be to use Special Purpose Companies under certain circumstances and describe how SPCs work and how they can benefit you.
Example One, Risk Reduction:
A company that owns a fleet of oil tankers might consider lowering and isolating its pollution risk exposure by setting up a number of Special Purpose Companies (SPC) and owning and operating each tanker under a separate SPC. By doing this, its group liability risk is lowered in relation to anti-pollution laws in the case of an environmental issue. In this situation, the SPC is used to alienate the high-risk asset/project from the corporation and isolate it to one company. In addition, an individual might consider the use of an SPC to isolate certain risks when investing or participating in a new business venture.
Example Two, Holding Assets:
To structure and hold certain specific assets, a corporation might consider the use of an SPC to hold certain assets, the operation of which requires non-transferable or difficult-to-transfer permits and licenses, such as is common with power plants. By having an SPC own the asset(s) and all permits, the SPC can be sold as a self-contained package, rather than attempting to assign or transfer numerous permits and licenses.
Example Three, Securitization:
In “securitization transactions,” the term securitization is used to describe transactions whereby a lender (bank or other) packages and sells/transfers a pool of receivables to an SPC. The SPC, in turn, uses this pool of receivables as security (collateral) to raise funds from investors. With the funds received from the investors, the SPC pays the lender for the receivables, while the various debtors in the pool pay back their loan.
The SPC, as the new owner of the receivables, receives and uses these funds to pay the investors, including agreed-upon interest and capital. For example, a bank may wish to issue a mortgage-backed security whose payments come from a pool of mortgages.
However, to ensure that the holders of the mortgage-backed securities have the first priority right to receive payments on the loans, these loans need to be legally separated from the other obligations of the bank. This is done by creating an SPC and then transferring the mortgages from the bank to the SPC.
Example Four, Real Estate Holdings:
As a tool to own and hold real estate, the use SPCs can also yield great advantages. By using an SPC to hold real estate, one could achieve the following advantages:
- Capital Gains Tax could be avoided on the sale of the real estate by selling and transferring the shares of the SPC instead of the real estate.
- By selling and transferring the shares of the SPC instead of the real estate itself, there would be a faster and easier completion of the sale; one would avoid all the legal requirements and procedures that need to be completed to effect the transfer of the title of the real estate to the new owner.
- Financial arrangements, such as property finance, can be dealt with more easily by using an SPC. By pledging the shares of the SPC that owns the real estate to a bank or other financial institution as collateral to secure a loan, funds could be obtained to invest in more real estate or to pursue other business ventures.
When contemplating the use of an SPC, one is also faced with the decision: What would be the best way to hold the shares of the SPC? Depending upon the circumstances, it might be advisable for the corporation or individual setting up the SPC to hold the shares of the SPC directly. In other circumstances, it would be necessary to separate the SPC from the corporation or person setting up the SPC.
There are various ways by which an SPC could legally be separated from the one who is setting up the SPC. The two most common methods are to use a Private Foundation or a Special Purpose Trust to act as the shareholder of the SPC. An SPC that is legally separated from its sponsor is also referred to as an Orphan SPC.
The Private Foundation is an independent legal entity, with no shareholders, which owns its assets directly. Because of this characteristic, we see that more and more advisors are electing for the Private Foundation to act as shareholder when setting up an Orphan SPC.
Some of the advantages of the Private Foundation that apply in this type of situation are:
- It has its own separate legal status.
- It has self-owned assets.
- Greater segregation of assets is achieved through the use of a foundation.
- It has no other members or shareholders.
- The foundation can be set up to have a specific purpose and it does not have to have beneficiaries.
- “Purpose foundations” can be set up for an indefinite term.
- It has the option for a third party to carry out its administration.
- There is greater security for third parties who are administering the foundation.
- Administrators can be changed easily without requiring assets to be transferred to the new officers
As opposed to a Private Foundation, a Special Purpose Trust is not an independent legal entity. A Trust is a legal arrangement between a Settlor (the one who place the assets in the Trust) and a Trustee (the one who manages the assets in the Trust). The Trustee’s job is to manage the trust assets in accordance with the provisions of the trust deed in favor of the beneficiaries of the Trust.
We agree that adequately describing the use and benefits of sophisticated financial structures such as SPCs in such a short article as this is a challenge—some topics are better discussed at length person to person. So, as usual, we remain at your disposal to answer your questions and provide more detailed information on how an SPC can benefit you.