Special purpose entity: Overview, definition, and example
What is a special purpose entity?
A special purpose entity (SPE) is a separate legal entity created for a specific, limited purpose, often to isolate financial risk or manage a specific project. An SPE is typically set up to handle particular assets, liabilities, or operations, and is legally distinct from the parent company. It is often used in complex transactions like asset securitization, joint ventures, or project financing.
For example, a company might create an SPE to own and operate a single building or a group of assets, keeping these separate from its core business to limit exposure to potential financial or legal risks.
Why is a special purpose entity important?
An SPE is important because it allows businesses to isolate specific financial risks, protect assets, and structure transactions more efficiently. By using an SPE, companies can reduce their liability and protect their main business from the risks associated with a particular project or investment. SPEs are often used to manage complex financing arrangements or to meet regulatory requirements that prevent certain activities from being directly tied to a company's main operations.
Understanding special purpose entity through an example
Imagine a company plans to develop a new shopping mall. Rather than having the entire project tied to the parent company, the business creates a special purpose entity to own and manage the mall’s construction and operation. This limits the financial and legal risks to just the assets and liabilities associated with the mall, while the parent company remains protected from any potential losses or legal issues that might arise from the project.
In another example, a company in the energy sector may create an SPE to manage the development of a wind farm. The SPE would hold the assets related to the wind farm project, such as land leases, equipment, and financing, ensuring that the risks and liabilities from the wind farm do not impact the parent company’s overall operations.
An example of a special purpose entity clause
Here’s how a clause related to a special purpose entity might appear in a contract:
“The Parties agree that the Special Purpose Entity formed for the purposes of this Agreement shall be the sole entity responsible for the execution of the project, and all liabilities arising from such execution shall be borne solely by the SPE, with no recourse to the Parent Company.”
Conclusion
A special purpose entity allows businesses to isolate specific risks and manage projects or assets more effectively. By creating a separate legal entity, companies can protect their core business from financial or legal exposure, and structure complex transactions to meet specific financial or regulatory goals. Understanding how and when to use an SPE is crucial for businesses involved in large-scale projects or transactions.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.