Corporation

Definition of a Corporation in Commercial Mortgages

In the context of commercial real estate and finance, a corporation is a legal entity that is created under the laws of a state and is treated as a distinct "person" separate from its owners (shareholders). For commercial mortgages, corporations serve as the borrowing entity, allowing individuals or groups to acquire, manage, and finance income-producing properties while maintaining a legal barrier between their personal assets and the obligations of the mortgage debt.

Detailed Description and Characteristics

When a corporation applies for a commercial mortgage, it operates as the primary obligor. This structure is favored by lenders and investors alike for several specific reasons related to liability, tax treatment, and operational continuity.

The following are the core components of how a corporation functions within the commercial mortgage landscape:

• Limited Liability Protection: One of the primary reasons for utilizing a corporation in a mortgage transaction is to protect the personal assets of the shareholders. In the event of a default or foreclosure, the lender's recourse is typically limited to the assets held by the corporation (the property itself), rather than the personal bank accounts or homes of the owners.
• Perpetual Existence: Unlike a sole proprietorship, a corporation has a perpetual life. This means the entity continues to exist and remain responsible for the mortgage even if a shareholder passes away or sells their interest. This provides stability for long-term commercial loans that may have terms of 10, 20, or 30 years.
• Special Purpose Vehicles (SPVs): In many commercial mortgage-backed securities (CMBS) transactions, lenders require the borrower to form a specific type of corporation known as a Single Purpose Entity. This corporation’s sole asset is the property being financed, which isolates the risk and prevents the entity from engaging in other business activities that could lead to bankruptcy.
• Corporate Governance: Commercial lenders evaluate the corporation’s Bylaws and Articles of Incorporation to determine who has the legal authority to sign loan documents. This formal structure ensures that the borrowing entity is legally bound by the terms of the mortgage through resolutions passed by a Board of Directors.

Recourse and Personal Guarantees

While the corporate structure is designed to limit liability, lenders often mitigate their risk by requiring a personal guarantee from the corporation’s principals, especially for smaller or less-established companies. This means that if the corporation fails to pay the mortgage, the individuals behind the corporation may become personally liable for the debt. However, for "non-recourse" commercial mortgages—which are common for large-scale institutional assets—the lender agrees to look only to the corporation's assets for repayment, reinforcing the corporate veil.

Creditworthiness and Underwriting

When underwriting a mortgage for a corporation, the lender focuses on the Debt Service Coverage Ratio (DSCR) and the financial health of the entity. They will review corporate tax returns, balance sheets, and profit and loss statements. Because a corporation is a separate taxpayer, its ability to deduct mortgage interest and depreciation as business expenses can significantly impact its net operating income and, consequently, its ability to qualify for more favorable financing terms.