Special Purpose Company (SPC)

Unlike an ordinary company, a special purpose company often operates as a paper company with no real staff or physical facilities.

This keeps operating costs low and lets the company concentrate solely on managing assets and distributing returns.

For corporate practitioners designing a complex financial structure, such a company can secure both investor protection and transactional stability at the same time.

The central purpose is risk isolation.

By ring-fencing a particular business within a separate company, you build a wall so that any loss from that business does not reach the parent company's assets.

Conversely, the structure ensures that even if the parent runs into trouble, the assets held by the special purpose company can be distributed safely to investors.

A special purpose company provides an effective structure for raising funds from investors and financial institutions.

Investors are not betting on the uncertainty of the parent company as a whole; they can decide whether to invest based on the cash flows of the specific business that the special purpose company carries out.

This works in their favor when seeking to lower the cost of funding or to attract large sums of capital.

In a large project involving multiple investors, defining each party's rights and obligations is highly complex.

Setting up a special purpose company allows the order of profit distribution and the voting rights to be set out clearly through a shareholders' agreement or the articles of incorporation.

This helps head off any future dispute over management control or the settlement of returns.

A special purpose company generally operates as follows.

Forming the special purpose company

A special purpose company is formed to carry out a specific transaction or business.

Because it is established to serve a particular purpose, its scope of business is narrower than that of an ordinary company.

The general formation procedure is as follows.

Transferring the assets or business

The parent company or the investors transfer specific assets or a business to the special purpose company.

In an asset securitization transaction, for example, accounts receivable or loan receivables are transferred to the SPC.

Raising funds from investors

The special purpose company raises funds from investors or financial institutions.

This is done through various methods, including issuing bonds, issuing asset-backed securities, and borrowing from financial institutions.

Operating the business and generating cash flow

The special purpose company generates cash flow by operating the business or assets.

In an infrastructure investment project, for instance, this may take the form of tolls, rents, or power generation revenue.

Distributing returns to investors

The cash flow generated is used to pay investors their principal and interest or dividends.

Transactions that use a special purpose company carry an ongoing risk of complex contractual relationships among stakeholders and breaches of financial regulation.

There is no problem while the project goes smoothly, but if profitability deteriorates because of an economic downturn, or unexpected costs arise, hard-fought legal battles can break out among investors, the developer, and the financial institutions.

In such a dispute, the plaintiff (an investor, for example) seeks to recover its rights by alleging a breach of the profit-distribution arrangement or mismanagement, while the defendant (the developer or the parent company) defends on the basis of a contractual exemption clause or a force majeure change in business conditions.

Such a matter can readily spread beyond a civil dispute into an inquiry by the financial regulator or a tax audit, so a sound legal defense should be built from the earliest stage.

The most frequent is a dispute among investors over the distribution of returns.

When the project's cash flow falls short of expectations, differences in interpretation arise over who should be paid principal and interest first.

If suspicions emerge that the parent company has improperly diverted funds in the course of operating the special purpose company, the matter can also escalate into a criminal issue such as occupational breach of trust.

A poor initial response can lead to a decline in the company's overall creditworthiness or even the possibility of a custodial sentence, and this should be kept in mind.

A special purpose company often has to maintain certain conditions in order to qualify for tax benefits.

If, for instance, the structure grants a corporate tax reduction only when at least 90% of distributable profits is paid out, missing this condition even once results in a substantial tax burden.

Unfair trading or a breach of disclosure obligations under the Financial Investment Services and Capital Markets Act is likewise a serious threat a company may face.