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BAD BOYS OR GOOD GUYS
WHICH ARE YOU?
NEW ISSUES IN NON-RECOURSE
For a long time now, one of the chief attractions of CMBS financing has been the availability of non-recourse loans. The exception to the general non-recourse nature of these loans has been the commission of certain bad acts by the borrowers including, by way of example, fraud, waste, misappropriation of funds, bankruptcy and prohibited transfers. As such, these type of exceptions have been memorialized as so-called “Bad Boy Carve-Outs” to the non-recourse provisions of the loan. Over the years, these bad boy carve-outs have expanded. Initially, while they may have been occasionally dismissed by a guarantor as being not likely to occur, the expansion of these carve-outs and the uncertainty from the Cherryland/Chesterfield cases have led guarantors to give greater consideration to their exposure under these so-called bad boy guaranties.
During the course of this last cycle of distress, default, foreclosure and workouts, borrowers and guarantors have fought vigorously to obstruct and delay the exercise by the lender of its remedies in many cases at the same time as a workout is being negotiated, and generally in order to encourage this to happen. Holding aside the philosophical discussion of whether or not these lenders should participate in the devaluation of their collateral and the rightsizing of their loans (after all, Wall Street created the recession, so shouldn’t they bear their proportionate burden?), they did not appreciate the interference with the exercise of their remedies while they were simultaneously endeavoring to negotiate a workout of the loan.
As such, now that money is once again flowing from CMBS lenders, in order to address this problem, the so-called “Bad Boy Carve-Outs”, have been further expanded to include, as an additional bad act, the interference with the exercise of the lender’s remedies. Taking a cue from the leasing context in which a so-called “Good Guy Guaranty” is utilized to compel the guarantor to be a “good guy” and make sure the tenant facilitates the speedy surrender of the premises to the landlord by making the guarantor agree to be liable for rent until the tenant does so, lenders have begun to include the non-interference carve-out in the bad boy guaranty documents.
In some cases, this type of “Good Guy Carve-Out” would include any action or proceeding which delays, obstructs, hinders or generally interferes with the efforts of the lender to exercise its rights and remedies. In other cases, if the borrower has the leverage to negotiate this, such carve-out may be limited to bad faith and, in this instance, the language may state that such interference is “solely for the sake of delay” or otherwise “in bad faith”. While the exercise by the lender of its recourse against the guarantor under the “bad faith” version of this language will likely stimulate creativity on the part of the lawyers for the lender and the lawyers for the guarantor in connection with the establishment of bad faith, it may make a guarantor think twice about its actions in this regard.
For these bad boy acts resulting in the conversion of these loans from non-recourse to recourse, some expose the guarantor to full recourse and others limit the exposure of the guarantor to the actual damages incurred by the lender arising out of the particular act. The non-interference carve-out seems likely to fall into the first category, although a borrower with significant leverage may be able to move this carve-out to the second category.
On a different but related note, many times the guarantors do not include all of the principals of the borrower, but rather may be given by the local “warm body” sponsors of the investment who may hold the minority position to the institutional equity fund which provides no such guaranties. While the joint venture agreements for these investments have always included provisions which create contribution obligations by the stakeholders not providing such guaranties in favor of those who have, these provisions should also now receive greater scrutiny. In particular, the language of these provisions which may trigger the contribution obligation from the stakeholder not providing such guaranty may need to be revisited to broaden its scope consistent with the expansion of these carve-outs. A review of the decision making provisions of the joint venture agreement should be made as well in light of these issues.
 The Cherryland and Chesterfield decisions, while overturned legislatively in Michigan, where these cases were brought, have created a tremendous amount of anxiety for both lenders and borrowers. In these cases, which both involved non-recourse loans with “Bad Boy Carve-Out” guaranties, one of the carve-outs was the breach or violation of the “single purpose entity/separateness” covenants which required that the borrower remain solvent and pay its debts from its assets as they became due. Although the borrowers were single asset entities, when the mortgage debt exceeded the value of the asset, they became technically insolvent and therefore were held to breach the “single purpose entity” or “separateness” covenants and thus became fully recourse loans to the guarantors. As such, the holdings in these cases have led to a much greater scrutiny and concern over the specific language in the carve-out guaranties
Vicki L. Berman
Attorney at Law