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JUNE 20, 2012 – JULY 3, 2012 Are carve-outs to nonrecourse loans only for the ‘bad boys’?

any commer- of insurance rower and guarantors may be maintain its SPE status when it cial loans that are proceeds, personally liable for the lender’s became insolvent. Among other secured by real condemna- losses or the entire debt regard- things, the borrower and guar- propertyM are nonrecourse to tion awards, less of whether the triggering antor argued that the mortgage the borrower and the borrow- trust funds, act is later cured or if the lender did not clearly spell out which er-related guarantors. In such rents or secu- is not directly harmed by the act. SPE covenants were covered by deals, the lender agrees that if rity deposits; Even a technical default or “foot the trigger and an interpretation an event of default occurs, the breach of rep- fault” by the borrower could that the borrower’s insolvency lender may exercise remedies resentations, irrevocably convert a nonre- converted the loan from nonre- against the real property and warranties course loan to partial or full course to recourse was against any other collateral given by the or covenants recourse debt if it falls within Alicia B. Clark both the character of a nonre- borrower securing the borrow- Counsel, Ballard pertaining to the recourse triggers. There course deal and public policy. er’s obligations under the loan, Spahr LLP, Denver environmen- have been several recent cases Nevertheless, the court held that but cannot enforce a deficien- tal matters; in which lenders have success- the loan became full recourse cy judgment against the bor- failure to pay fully enforced these provisions upon the borrower’s insolven- rower or guarantors or sue on real estate taxes or insurance against borrowers and guaran- cy as expressly provided in the the note. This is almost always premiums; material physical or tors in which the courts have loan documents. This decision the case for commercial mort- economic waste of the secured dismissed arguments such as shocked the commercial real gage-backed security loans, property; voluntary bankruptcy imposing recourse liability is estate community because it which also usually require the by the borrower; and consent to contrary to the parties’ intent called into question whether bil- borrower to be a single-asset, or acquiescence by the borrower and the lender suffered no direct lions of dollars in CMBS loans bankruptcy-remote entity, more in an involuntary bankruptcy of loss as a result of the trigger at (and other nonrecourse loans commonly known as a special- the borrower. However, another issue. On the contrary to such with similar recourse triggers purpose entity. The restriction common trigger for recourse arguments, courts have been and SPE provisions) would on enforcement actions against liability is a violation of some willing to impose recourse lia- become recourse merely upon the collateral only is subject to or all of the borrower’s SPE cov- bility against the borrowers and a borrower’s inability to pay a litany of exceptions, some of enants. The SPE covenants that guarantors when the language which trigger recourse liability trigger recourse liability when of the loan documents expressly its loan. After an immediate against the borrower and guar- violated may be as narrow as a permits it on the grounds that national backlash against the antors for the amount of the loss limitation on the borrower’s sole the lenders deserve the benefit court’s decision, the Michigan suffered by the lender, while purpose as owning, operating of their contractual bargains. Legislature passed a law pro- others trigger full recourse lia- and leasing the secured prop- The most talked about case in hibiting a solvency covenant bility against the borrower and erty and engaging in related the legal community in recent from triggering full recourse of guarantors for the entire loan activities. Or, the SPE covenants months that addresses nonre- a nonrecourse loan, effectively amount and any other obliga- included in the recourse trig- course carve-outs is the Cher- overturning the Cherryland deci- tions to the lender. These excep- gers may encompass a long list ryland case, which was decided sion in Michigan. tions often are referred to as of separateness covenants, such by Michigan’s Court of Appeals Borrowers and guarantors “bad boy” carve-outs because as maintaining separate books, (Wells Fargo Bank NA v. Cherry- should always carefully read the triggers for recourse liabil- records, financial statements land Mall Limited Partnership, et the nonrecourse carve-outs and ity are thought to be limited to and bank accounts; conducting al., Dec. 27, 2011). In Cherryland, ensure that they understand the bad acts of the borrower and business in the borrower’s own after the lender foreclosed on scope of the prohibited actions guarantors. However, the actual name; using separate stationery, the secured property, it sought and who is in a position to cause language in the loan documents invoices and checks bearing the to recover more than $2 million or prevent them. Of course, it is for these carve-outs may well be borrower’s own name; not com- on a mortgage deficiency claim too late to negotiate these provi- much broader. mingling the borrower’s assets against the borrower and indi- sions once a loan is closed. But, The triggers for partial or full with those of anyone else; main- vidual guarantor. The lender when possible, borrowers and recourse liability of the borrower taining adequate capital; and asserted that the loan became guarantors should be careful to and guarantor usually include remaining solvent. full recourse against the bor- consider the consequences of such bad acts as material mis- Unless the loan documents rower and guarantor upon the taking or omitting to take any statements of fact; fraud; mis- provide otherwise, once a listed occurrence of the trigger event action that may trigger recourse appropriation or misapplication trigger event occurs, the bor- that the borrower failed to liability.s