On April 7, 2014, the US District Court in the Southern District of New York granted summary judgment in favor of the Guarantor in CP III Rincon Towers, Inc. (Plaintiff) v. Richard Cohen (Defendant) (No. 10 Civ. 4638 (DAB). The substance of the court action revolved around a CMBS mortgage loan on property located in San Francisco, CA that had gone into default. The Plaintiff was attempting to recover the full outstanding amount owed under the loan from the Defendant alleging that the violation of certain “bad boy” provisions under the Guaranty executed by the Defendant triggered full recourse liability.
The borrower on this loan was delinquent on certain owner’s association fees, the amount of which it was disputing with the owner’s association. The borrower had also not paid certain contractor invoices due to a dispute over the work completed. These disputes, combined with nonpayment of the related invoices, resulted in liens being filed on the mortgaged property.
The Plaintiff, in filing its action against the Defendant, alleged that the resulting liens on the property violated three full recourse provisions in the Guaranty: the “voluntary Lien, Indebtedness (without lender’s prior consent) and Transfer.” The Defendant moved for summary judgment in its favor stating that the liens in question did not fall under either of these 3 provisions and therefore did not justify the Defendant being subject to full recourse liability.
The Court agreed with the Defendant.
In negotiating the Guaranty with the Plaintiff’s predecessor who negotiated the loan, the Defendant and his counsel were quite aggressive in pushing back on the form language in the agreement. Kudos to the Defendant’s counsel for doing his job well. The takeaway for any would-be borrower or guarantor is to not blindly accept the CMBS loan documents and assume there is no room for negotiation. There is. The so-called bad boy provisions that trigger loss recourse and full recourse on the CMBS loans are broadly drafted and, from the perspective of a borrower or guarantor, need to be tightened up. Borrowers and guarantors who sign commitment letters and term sheets with these provisions already contained within the commitment document are acting foolishly, as they have pulled the rug out from under their lawyers and have undercut their ability to do their job.
In this court action, the Plaintiff had attempted to argue that the actions or inactions of the borrower, by not paying invoices on time and/or disputing amounts, where voluntary choices and therefore the resulting liens should be categorized as “voluntary.” The court didn’t buy into the Plaintiff’s argument, finding instead that mechanic’s liens arise by force of statute, not by an agreement of the parties. The court also held that judgment liens are imposed on the losing party and again, cannot be construed as voluntary. Strike one against the Plaintiff.
Second, while both parties agreed that the resulting liens on the mortgaged property was properly viewed as indebtedness, the loan agreements clearly limited the full recourse trigger to indebtedness that was incurred without the lender’s prior written consent. The court interpreted this to mean it only addressed situations where a lender’s prior written consent is required before entering into the indebtedness, liability or obligation. The borrower did not need lender’s consent before starting construction or paying association fees, therefore the court held that the circumstances in this case did not fall under the full recourse provision.
Finally, the Plaintiff argued that the liens on the property should be considered a “Transfer” which was broadly defined in the loan documents to include acts that “encumber” the mortgaged property. The court reviewed the interpretations argued by both parties and found the language to be ambiguous. It then looked outside the terms in the loan documents and revised the negotiations of borrower and lender prior to entering into the loan. Based on such external (i.e. “extrinsic evidence”), the court held that the parties clearly never intended these sorts of liens to trigger full recourse liability.
The bottom line for parties on CMBS loans—Negotiate to protect your interests. It is important to clarify what will and will not trigger full recourse or loss recourse liability. From a borrower perspective, narrower, more specific provisions are better. A borrower also needs to review how these provisions might be unwittingly triggered by borrower’s standard operational procedures or even the simple desire to restructure ownership for estate planning purposes. Finally, work to ensure the language in the agreements clearly reflects everyone’s intentions. Otherwise, a court will interpret it for you.