CMBS "Bad Boy" Clauses: More Fallout From Court Decisions

As we have addressed in prior blog posts about “bad boy” clauses in a CMBS loan, if any of these provisions are violated, the nonrecourse nature of the loan will be partially or completed negated depending on which provision is violated.

 

Courts typically interpret these clauses very strictly and that has come back to bite both the borrowers and guarantors and the lenders.  For example, in Euclid Housing Partners, Ltd., et al. vs. Wells Fargo Bank, NA, as Trustee, 2012 Ohio Misc. Lexis 16 (Ohio Ct. of CP 2012), the guarantor had loaned funds to the borrower, likely in a vain attempt to keep the borrower and mortgaged property solvent and prevent a payment default. However, the loan agreement prohibited the borrower from incurring any other debts and the guarantor’s loan was made without obtaining lender’s prior consent. Because guarantors are often majority owners of the borrowers, it’s not surprising that the guarantor in this case provided the funds to the borrower.  However, that one action cost the guarantor more than he bargained for. It violated one of the “bad boy” provisions and subjected him to full recourse liability. Ironically, had he just put the money into the borrower as a capital contribution instead of a loan, the loan would have remained nonrecourse.

 

On the flip side, in GECCMC 2005-C1 Plummer Street Office Limited Partnership vs. NRFC NNN Holdings, LLC, 204 Cal. App. 4^th 998, 2012 Cal. App. LEXIS 366 (2012), it was the lender that had to live strictly by the loan terms and was unsuccessful in seeking full recourse against the guarantor.  The mortgaged property was leased to Washington Mutual Savings and Loan (“Washington Mutual”). When Washington Mutual went out of business and abandoned the property, the lender foreclosed on the mortgage and then pursued the guarantor for the deficiency balancing claiming that Washington Mutual’s leaving the property was tantamount to a termination of the leases without lender’s consent, a violation that would trigger full recourse against the borrower and the guarantor. The court disagreed, finding the lender’s interpretation to be stretching it a bit. The borrower did not take action to terminate the lease, and the court found that the lease continued to exist despite the tenant’s abandonment.

 

Despite the significant consequences if these “bad boy” clauses are not followed, many borrowers and their attorneys give inadequate attention to their terms. Worse, some CMBS lenders are putting these critical loan provisions in their term sheets, and the borrowers and guarantors are signing the term sheets before bringing their lawyers into the deal. This effectively ties the lawyers’ hands and prevents them from taking steps to protect the borrowers and guarantors.