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. 4th
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.
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