Are bad boys getting worse: Courts lay down the law on commercial real estate guarantors

Practical Law

If you are in-house counsel, chances are that your organization is or will be a guarantor for a real estate transaction under a bad boy guaranty. Litigation of these nonrecourse carveout guaranties has been on the rise since the financial crisis of 2008 and represents significant risk for corporate organizations.

Many commercial real estate attorneys believed that the passage of Michigan's Nonrecourse Mortgage Loan Act (NMLA) and Ohio's Legacy Trust Act (LTA) signaled an end to the national trend of enforcing full-loan liability against guarantors based on very technical readings of guaranty language embodied by a few surprising and well-publicized cases (see, e.g., Wells Fargo Bank, NA v. Cherryland Mall Ltd. Partnership (No. 304682, 295 Mich.App. 99); 51382 Gratiot Avenue Holdings, LLC v. Chesterfield Development Co., LLC (No. 2:11-cv-12047, 835 F.Supp.2d 384); and CSFB 2001-CP-4 Princeton Park Corporate Center, LLC v. SB Rental I, LLC (410 N.J. Super. 114, 980 A.2d 1)). However, despite these legislative developments, recent case law suggests that you should be more attentive than ever to the perilous position of a guarantor, in which you may potentially face full-loan liability.

Triggering events for guarantor liability have become expansive both in number and in nature. If guarantors are not careful when negotiating the language of their guaranties, minor infractions (such failing to maintain separate letterhead from the borrower) can lead to major payouts. Some examples of the tenuous position encountered by guarantors include:

• A guarantor being found liable for the full amount of the loan after a statutory lien for utility services was held to be a "transfer" under the loan documents (Federal National Mortgage Association v. CG Belkor, LLC (No. 3:13-cv-39 (DJN), 980 F.Supp.2d 703)).
• Another guarantor being found liable for even more than the full amount of the loan principal (thanks to a massive prepayment premium) because minor mechanics’ liens were deemed to be impermissible transfers (Weinreb v. Fannie Mae (No. 49A04-1211-PL-587, 993 N.E.2d 223)).
• A guarantor being found fully liable for the loan when the borrower failed to respond to the lender’s request for a copy of the rent roll and other financial information following a payment default (US Bank NA v. Green Meadows SWS, LLC (No. 13-CAE-08-0063, 9 N.E.3d 433)).

Indeed, cases that turn out well for guarantors are still the exception, not the rule. What is clear from caselaw is that the outcome of most bad boy guaranty litigation hinges primarily on the drafting of the loan documents and the guaranty agreement. Accordingly, the ultimate goal of in-house counsel should be to ensure that key documents are drafted in a manner that is simple, straightforward and readily comprehensible, reflecting the true intentions of the parties' negotiated agreement. Two key pieces of advice for achieving that objective follow.

1.  Be vigilant about consistency in defined terms across all documentation for the entire transaction.
When read together as a whole, these documents can be intricately complex, including various cross-references and intertwining defined terms. Check, double-check and cross-check to ensure that each usage of a defined term has the same meaning, and that new terms are defined if a different meaning is intended. Any ambiguity is a signal that the documents are not drafted as tightly as they should be and can increase the chance of a bad outcome.

2.  Pay particular attention to the events that can trigger full-loan liability and make sure that the drafted terms coincide with the actual intention of the parties.
The negotiations concerning full-loan liability should begin as early on in the transaction as possible, and you should not hesitate to advise your organization to seek out other lenders if you are not comfortable with anything in the draft guaranty that the lender says is non-negotiable, such as:

• Particular nonrecourse carveout events, for example, full-loan liability for recordation of a mechanic's lien or other lien against the real property collateral, no matter how minor it is or how quickly it is cured (see Princeton Park).
• The language drafted to describe agreed-on nonrecourse carveout events, for example, a broadly phrased nonrecourse carveout covering "failure by the borrower to comply with any special purpose entity covenant" without exclusions for specific, inapplicable covenants such as the borrower's covenant to remain solvent at all times (see Cherryland and Chesterfield).

Practical Law provides many helpful resources for getting up to speed on nonrecourse carveout guaranties, including:

• Practice Note, Commercial Real Estate Loans: Trends in Carveout Guaranties
• Practice Note, Commercial Real Estate Loans: Negotiating Carveout Guaranties
• Practice Note, Guaranties in Commercial Mortgage Loans: Negotiating and Other Guidance for Guarantors and Borrowers

In addition, for a form of a guaranty with drafting notes to assist counsel representing guarantors (as well as counsel representing lenders), see the Practical Law Standard Document, Guaranty of Nonrecourse Carveout Obligations.

For more information about Practical Law or to request a free trial, visit PracticalLaw.com.

Follow us on Twitter