Non-recourse Loans: A Game of
Musical Chairs where the Borrower
Loses when the Music Stops
WCRE Economic Forum
April 16, 2013
Ann Peldo Cargile
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Agenda
 What Is Non-recourse Debt?
 Recent Scary Case Law
 What to Fight about
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Non-Recourse Debt
 Lender underwrites the loan based solely on
the value of the property and its income
stream
 Lender agrees it will only look to the property
for repayment
 The loan is “non-recourse” to the Borrower
 Theoretically, if the property does poorly, the
Borrower can hand the Lender the keys and
walk away
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Carve-outs
 BUT the Lender won’t accept certain
risks related to the property:
– Environmental problems
– Bad acts of the Borrower
• Fraud
• Theft
• Bankruptcy
 These are the “carve-outs”
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Carve-outs (cont.)
 The Lender will want a warm body liable
for the carve-outs – a Guarantor
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Types of Carve-outs
 “Above the line” – Guarantor liable for
damages only
 “Below the line” – Guarantor fully liable
for the debt
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Really Scary Case
 Wells Fargo Bank, NA v. Cherryland Mall
Limited Partnership (Michigan)
 Interrelation between Carve-outs and
Special Purpose Entity (“SPE”) Provisions
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Standard Non-recourse Clause
 If a Default has occurred, Lender shall have full
recourse to the Secured Property to secure any or all
of the Obligations, provided that any judgment
obtained by Lender in any proceeding to enforce such
rights shall be enforced only against the Secured
Property.
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Recourse Carve-out for SPE
 The foregoing restriction on liability shall not
apply if Borrower shall violate [ANY OF THE
SPE PROVISIONS] of this Deed of Trust.
 SPE provisions are specially designed to expedite
the Lender’s ability to get control of the property if
a bankruptcy is filed
 The is a “below the line” carve-out – full
recourse for the debt
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SPE Clause
 Grantor is and will remain solvent and Grantor
has and will pay its own debts and liabilities
from its assets, as the same shall become due.
 Who would give back a property unless it were underwater?
 Why shouldn’t a Borrower use money from other sources to
keep the property afloat?
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SPE Clause
 Grantor is and will remain solvent and Grantor
has and will pay its own debts and liabilities
from its assets, as the same shall become due.
 THIS IS A KILLER!
– The loan becomes full recourse if the property is under water,
or if the Borrower uses other resources to pay its debts
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Cherryland Results
 The language was clear
 But obviously this was not the intention
of the parties
 Who won?
 THE LENDER!
 Guarantor was fully liable for a multimillion dollar deficiency
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Tennessee Law
 You think Cherryland is a hypothetical
risk in Tennessee?
 TENNESSEE HAS HAD A HOLDING JUST
LIKE CHERRYLAND!
– Orix Capital Markets, LLC v.
Wegener (Memphis)
© 2012 Bradley Arant Boult Cummings LLP
Is there a Fix?
 Michigan Act
– (1) A post closing solvency covenant shall not be used, directly or indirectly, as
a nonrecourse carveout or as the basis for any claim or action against a
borrower or any guarantor or other surety on a nonrecourse loan.
– (2) A provision in the documents for a nonrecourse loan that does not comply
with subsection (1) is invalid and unenforceable.
 Ohio has a similar act.
 There was an identical bill presented to the Tennessee Bankers
Association, but they chose not to sponsor it, and no bill has been
filed.
 NO PROTECTION IN TENNESSEE!
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Other Carve-outs
 There are lots of other carve-outs to
worry about even if you do not have a
loan with SPE covenants!
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Other Carve-outs:
Misrepresentation
 any misrepresentation of fact by
Borrower
– Could be a minor issue
– Could be unintentional
 fraud or intentional misrepresentation of
a material fact by Borrower
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Other Carve-outs:
Waste
 any waste of the Secured Property
– What if there is not enough money to prevent waste?
 any intentional waste of the Secured
Property
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Other Carve-outs:
Bankruptcy
 Borrower shall be the subject of any petition or proceeding for
bankruptcy, reorganization or arrangement pursuant to federal
bankruptcy law, or any similar federal or state law that remains
undismissed for a period of sixty (60) days or more, or Borrower
shall admit in writing that it is insolvent or unable to pay its debts
when due
 Should the Guarantor be liable if this was an involuntary
bankruptcy?
 Should the loan be full recourse or should the Lender only
recover damages (above the line or below the line)?
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Other Carve-outs:
Bankruptcy
 Borrower shall file or collude in the filing of any petition or
proceeding for bankruptcy, reorganization or arrangement
pursuant to federal bankruptcy law, or any similar federal or state
law that remains undismissed for a period of sixty (60) days or
more, or Borrower shall admit in a pleading to court that it is
insolvent or unable to pay its debts when due
 Make sure this is an “above the line” carve-out, so that if the
Lender suffers nothing more than delay, the Guarantor does
not have full recourse liability
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Other Carve-outs:
Admission of Insolvency
 Borrower shall be the subject of any petition or proceeding for
bankruptcy, reorganization or arrangement pursuant to federal
bankruptcy law, or any similar federal or state law that remains
undismissed for a period of sixty (60) days or more, or Borrower
shall admit in writing that it is insolvent or unable to pay its debts
when due
 How do you start a conversation with a Lender about a
workout without saying the Borrower is insolvent?
 Remember email is a writing
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Other Carve-outs:
Admission of Insolvency
 Borrower shall be the subject of any petition or proceeding for
bankruptcy, reorganization or arrangement pursuant to federal
bankruptcy law, or any similar federal or state law that remains
undismissed for a period of sixty (60) days or more, or Borrower
shall admit in a pleading to court that it is insolvent or unable to
pay its debts when due
 Make sure this is an “above the line” carve-out, so that if the
Lender suffers nothing more than delay, the Guarantor does
not have full recourse liability
© 2012 Bradley Arant Boult Cummings LLP
Other Carve-outs:
Enforcement Costs
 costs of enforcing the Loan Documents
 Should the Borrower pay foreclosure costs even if it is not
resisting?
 What if the Borrower has a valid grounds for complaint?
 costs of enforcing the Loan Documents
in the event of an unsuccessful
challenge by Borrower of Lender’s rights
thereunder
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Other Carve-outs:
Taxes and Insurance
 Borrower’s failure to pay taxes or insurance premiums or to
obtain insurance as required in the Loan Documents
 What if the Lender has escrowed sums and won’t release
them?
 What if there is no money to pay for these items?
 What if there is a receiver in place?
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Other Carve-outs:
Taxes and Insurance (cont.)
 Borrower’s failure to pay taxes or insurance premiums or to
obtain insurance as required in the Loan Documents, except to
the extent that (a) the sums were escrowed with Lender; (b) the
income from the Property after payment of debt on the Loan is
not sufficient to pay such amounts; and (c) the obligation for such
expense arises after Lender takes control of the Secured Property
by receivership or other legal action.
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Why Is this Talk Important?
 Can’t my lawyer just handle it?
– Recourse language is fixed at the commitment
stage and often the lawyer is not asked to
review the commitment
– The practical consequences of this language
are not always obvious:
• On their face, the carve-outs look like liability only
for bad acts
• But the recession taught us these clauses contain
numerous traps
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Why Is this Important? (cont.)
 It may be too late
– Lots of closed loans have these problems!
– It make cost you more to give the property
bank to the Lender than you might think
 Lenders are starting to make loans
again, so be aware of these issues
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What Should I Do?
 Never sign a commitment letter for a
non-recourse loan without a thorough
review of the carve-outs
 Make sure you read the carve-outs if you
have a problem property
© 2012 Bradley Arant Boult Cummings LLP
QUESTIONS?
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