Babc.com ALABAMA I DISTRICT OF COLUMBIA I MISSISSIPPI I NORTH CAROLINA I TENNESSEE Non-recourse Loans: A Game of Musical Chairs where the Borrower Loses

babc.com ALABAMA I DISTRICT OF COLUMBIA I MISSISSIPPI I NORTH CAROLINA I TENNESSEE

Non-recourse Loans: A Game of Musical Chairs where the

Borrower Loses when the Music Stops

WCRE Economic ForumApril 16, 2013

Ann Peldo Cargile

© 2012 Bradley Arant Boult Cummings LLP

Agenda

What Is Non-recourse Debt?

Recent Scary Case Law

What to Fight about


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


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”


Carve-outs (cont.)

The Lender will want a warm body liable for the carve-outs – a Guarantor


Types of Carve-outs

“Above the line” – Guarantor liable for damages only

“Below the line” – Guarantor fully liable for the debt


Really Scary Case

Wells Fargo Bank, NA v. Cherryland Mall Limited Partnership (Michigan)

Interrelation between Carve-outs and Special Purpose Entity (“SPE”) Provisions


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.


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


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?


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


The language was clear But obviously this was not the

intention of the parties Who won?

THE LENDER! Guarantor was fully liable for a

multi- million dollar deficiency

Cherryland Results


You think Cherryland is a hypothetical risk in Tennessee?

TENNESSEE HAS HAD A HOLDING JUST LIKE CHERRYLAND!– Orix Capital Markets, LLC v.

Wegener (Memphis)

Tennessee Law


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!


Other Carve-outs

There are lots of other carve-outs to worry about even if you do not have a loan with SPE covenants!


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


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


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)?


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


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


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


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


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?


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.


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


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


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

babc.com ALABAMA I DISTRICT OF COLUMBIA I MISSISSIPPI I NORTH CAROLINA I TENNESSEE

QUESTIONS?