BE CAREFUL WHAT YOU PROMISE:A CRITICAL, CROSS-BORDER DISCUSSION OF

GUARANTIES, INDEMNITIES AND “BAD BOY” CARVE-OUTS

Catherine E. Bray, Esq.Borden, Ladner Gervais LLP

Toronto, Canada

Michael D. Goler, Esq.Miller Goler Faeges Lapine LLP

Cleveland, OH

Kathleen J. Hopkins, Esq.Real Property Law Group, PLLC

Seattle, WA

Kenneth Miller, Esq.Ervin Cohen & Jessup LLP

Beverly Hills, CA

ACMA ANNUAL MEETINGSeptember 22-24, 2016

Resort at Pelican HillNewport Beach, California

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Don’t be a “Bad Boy” - Non-Recourse Carve Out Guaranties and Indemnities Revisited

A Soup to Nuts Basics of Bad Boy Guaranties for the Commercial Dirt Lawyer

By Kathleen J. Hopkins, Esq., Seattle WA

and

Kenneth Miller, Esq., Beverly Hills, CA

I. Introductory Question: Who is liable?

a. Similar Inquiries for Borrower, Indemnitor and Guarantori. Individual(s)

If an individual, do they own the collateral?

Counsel your lender clients: if a high wealth individual is your obligor, most likely isusing trusts – will want obligations to attach to borrower’s/guarantor’s and trust’sassets

Do they have capacity (and authority when applicable) to enter into loan?

If married, whose assets are considered in credit decision?

Spouse issues:o Is collateral a marital asset?o Are marital assets included in credit decision?o Will spouse consent to co-liability?o If no, will spouse agree borrower’s individual assets and either all or

borrower’s interest in marital assets subject to liability?o Also, if no will spouse confirm financial statements not include spouse’s

assets, and that any assets subsequently transferred from borrower ormarital property to spouse are subject to liability

o Also consider if a spouse’s credit is required or necessary to bind her/hispart of the marital assets, of it the signature is being required in violation ofthe federal Equal Credit Opportunity Act (aka “Reg B” or “ECOA”) (see 15USC §1691, also 12 CFR Parts 202.1 et. seq., 1002.1 et. seq.) ECOA has beenheld to apply in guaranties. See RL BB Acquisition LLC v. BridgemillCommons Dev. Group, LLC, 754 F.3d 380 (6th Cir. 2014); see, also, Hawkins vCommunity Bank of Raymore, 577 U.S.___ U.S. S. Ct. Case #14-520 (case#14-520, slip opinion dated 3/22/16) and its underlying 8th Circuit decisionunder Case No. 13-3065 decided 8/5/14.

Dead Guarantors:o Will want to check state law to file claimso Lender might initiate action to require estate set aside funds to satisfy

contingent obligationo Replacement guarantor – Lender’s deadline will be before time limit for

asserting claim against estate

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ii. Entities1. Basics Applicable to Most Entities

A. Check entity documents for authority and limitations

Likely need resolutions or entity action

Both to approve loan and designate signatories

Opinion letter from counsel for borrower, indemnitor, guarantor

B. Do they need to be registered to do business in state?C. Are they in good standing?

2. Special Issues for Partnerships

If a GP or LP, then general partners should have same liability as theborrower entity, consider impact of obtaining a guaranty from a generalpartner

For dirt loan, guaranty may be “sham” and unenforceable attempt tocircumvent anti-deficiency limitation after certain foreclosure

Guaranty might also be viewed as limiting general partner’s otherwiseunlimited liability

3. Special Issues for Trusts

For authority may have statutory trustee’s certificate – recite that lender canrely on certificate for authority

Certain states require notice to beneficiaries for major transactions – if so,include recital in the trustee’s certificate

Consider type of trust, ability to reach trust assets and limitations for trusttransferring assets

b. Additional Considerationsi. Whose assets included in credit decisionsii. Authority and ability to reach assetsiii. Limitation on transfer of assets, minimum tangible net worth requirements?iv. Financial reporting to check on assets?v. Individuals may want ability to make giftsvi. Entities transfer assets, make distributions, conduct business in ordinary course

c. Multiple Obligorsi. Joint Liability: Each is 100% liable for the guaranteed obligation – performance

by one obligor discharges [may discharge] other guarantorsii. Joint & Several Liability: each guarantor 100% liable for obligations, but text

used to give obligor who satisfies claim the ability to recover contributions fromother obligors

iii. Several Liability: proportionate share: liability is allocated up front amongobligors on a percentage basis

Each obligor only liable for specific portion of obligations

Consider how proportions are determined (e.g. ownership in borrower)

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Drafting tip: Consider also whether the proportionate share applies to thebad-boy/carve-out guaranties

Iv. Accommodation Maker? Watch for a co-signor who is a disguisedguarantor/surety – i.e. not getting a benefit for giving the instrument. See,generally, UCC 3-419.

II. Indemnity vs. Guarantya. Basic Overview Question: What is a Guaranty?

A guaranty is the promise to the lender to answer for the debt or otherobligation of another.

In many jurisdictions, guaranties are divided into two categories – a guaranty ofpayment and a guaranty of collection.

o A guaranty of collection is an absolute and unconditional promise to paythe debt upon default or maturity if not paid by the principal obligor(the borrower), conditioned upon the lender exhausting remedies setforth in the guaranty, such as proceeding against the borrower.

o A guaranty of payment is a promise to answer for the debt of theborrower without resort by the lender to any other party including theborrower.

Both guaranties of payment and guaranties of collection require a three partytransaction (the borrower, lender and third party guarantor), as the obligationof the guarantor is separate and distinct from that of the borrower. Guarantiesof payment are much more common than guaranties of collection as they arefar more favorable for the lender.

More general background see Restatement (Third) of Suretyship & Guaranty(1996)

b. Basic Overview Question: What is an Indemnity?

An indemnity is a promise made by the indemnitor to reimburse another party,the indemnitee, should a stated liability arise.

Unlike a guaranty, an indemnity is a two party transaction and the indemnitor isdirectly liable for a breach of the indemnity, as opposed to a guarantor who issecondarily liable for the debt of the borrower.

c. Remember your basic elements for enforceability:

Authority

Acceptance/Assent (usually waived in document: “Guarantor hereby waives noticeof acceptance of this Guaranty…”)

Consideration (recite the consideration; watch for past consideration; considerpromissory estoppel as possible defense to defective consideration)

Writing (check state law for statute of frauds requirements)

III. Recourse vs. Non-Recourse Liability – General Backgrounda. General rule: silence = full recourse liability (but still need to determine if guaranty of

payment or guaranty of collection)

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b. c.f. UCC 9-607: collection and enforcement generally include right to seek payment; UCC3-415(b) an endorsement must state “without recourse” or otherwise disclaim liabilityof endorser).Side note: there are tax implications on recourse vs. non-recourse debt that rea notincluded in this paper. See, e.g. IRC 752; Blake D. Rubin, Andrea Macintosh Whiteway,John Finkelstein, Recourse or Nonrecourse: Treatment of Liabilities in a Complex World,ALI-ABA Course of Study, 2011: Creative Tax Planning for Real Estate Transactions.

b. Full Recourse Preferred by Lendersi. Lender can reach all borrower’s, indemnitor’s or guarantor’s assets, not merely

collateral pledged to secure obligationii. Usually seen with construction loans, but for permanent loans non-recourse or

limited recourse loans prevalent (see discussion on carve-out liability below).ii. Some recourse limitations from state anti-deficiency statutes

• If lender forecloses on collateral, may be limited from pursuing otherassets

• Usually applies for non-judicial foreclosures (so lender may elect ajudicial foreclosure or sue on the note, in order to recover more thancollateral)

• Some states, commercial loans will permit deficiency recovery againstguarantor or indemnitor after a non-judicial foreclosure; providedcertain procedures, notices and deadlines satisfied

c. Non-Recourse Liability Preferred by Borrower, Indemnitor and Guarantori. Limits lender’s recovery after loan default to collateral – used by borrower when

it owns more than pledged collateral (in other words is not a Single Asset Entityor Single Purpose Entity – aka “SPE”)

ii. Usually exceptions: environmental indemnities, bad boy guaranties (see below),other indemnities

d. Carve-Out and Springing Liability – Bad Boy Guaranties – General Description

Lenders identify defaults that pose special risks and carve them out of thegeneral non-recourse provisions. Some carve-outs are limited to the damage alender or the collateral might incur due to an event or omission, others triggerfull recourse liability.

Carve-outs provide for protection that lenders require, personal liability, toinsurance the incentive to repay the loan and maintain the viability of thecollateral. Heller Financial, Inc., v Lee, 2002 WL 1888591, (N.D. Ill.8/16/2002)(citing Portia Owen Morrison and Mark A. Senn, Carving up the‘Carve-Outs’ in Nonrecourse Loans, 9-June Prob. & Prop. 8 (1995).

IV. General Guaranty Law – Suretyship; Waivers

a. Guaranty vs. Surety?

Some states no distinction, such as California. See Engelman v Bookasta, 264 Cal.App.2d 915 (1968).

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Other states make a distinction in terms of their relationship with a principal, withdifferences in notice requirements, with others requiring use of specific terms andothers looking at substance.

For an exhaustive discussion of Guarantors and Sureties, see Penelope L.Christophorou, Neil B. Cohen, Patrick A. Guida, Brian D. Huslse, Commercial LendingToday: Sureties and Guarantors (ALI CLE May 2016)

b. General Rules:i. Guarantor is a “favorite of the law”ii. Assume guaranties will be strictly construed in favor of guarantoriii. In addition to suretyship defenses, consider if defenses available to borrower

that could also be raised by guarantoriv. Suretyship defenses are designed to protect the guarantor from changes to the

underlying obligation, such as modification of the debt, impairment of recourseor the lender’s failure of presentment, demand or protest to Borrower. Statesvary on whether a suretyship defense relieves a surety entirely or only to theextent the change harmed the guarantor.

v. Some guaranty/suretyship defenses are waivable at time guaranty granted, butothers cannot be waived at time of guaranty (again, state specific, please checkcurrent state statutes and case law). The waivers are intended to establish theguaranty as a stand-alone enforceable contract, regardless of changedcircumstances concerning the original borrower or obligation.

vi. Waivers.

For standard suretyship waivers, see Appendix 1 for examples (but rememberstate law specific).

vii. Why some defenses not waivable up front:• Could be statutory or public policy limitation (e.g. may not waive anti-

deficiency defenses, redemption rights)• Under UCC9 a waiver of commercial reasonableness in disposition of

collateral is not enforceable.• Some waivers not effective because the guarantor’s right to asset a

defense has not matured until after a default, accordingly in a post-default agreement lender might require waiver of these defaults “inconsideration” for lender agreed to defer prosecuting claim orrestructuring debt

• A guarantor cannot waive its own ultra vires defense• Some states (e.g. California) have statutory requirements for valid

waivers• Sample cases on enforceability of waivers:

Engelman v Bookasta, 264 Cal. App.2d 915 (1968): enforcingnumerous waivers, frequently used by creditors to enforce aguaranty without first exhausting collateral securing a loan.

California Bank & Trust v Delponti, 181 Cap. Rptr. 3d 216 (2014):a waiver of all defenses “except as prohibited by law” is notenforceable to waive the defense of lender’s misconduct (this

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might be considered a public policy exception as well,prohibiting the lender from capitalizing on its own misconduct).

V. General Full Recourse Guarantya. A recourse guaranty allows a lender to attach not only the collateral, but also to seek

judgment against the guarantor’s personal assets. Black’s Law Dictionary 98th ed. 2004)

VI. Carve Out aka Bad Boy Guaranties: Partial Recovery (loss or damages)a. How documented

i. Usually one document with a partial and full recourse sections, plusrepresentations, warranties, waivers of suretyship and other defenses (e.g.statute of limitations, jury trial, etc. – watch state law limitations on waivers,and state specific statutory waiver text)

ii. Occasionally two documents: if so, consider whether the partial recovery(damages) is better as an indemnity vs a guaranty?

b. General idea: Lender can recover from the Guarantor the amount of Guarantor’s loss ordamage incurred arising from certain events, actions or omissions

c. Usual Carve Outs:• Fraud or intentional misrepresentations

o Could be by borrower or guarantoro May be limited to matters concerning the property, leases, making and

delivery of loan documents or any other materials or informationprovided by or for borrower or guarantor in connection with loan

o Some lenders designate fraud as springing full recourse trigger• Environmental: breaches of representations, warranties, covenants• Removal or disposition of collateral (sometimes limited to after a default)• Misapplication of security deposits, tenant tax and insurance escrows, insurance

proceeds, condemnation proceedso Lender will include failure to turn over security deposits and tenant

escrows if there is a foreclosureo Loan documents may allow application of insurance or condemnation

proceeds to restore improvements – guarantor should confirm text inguaranty permits such actions as well as rights granted under state law– see, for example, Schoolcraft v. Ross, 81 Cal App 3d 75 (1978) andCalifornia Code of Civil Procedure Section 1265.225.

• Income from property not applied to pay loan (or otherwise as required underloan documents)o Guarantor should try to limit to only income received during a loan

default or for capital improvements to the collateral.o Lender will include as part of this carve-out or separately, any

judgments, termination payments, settlements with tenants• Judgments, settlements, payments, including in connection with litigation,

relating to defects in improvements located on the property, not applied asrequired under loan documentso Guarantor should negotiate for ability to limit liability if funds were not

applied to restore the improvements or paid to lender

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• Failure to maintain collateralo May be expanded: failure to manage, operate and maintain property in

a commercially reasonable manner for similar property types in samegeographic area

• Damage to value of collateral due to wasteo Guarantor may try and limit to intentionally or grossly negligent waste

committed or permitted by guarantor or borrower (lender will add ortheir Affiliates)

o Consider defining waste, lender should include any material abuse ordestructive use (whether by action or inaction)

• Removal of personal property or fixtures and not replaced as required underloan documentso Lender should include its cost to replace such personal property or

fixtures• Failure to timely insure collateral as required under loan documents

o Lender may expand to include penalties, late charges and interesto Lender may expand to include cost of restoring any casualty not covered

by insurance, including deductibleso Some lenders move this to springing full recourse –beware

• Failure to pay property taxes and other assessmentso Include penalties, interests, late charges, losses relating to sale or

forfeiture of property due to failure to pay taxeso Some lenders move this to springing full recourse - beware

• Failure to pay for labor or materialso Guarantor try and limit to those that create liens or judgments that are

not timely removed pursuant to borrower’s rights under loandocuments

• Failure to perform landlord obligations under leaseso Lender should specifically include recovery of funds expended by lender

to fulfill such obligations (but take care in drafting so recovery notlimited to only funds expended, and not drafted to require lender toact)

• Acts of terrorism (this is usually added if terrorism insurance (or “no exclusionsfor acts of terrorism”) is not an insurance requirement under loan documents)

• Breaches of easements or Permitted Exceptions (this should be customized bylender to specific property)

d. Special Circumstances• Damages arising from SPE violations (see Full Recourse as well)

o Borrower failing to be an SPE at loan closing and at all time during termof loan

o Filing by anyone of a motion for substantive consolidation or jointadministration citing Borrower’s failure to remain an SPE

o Lender should clarify the damages/loss liability under this section is inaddition to any Springing Full Recourse Guaranty liability for SPEviolations

• Also used as a catch-all when unusual circumstances for collateralo Certain environmental clean-up or history

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o Concerns with specific leases or tenantso Specific covenants in loan documents (e.g. use of union labor or

compliance with prevailing wage)

e. Less Frequent Provisions

Intentional breach of applicable laws

OFAC, USA Freedom Act or Money Laundering Violationso Lender may try for Springing Full Recourse. Particularly if fraud

VII. Bad Boy Guaranties – Springing Full Recourse

a. General idea: Guarantor becomes liable for the entire loan upon occurrence of certainevents, actions or omissions

b. Usual Carve Outs

i. Unpermitted Transfers of Collateral or Interest in Borrower

Usual violation is any voluntary transfer of interest in property or borrower,unless lender permits

Check loan documents - they usual allow certain transfers without triggeringdefaults – guarantor should require text confirm that only transfers that triggerloan defaults trigger the springing full recourse under the guaranty

Transfers often specifically negotiated in loan documents:o transfers by operation of law,o transfers for estate planning (but lender may require transferee to assume

liability – at least to extent of transfer)o transfers to related entities (if they assume liability)o unrelated transfers that lender approves

• Other unpermitted transfer could be junior liens or pledges of ownershipinterest in borrower (or further upstream) aka “mezzanine loans”

• Some cases, failure to clear liens (but guarantor should argue involuntary liensand statutory liens are not “voluntary” and liability should be limited todamage/ loss to lender – best to have it listed in partial bad boys for clarity).See Heller Financial Inc. v. Lee, 2002 WL 1888591, (N.D. Ill. 8/16/2002), see,also, JLM Financial Investments 4 v. Aktipis, 2013 WL 2434607 (N.D. Ill.6/3/2013)(lender’s attempt to claim full recourse carve-out liability deniedwhere mechanics lien was not a voluntary lien or transfer); CP III Rincon Towersv Cohen, 13 F. Supp. 3d 307 (S.D.N.Y. 2014)(referencing bankruptcy law todistinguish between voluntary and involuntary liens to prevent full recoursecarve-out; refusing to find full recourse liability even where mechanics liensspecifically listed as impermissible transfers); but see 8375 Honeytree BoulevardHoldings, LLC v. Starman, 2012 WL 683379 (E.D. Mich. 3/2/2012) (mechanicsliens found an impermissible transfer, one of the grounds for finding fullrecourse liability triggered).

• Might also include change in zoning (See Blue Hills Office Park, LLC v. J.P.Morgan Chase Bank, 477 F. Supp.2d 366 (D. Mass, 2007).

• Forfeitures as unpermitted transfer

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o forfeiture because of conduct or purported conduct of criminal activityby borrower, guarantor, principal (consider how this applies to thecurrent mess with cannabis laws)

ii. Fraud• Guarantor may try to move this up to partial recourse damages/loss liability (see

above)

iii. Insolvency Events: Receivership, Bankruptcy or Equivalent• Appointment of receiver (for borrower, any guarantor, over the collateral)• General assignment for benefit of creditors• Bankruptcy filing where borrower or any guarantor is debtor

o Lender should expand to include “a petition in bankruptcy or insolvency,or a petition or answer seeking any reorganization, arrangement,composition, readjustment, liquidation, dissolution or similar reliefunder the bankruptcy code, other insolvency laws, or any otherapplicable federal, state or other entity’s statute or law”

o Borrower and guarantor should try for distinction for involuntary filingso Full recourse if complicit (which could be described to

include soliciting petitioning creditors to file a bankruptcypetition)

o Lender may also require full recourse for involuntary ifdebtor does not get case promptly dismissed (60-90 days)

Cases enforcing full recourse liability:o 111 Debt Acquisition Holdings, LLC v. Six Ventures Ltd, 413 Fed. Appx. 824

(6th Cir. 2011) Not For Publication (even a bankruptcy petition filed withoutproper corporate authority, and even where guarantor objected tobankruptcy filing, full recourse guaranty liability triggered).

o 8375 Honeytree Boulevard Holdings, LLC v. Starman, 2012 WL 683379 (E.D.Mich. 3/2/2012) (full recourse liability triggered: mechanic’s liens wereimpermissible transfers, and unauthorized bankruptcy filing).

iv. SPE Violations• Usual text is “any violation of Borrower’s single purpose entity (SPE)

covenants in the loan documents and such breach results in substantiveconsolidation [or joint administration] of borrower with any affiliate, ina bankruptcy, receivership, insolvency or similar proceeding.”

c. Borrower and guarantor should take care to review SPE covenants to ascertain if compliance ispossible and practicable, or illusory Special Circumstances

i. Ground Leased Property: termination of ground lease• Borrower should carve out termination relating to borrower purchase of fee

title – which lender should permit if deed of trust/mortgage has provision tospread to fee title upon borrower’s acquisition

ii. Lease termination – single tenant property• Lender may not want to foreclose on a vacant property with no income

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d. Less Frequent Provisionsi. Expand Bankruptcy, insolvency to filing by or against any principal of a borrower or

guarantor (may go further upstream)ii. Any legal proceeding by borrower, a guarantor, affiliate or principal which interferes,

delays or frustrates lender’s efforts to enforce rights under loan documents orotherwise relating to the collateral or loano For example, see: Wells Fargo Bank, N.A. v RLJ Lodging Trust, 2016 WL 427487, ___

F. Supp. 3d ___ (N.D. Ill. 2/4/2016) where the Court denied a guarantor’s summaryjudgment motion and found the below quoted full recourse guaranty triggeredwhen a borrower answered a foreclosure complaint, and its answer includeddenying allegations, asserting affirmative defenses and seeking an affirmativeprayer for relief. The applicable guaranty’s text stated:

[I]n the event…any Grantor or any Affiliate of any Grantor contests or materiallyinterferes with, director or indirectly (collectively, a “Contest”), any foreclosureaction, …whether by making any motion, bringing any counterclaim, claimingany defense, seeking any injunction or other restraint, commencing any action,or otherwise…then the Guaranteed Obligations shall also include the unpaidbalance of the Debt…

See, also, Tamach Airport Manager, LLC, v. HRC Fund III Pooling Dom. LLC,603817/08, 2010 WL 2106221 (N.Y. Sup. May 10, 2010)(cited in RLJ LodgingTrust)(even where Borrower’s efforts to stop foreclosure sale ultimatelyunsuccessful, the commencing of litigation to halt a foreclosure sale nullified non-recourse nature of loan).

iii. First full monthly payment amount is not paid when due

iv. Borrower’s inability to rebuild improvements after a casualty or condemnation assubstantially existed at closing, in compliance with applicable law

v. Failure to pay taxes or insure – sometimes moved from damages/loss to springing fullrecourse

vi. Property control issues: fails to permit lender inspections of property, fails to providerequired financial information (see U.S. Bank N.A. v. Green Meadow SWS L.L.C., 9.N.E.3d 433 (Ohio App. 2014), fails to appoint new property manager {all of the foregoingshould be set forth as lender rights in loan documents before guarantor agrees to put ithere}

VIII. Side discussion on SPE Requirements1

a. Common requirement for CMBS loans. “An SPE is an entity, formed concurrently with orimmediately prior to the subject transaction, that is unlikely to become insolvent as a result ofits own activities and that is adequately insulated from the consequences of a related party’sinsolvency.” Standard & Poor’s, US. CMBS Legal and Structured Finance Criteria, Section 3:Special-Purpose Bankruptcy-Remote Entities (May 1, 2013, republished December 9, 2011).

1Attribution for the SPE analysis in this section is given to Harriet “Beth” Alexson, Peter Munoz, Edward Wender,

Bankruptcy Remoteness Non-Recourse Carve Outs Non-Consolidation and the Meaning of Life, presentation atABA Business Law Section, Real Estate Financing Subcommittee Meeting, April 2016.

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b. General purpose: insulate the borrower from being pulled into the bankruptcy case of its parent,affiliate or principals (either through substantive consolidation or joint administration)

c. SPE requirements usually hard coded both as covenants in loan documents and borrower’sentity documents

d. SPE requirements genesis is from bankruptcy substantive consolidation cases, quite similar topiercing corporate veil common law; do not want intermingling with affiliates business operations,assets or liabilities; do not want borrower propped up by its affiliates, nor propping them up, throughsweetheart deals. Attached as Appendix 2 are two sets of SPE requirements; the first from a small nonCMBS loan, the second from a recent CMBS loan. Every lender’s counsel has their own variations andcare should be taken in reviewing the SPE requirements to confirm they apply to the deal at hand andcan be performed by the borrower and guarantors.

f. Worrisome Covenants for Bad Boy Guarantors – since violations = springing full recourse liabilityi. Paying debts and liabilities as they come due from borrower’s assets only – what is fall

short?• Remain solvent or sufficiently capitalized – seems illusory since a loan default could

be interpreted as insolvency, meaning the guaranty is really full recourse. This wasthe unfortunate result, in a commercial loan, the springing full recourse guarantywas triggered by failing to pay loan. In Wells Fargo Bank N.A. v Cherryland Mall L.P.,295 Mich. App. 799, 812 N.W.2d 79(2011) the SPE provision at issue required thatthe borrower not “become insolvent or fail to pay its debts from its assets as thesame shall become due.” Id. At 123. When the borrower defaulting on paying theloan, the Court found a breach of the SPE provisions which, in turn, triggered fullrecourse under the guaranty.

For a discussion on the Cherryland Mall response and other potential defenses, see,generally, Penny L. Christophorou, Limited Recourse/Carve-out Guaranties and BayBoy Provisions, Response to Cherryland Mall Case, ALI 2015: Commercial LendingToday.

• Drafting suggestion for borrowers: Care to review all of the SPE requirements, if anyviolation triggers the full recourse guaranty consider if really a full recourse loan atthe onset. If so, argue for limitations on the lack of capitalization, involuntary liensand insolvency provisions – if the borrower complies with the lender approvedbudget or the lender otherwise approves additional expenses (indebtedness), andproject still underwater, then do not want full recourse liability triggered, but insteadshould only trigger the damages/loss guaranty liability to the extent such SPEviolations cause the substantive consolidation of the borrower’s case with thebankruptcy of the borrower’s affiliate or principal.

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IX. Other Guaranty Issues

a. Capped Guarantiesi. Must be drafted carefullyii. Avoid use of terms “top” or “first” $ amount – creates an ambiguity and might be

construed as paid off if borrower has paid a portion of the debt or if there has been aforeclosure with a deficiency remaining

iii. Consider if part of a joint and several guarantyiv. Consider if cap does not limit certain recoveries

o Attorney’s feeso Recovery under environmental indemnitieso Carve Outs (particularly partial bad boy damages/loss guaranties)

b. Construction Guarantyi. Construction/Completion Guarantiesii. Case law split on whether a construction guaranty is a guaranty or indemnity, see, e.g.,

Chase Manhattan Bank, N.A. v American Nat. Bank & Trust Co. of Chicago, 93 F.3d 1064(2d. Cir. 1996), compared to Turnberry Residential L.P. v Wilmington Trust FSB, 950N.Y.S.2d 362 (2012).

iii. Avoid ambiguity by using a direct indemnity insteadiv. Consider what lender attempting to obtain, possibilities:

• Cost to complete construction• Equity shortfall in constructing• Shortfall in value of collateral for failure to complete• When is it satisfied? CO? TI Completion?• Who controls construction?• If guarantor constructing, will lender fund balance of loan draws?

X. Guaranty Enforcement – Issues Concerning Bad Boy Carve-Outs(this discussion includes both partial recourse and full recourse carve-out guaranties)

a. Strict Construction of “Bad Boy” Provisions – Lender Wins.i. Wells Fargo Bank N.A. v. Cherryland Mall L.P., 295 Mich. App. 99, 812 N.W. 2d 799

(2011). Full recourse carve-out requiring borrower to remain solvent and pay its debtsas they become due held to be enforceable. Subsequently covered by legislation whichoverruled Cherryland, which legislation was upheld in LZLC. v. 18718 Borzman, LLC, 777F. 3d 816 (2015).

II. Heller Financial v. Lee, 2002 WL 188591 (N.D. Ill. 2002). Full recourse covenantprohibiting the borrower from granting or allowing the filing of any lien or encumbranceon the project held to be enforceable and triggered by mechanic’s lien and tax liensrecorded against the property. But see CP III Rincon Towers, Inc. v. Cohen, 13 F. Supp.3d 307 (S.D. N.Y. 2014)(Appeal filed May 6, 2014) Full recourse covenant prohibiting theborrower from granting or allowing the filing of any voluntary lien not triggered bymechanic’s lien as mechanic’s lien determined not to be a voluntary lien.

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iii. G3-Purves Street, LLC v, Purves, 953 N.Y.S. 2d 109 (2012). Full recourse covenant inguaranty agreement allowing full recourse liability due to borrower’s failure to pay taxesheld to be enforceable and not a liquidated damage provision that imposed anunenforceable penalty.

iv. In re Inn at Woodbridge, 2015 WL 1013585 (D. New Jersey 2015). Full recoursecovenant in guaranty agreement allowing for full recourse liability upon the bankruptcyfiling of borrower held enforceable despite lender’s settlement with borrower.

v. 111 Debt Acquisition Holdings, LLC v. Six Ventures Ltd., 413 Fed Appx 824 (6th Cir. 2014)Not For Publication. Full recourse covenant in guaranty agreement allowing fullrecourse liability upon the filing of a bankruptcy petition by or against, or “consented toor acquiesced in by” borrower or guarantors held to be enforceable when borrowerfiled for bankruptcy relief, even if a guarantor contested the bankruptcy filing.

vi. U.S. Bank National Association v. Green Meadows SWS LLC, 9. N.E. 3d 433 (Ohio, 2014)Full recourse covenant allowing full recourse liability upon failure to satisfy reportingrequirements due under loan agreement held to be enforceable.

b. Failed Defenses To Bad Boy Carve-Out Provisionsi. Violates Public Policy;ii. Unreasonable Penalty;iii. Breach of the Implied Covenant of Good Faith and Fair Dealing; andiv. Actions Beyond Guarantors’ Control.

c. Possible Defenses To Bad Boy Carve-Out Provisionsi. Materiality?

o Wells Fargo Bank, N.A., v. RLJ Lodging Trust, 2016 WL 427487 (N.D. Ill 2016). Fullrecourse covenant in guaranty agreement allowing for full recourse liability should theguarantor contest or in any material way interfere with any foreclosure by lender. Afterborrower’s default, borrower offered to surrender real property but answered lender’sforeclosure complaint, denying certain allegations and alleging affirmative defenses.Summary judgment denied upon challenges to the term “material” and “contest.”

ii. Careful Reading of Lease/Loan Documents –o GECCMC 2005-C1 Plummer Street Office Limited Partnership v. NRFC NNN Holdings,

LLC, 204 Cal App 4th 998 (2012). Full recourse covenant in guaranty agreementguarantying $44 million loan and providing for full recourse upon termination ofspecified lease held to be enforceable, although not triggered by the provisions of theloan and lease documentation at issue in the case.

XI. Guaranty Enforcement – Issues Concerning One Form of Action Rule

a. What Is The One Form Of Action Rule?i. Pursuant to California Civil Code Section 726, the only remedy to enforce an obligation

secured by real property is foreclosure. The one form of action rule does not apply toliens on personal property unless the debt is secured by both personal property and realproperty collateral.

ii. Applies only to obligations secured by real property.iii. Definition of what is an “action” is unclear under state law.

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b. Dual Components Of The One Form Of Action Rule:i. Secured creditor must foreclose the security prior to any other action against the

borrower and is violated if the secured creditor takes any other “action” for recovery ofthe secured debt without a foreclosure of the security (one action aspect); and

ii. The secured creditor cannot undertake an action without including all of the realproperty security of the debt (security first aspect).

c. Public Policy Concerns Underlying The One Form of Action Rule.i. Avoid a multiplicity of actions filed against defaulting borrower.ii. Compel competitive bidding at foreclosure to test the value of the security.iii. Compel the secured creditor to look to the collateral as the primary source of

repayment of the secured debt before looking to the other assets of the borrower.iv. Credit the borrower with the fair market value of the secured property before possibly

subjecting the borrower to personal liability.

d. Brief overview of judicial and non-judicial foreclosure.i. Non-Judicial Foreclosure

(a) Recordation of notice of default;(b) Publication of notice of sale.

ii. Judicial Foreclosure(a) Judgment Permitting Judicial Foreclosure;(b) Judicial Foreclosure;(c) Fair Value Hearing;(d) Deficiency Judgment

e. Relationship Between The One Form Of Action Rule And The Anti-Deficiency Statutes.

The anti-deficiency statutes prohibit in many circumstances the ability of the lender recover anydeficiency following foreclosure of an obligation secured by a deed of trust. The one form ofaction rule requires that the secured lender forecloses on an obligation secured by a deed oftrust before taking any other action.

f. The Impact Of The One Form Of Action Rule And The Anti-Deficiency Statutes On A Guaranty OfA Real Property Secured Loan.i. The one form of action rule does not affect a guaranty agreement that is not secured by

real property, even if the loan guaranteed by the guarantor is secured by a deed of trustbecause a guaranty is a separate and distinct obligation from that of the loan. AlthoughCalifornia law requires that a lender first seek recovery against its collateral and theborrower before proceeding against the guarantor, most guaranty agreements containvalid waivers of this requirement.

ii. The anti-deficiency statutes also do not impact the liability of a guarantor even thoughthe guarantor’s right to subrogation as against the borrower may be eliminated,provided that the guaranty is not secured by real property and the guaranty agreementcontains a valid waiver of such requirement. Thus, a lender may recover a deficiencyjudgment from a guarantor who waives his or her anti-deficiency protections, eventhough the anti-deficiency statutes would bar the lender from recovering that samedeficiency from the primary borrower. However, to collect a deficiency from a

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guarantor, the guarantor must be a true guarantor and not merely the principal debtorunder a different name.

XII. SHAM GUARANTIES.

a. What Is A Sham Guaranty.i. The sham guaranty defense is used to disprove that a valid and enforceable guaranty

exists and is typically raised when the lender seeks to obtain judgment on a guarantyfollowing non-judicial foreclosure. A guaranty is a sham where the guarantor is theprincipal obligor on the debt, either because he or she personally executed the note ordeed of trust, or because the guarantor is liable for the debts of the borrower byoperation of some legal or equitable principle. Where there is legal separation betweenthe borrower and guarantor, however, the guaranty is enforceable unless the loantransaction has been structured to subvert the anti-deficiency laws. Understanding thesham guaranty defense is critical because if a guarantor is successful in asserting thisdefense, it will be a complete defense and bar enforcement of the guaranty.

b. Sham Guaranty - Guarantor Is Directly Liable Under The Loan Documentsi. Union Bank v. Dorn, 254 Cal. App. 2d 157 (1967). Guaranty is not enforceable because

the guarantors were general partners of a general partnership.ii. Torrey Pines v. Hoffman, 231 Cal. App. 3d 308 (1991). Guaranty is not enforceable

because the guarantors were the trustor, beneficiary and trustee of the revocable trustborrower. The defendant guarantors were determined to be nothing more than theprincipal obligors under another name.

c. Guarantor Is An Instrumentality Of The Borrower To Avoid The Anti-Deficiency Statutesi. Valinda Builders, Inc. v. Bissner, 230 Cal App 2d 106 (1964). The defendants guaranteed

a loan taken out by their corporation, which was organized for the sole purpose oftaking on the loan. The corporation had a paid-in capital of only $200, and thedefendants and their wives were its only stockholders, directors, and officers. Relying onalter ego principles, the court concluded there was no evidence the corporation wasanything other than “an instrumentality used by the individuals or that defendants wereever removed from their status and obligations of purchasers.” Thus, the allegedguaranty of defendants was no more than a promise to pay their own debt.

ii. River Bank America v. Diller, 38 Cal. App. 4th 1400 (1995). In the River Bank case, theplaintiff tried to enforce guaranties executed by the defendants in connection with aloan made to a limited partnership of which the defendants' corporation was thegeneral partner. The court reversed the trial court's grant of summary judgment infavor of the lender. The River Bank court decided that the borrower had raised a triable issue of fact

as to whether the lender structured the transaction to avoid the purpose of theanti-deficiency laws based on evidence that the lender relied on extensivefinancial statements from the guarantors but never inquired about the financialstanding of the borrower. The River Bank court also concluded the “purpose andeffect” of the agreements was pertinent, since there was evidence that thelender required the borrower to be a limited partnership and insisted that oneof the defendants be removed as general partner so it could be replaced with ashell corporation. Thus, according to the River Bank court, the lender

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“subverted” the purposes of the anti-deficiency laws by imposing specificdirectives on the loan to the principal obligor. The River Bank court held it wasnot conclusive that the general partner was a long-standing corporation thatadhered to all formalities or that the debt did not directly obligate thecorporation's shareholders and officers, reasoning that the lender structuredthe transaction to relegate the obligors to the position of guarantors.

iii. CADC/RAD Venture 2011-1 LLC v. Bradley, 235 Cal App 4th 775 (2015). Reversing thejury decision of the trial court in favor of the guarantors, the CADC/RAD court found thatenforcement of the guaranty was equitable even though the lender looked only to theguarantors to maintain the loan and did not even review the financial information of theborrower. Of utmost importance to the CADC/RAD court was that the borrower andguarantors designed the structure of the loan transaction. Therefore, since the lenderdid not structure the loan transaction to deprive the guarantor of the protections of theCalifornia anti-deficiency statutes as in the River Bank decision, the CADC/RAD courtheld that the guaranties were enforceable.

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APPENDIX 1

SAMPLE SURETYSHIP DEFENSE WAIVER

(a) Lack of diligence or any delays in collecting or enforcing the LoanDocuments;

(b) The failure or invalidity of, or any defect in, the Loan Documents;(c) Any disability or other defense of the Borrower, or any other guarantor,

or any other person;(d) The termination from any cause whatsoever of any of the obligations

under the Loan Documents, except upon satisfaction of all of theGuaranteed Obligations, including payment in full of all of theIndebtedness and satisfaction of all of Borrower’s other obligationsunder the Loan Documents;

(e) The loss or impairment of any right of recourse, reimbursement,contribution, subrogation, or any other right or remedy of anyGuarantor against Borrower, any other guarantor, or any other personto recover amounts which Guarantor is obligated to pay under thisGuaranty;

(f) Any modification of any of the terms and conditions of the LoanDocuments in any form whatsoever, and without notice to anyGuarantor, including the renewal, extension, compromise, acceleration,or other change in time for payment or performance thereof and anyincrease or decrease in the rate of interest thereon;

(g) Lender’s foreclosure of the Collateral or any portion thereof; it beingintended that this Guaranty will survive the realization upon any of theCollateral, including by nonjudicial foreclosure. Such waiver will includeany defense, right, or claim that any such foreclosure satisfied theobligations secured thereby pursuant to [insert non-judicial foreclosurestatute], as amended or such successor statutes; and

(h) Any right to demand a trial by jury in any proceeding relating to thisGuaranty.

[(i) IN CALIFORNIA ADD: Further, each Guarantor hereby waives any defensebased on any of the following:(i) Any rights of Guarantor of subrogation, reimbursement,

indemnification, and/or contribution against Borrower or anyother person or entity, and any other rights and defenses thatare or may become available to Guarantor or any other personor entity by reasons of Sections 2787 - 2855, inclusive of theCalifornia Civil Code;

(ii) All rights and defenses arising out of any election of remediesby Lender even though that election of remedies, such as anonjudicial foreclosure with respect to the security for theGuaranteed Obligations, has destroyed the Guarantor's rights ofsubrogation and reimbursement against Borrower by the

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operation of Section 580d of the California Code of CivilProcedure or any similar law of California or of any other Stateor of the United States; and

(iii) All rights and defenses that Guarantor may have because theGuaranteed Obligations are secured by real property or anyestate for years. These rights or defenses include, but are notlimited to, any rights or defenses that are based upon, directlyor indirectly, the application of Section 580a, Section 580b,Section 580d or Section 726 of the California Code of CivilProcedure.

(iv) The provisions of this subsection (c) mean, among other things:(v) Lender may collect from Guarantor without first foreclosing on

any real or personal property collateral pledged by Borrower forthe Loan; and

(vi) If Lender forecloses on real property collateral pledged byBorrower:

(vii) The Guaranteed Obligations may be reduced only by the pricefor which such real property collateral is sold at the foreclosuresale, even if such real property collateral is worth more than thesale price; and

(viii) The Lender may collect from the Guarantor even if the Lender,by foreclosing on the real property collateral, has destroyed anyright the Guarantor may have to collect from the Borrower.

The foregoing is an unconditional and irrevocable waiver of any rightsand defenses each Guarantor may have because Borrower’s obligationsare secured by real property. These rights and defenses, include, butare not limited to, any rights or defenses based upon Section 580a,Section 580b, Section 580d or Section 726 of the California Code of CivilProcedure.]

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APPENDIX 2

STANDARD SPE REQUIREMENTS

I. From a smaller, non-CMBS 2015 Loan-similar text should be in both the loan agreement andalso the Borrower’s governing document (e.g. LLC Operating Agreement):

(i) The Borrower will not:o engage in any business or activity other than the ownership, operation and maintenance

of the Property, and activities incidental thereto;o acquire or own any assets other than (a) the Property, and (b) such incidental personal

property as may be necessary for the ownership, leasing, maintenance and operation ofthe Property;

o merge into or consolidate with any person, or dissolve, terminate, liquidate in whole orin part, transfer or otherwise dispose of all or substantially all of its assets or change itslegal structure;

o fail to observe all organizational formalities, or fail to preserve its existence as an entityduly organized, validly existing and in good standing (if applicable) under the applicablelegal requirements of the jurisdiction of its organization or formation, or amend, modify,terminate or fail to comply with the provisions of its organizational documents;

o own any subsidiary, or make any investment in, any person;o commingle its funds or assets with the funds or assets of any other person;o fail to maintain all of its books, records, financial statements and bank accounts

separate from those of any other person (including, without limitation, any Affiliates).The Borrower’s assets have not and will not be listed as assets on the financialstatement of any other person; provided, however, that the Borrower’s assets may beincluded in a consolidated financial statement of its Affiliates provided that (a)appropriate notation shall be made on such consolidated financial statements toindicate the separateness of the Borrower and such Affiliates and to indicate that theBorrower assets and credit are not available to satisfy the debts and other obligations ofsuch Affiliates or any other person and (b) such assets shall be listed on the Borrower’sown separate balance sheet. The Borrower has maintained and will maintain its books,records, resolutions and agreements as official records;

o assume or guaranty the debts of any other person, hold itself out to be responsible forthe debts of any other person, or otherwise pledge its assets for the benefit of any otherperson or hold out its credit as being available to satisfy the obligations of any otherperson;

o make any loans or advances to any person;o fail to (a) hold itself out to the public and identify itself, in each case, as a legal entity

separate and distinct from any other person and not as a division or part of any otherperson, (b) conduct its business solely in its own name, (c) hold its assets in its ownname or (d) correct any known misunderstanding regarding its separate identity;

o make any dividend or distribution to its partners, members, managers, shareholders ordirectors, as applicable, if doing so would cause it to become insolvent or to fail tomaintain adequate capital for the normal obligations reasonably foreseeable in abusiness of its size and character and in light of its contemplated business operations,

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provided, however, that the foregoing shall not be deemed to require any partner,member, manager, shareholder or director to make any capital contribution or otherequity investment;

o undertake any of the following without the prior unanimous written consent of all of itspartners, members, managers, shareholders or directors, as applicable: (a) file orconsent to the filing of any petition, either voluntary or involuntary, to take advantageof any Creditors' Rights Laws, (b) seek or consent to the appointment of a receiver,liquidator or any similar official, (c) take any action that might cause such entity tobecome insolvent, or (d) make an assignment for the benefit of creditors;

o fail to allocate shared expenses (including, without limitation, shared office space) or failto use separate stationery, invoices and checks with its own name;

o acquire obligations or securities of its partners, members, managers, shareholders,directors or other Affiliates, as applicable;

o identify its partners, members, managers, shareholders, directors or other Affiliates, asapplicable, as a division or part of it; or

o maintain its assets in a way difficult to segregate and identify.

(ii) As long as any portion of the Loan remains outstanding, the Borrower will not:o dissolve, merge, liquidate or consolidate;o except in connection with a sale or other transfer permitted under the Loan Documents,

sell all or substantially all of its assets; oro amend [the SPE Section of LLC agreement] without the consent of Lender.

(iii) As used in herein the capitalized terms are defined as follows:o “Affiliate” of a Person means: (A) any officer, partner, director, manager, trustee,

member, or controlling shareholder of such Person; (B) any Person controlling,controlled by or under common control with such Person; and (C) any officer, partner,director, manager, trustee, member, or controlling shareholder of any Person describedin (B) above. For purposes of this definition, the term “control” shall mean the power todirect the management and policies of such Person, directly or indirectly, by or throughstock ownership, agency or otherwise, or pursuant to or in connection with anagreement, arrangement or understanding (written or oral) with one or more otherPersons by or through stock ownership, agency or otherwise; and the terms “affiliated”,“controlling” and “controlled” shall have meanings correlative to the foregoing.

o “Person” means any individual, general partnership, limited partnership, limited liabilitycompany, limited liability partnership, corporation, trust, estate, real estate investmenttrust, association, or other entity.

(iv) Standards Governing Actions. To the fullest extent permitted by applicable law, themembers shall at all times take into account the interests of the Borrower’s creditors aswell as the interests of its members in connection with all matters subject to theconsideration or vote of the members.

(v) Office. The Borrower will establish and maintain an office through which its businessshall be conducted separate and apart from that of any of its Affiliates or Person andshall allocate fairly and reasonably any overhead for shared office space.

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(vi) Payment. The Borrower will pay any liabilities out of its own funds, including salaries ofany employees, not funds of any Affiliate or any Person.

(vii) Arm’s Length. The Borrower will maintain an arm’s length relationship with any Affiliateor Person.

II. From a 2015 CMBS Loan (large loan) -similar text should be in both the loan agreement andalso the Borrower’s governing document (e.g. LLC Operating Agreement):

(i) Borrower Will not do any of the following [until all obligations under Loan Documentssatisfied in full and Deed of Trust reconveyed]:

engage in any business or activity unrelated to the acquiring, developing, owning,holding, selling, leasing, transferring, exchanging, financing, managing, operating andmaintaining the Property, and activities incidental thereto;

acquire or own any assets other than (A) the Property, and (B) such incidental PersonalProperty as may be necessary for developing, owning, holding, selling, leasing,transferring, exchanging, financing, managing, operating and maintaining the Property;

merge into or consolidate with any Person, or dissolve, terminate, liquidate in whole orin part, transfer or otherwise dispose of all or substantially all of its assets or change itslegal structure;

to the fullest extent permitted by law, engage in, seek or consent to, (A) any dissolution,winding up, liquidation, consolidation or merger, (B) except as permitted under theterms of this Agreement, any transfer of partnership or membership interests (if suchentity is a general partner in a limited partnership or a member in a limited liabilitycompany), or (iii) any amendment of its limited partnership agreement, articles ofincorporation, articles or organization, certificate of formation or operating agreement(as applicable) with respect to the matters set forth in this Section without the writtenconsent of Lender;

fail to observe all organizational formalities, or fail to preserve its existence as an entityduly organized, validly existing and in good standing (if applicable) under the applicableLegal Requirements of the jurisdiction of its organization or formation and, if applicable,qualified in the jurisdiction where the Property is located, or amend or modify itsorganizational documents to amend or modify the provisions of this Section as set forthin such organizational documents, or terminate or fail to comply with the provisions ofits organizational documents;

own any subsidiary, or make any investment in, any Person (other than, with respect toany SPE Component Entity, in Borrower);

commingle its funds or assets with the funds or assets of any other Person;

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incur any Indebtedness, secured or unsecured, direct or contingent (includingguaranteeing any obligation), other than (A) the Debt, (B) trade and operationalindebtedness (including, without limitation, Permitted Equipment Leases) incurred inthe ordinary course of business (provided such indebtedness is unsecured) relating tothe ownership and operation of the Property and the routine administration ofBorrower, in amounts not to exceed two percent (2%) of the outstanding principalamount of the Debt, which liabilities are not due more than sixty (60) days past the dateincurred, are not evidenced by a note and are paid within sixty (60) days of when due(unless the payment thereof within such sixty (60) day period cannot be made becauseof the absence of cash flow or, to the extent the intended source of such payment is anAdditional Advance or disbursement from an applicable Reserve Account, the failure ofLender to disburse an Additional Advance or funds from an applicable Reserve Accountin breach of this Agreement), and which are normal and reasonable under thecircumstances, (C) non-delinquent property taxes and assessments (unless the paymentthereof cannot be made because of the absence of cash flow or, to the extent theintended source of such payment is an Additional Advance or disbursement from anapplicable Reserve Account, the failure of Lender to disburse an Additional Advance orfunds from the applicable Reserve Account in breach of this Agreement), and (D)indebtedness otherwise expressly permitted by this Agreement or which is approved inwriting by Lender (if Lender’s approval thereof is required pursuant to the termshereof), which approval may be granted or withheld in Lender’s sole and absolutediscretion (except as otherwise set forth herein) (collectively “PermittedIndebtedness”); provided, however, the foregoing shall not require any direct or indirectowner, member or partner to make any additional capital contributions or advance anyfunds to such Person or prohibit capital contributions and distributions permitted underthe terms and conditions of the Loan Documents and Borrower’s organizationaldocuments and applicable law and properly reflected in the books and records ofBorrower. No Indebtedness other than the Debt may be secured (subordinate or paripassu) by the Property;

fail to maintain all of its books, records, financial statements and bank accountsseparate from those of any other Person (including, without limitation, any Affiliates).Borrower’s assets have not and will not be listed as assets on the financial statement ofany other Person; provided, however, that Borrower’s assets have been and may beincluded in a consolidated financial statement of its Affiliates provided that (A)appropriate notation shall be made on such consolidated financial statements toindicate that Borrower’s assets are owned by Borrower and (B) such assets shall belisted on Borrower’s own separate balance sheet. Borrower has maintained and willmaintain its books, records, resolutions and agreements as official records;

enter into any contract or agreement with any general partner, member, shareholder,principal or Affiliate, except upon terms and conditions that are intrinsically fair andsubstantially similar to those that would be available on an arm’s-length basis withunaffiliated third parties;

maintain its assets in such a manner that it will be costly or difficult to segregate,ascertain or identify its individual assets from those of any other Person;

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assume or guaranty the debts of any other Person, hold itself out to be responsible forthe debts of any other Person, or otherwise pledge its assets for the benefit of any otherPerson or hold out its credit as being available to satisfy the obligations of any otherPerson;

make any loans or advances to any Person;

fail to file its own tax returns, except to the extent that it is treated as a “disregardedentity” or part of a consolidated group for federal or state income tax purpose and isnot required to file federal or state income tax returns under applicable LegalRequirements;

fail to (A) hold itself out to the public and identify itself, in each case, as a legal entityseparate and distinct from any other Person and not as a division or part of any otherPerson, (B) conduct its business solely in its own name, (C) hold its assets in its ownname or (D) correct any known misunderstanding regarding its separate identity;

fail to maintain adequate capital for the normal obligations reasonably foreseeable in abusiness of its size and character and in light of its contemplated business operations (tothe extent there exists sufficient cash flow from the Property to do so); provided,however, the foregoing shall not require any direct or indirect owner, member orpartner to make any additional capital contributions or advance any funds to suchPerson or prohibit capital contributions and distributions permitted under the terms andconditions of this Agreement and Borrower’s organizational documents and applicablelaw and properly reflected in the books and records of Borrower;

without the prior unanimous written consent of all of its partners or members, asapplicable, and the prior written consent of the Independent Director, (A) file or consentto the filing of any petition, either voluntary or involuntary, to take advantage of anyCreditor’s Rights Laws, (B) seek or consent to the appointment of a receiver, liquidatoror any similar official, or (C) make an assignment for the benefit of creditors;

fail to allocate shared expenses (including, without limitation, shared office space) or (B)fail to use separate stationery, invoices and checks bearing its name (or the name of anentity designated as being Borrower’s agent) or the name or the name of the Property;

fail to pay its own liabilities (including, without limitation, salaries of its own employees(if any)) from its own funds or fail to maintain a sufficient number of employees (if any)in light of its contemplated business operations (in each case to the extent there existssufficient cash flow from the Property (or funds from the designated sources for suchpayments pursuant to the terms of this Agreement) to do so and such cash flow (orfunds) is made available to Borrower); provided, however, the foregoing shall notrequire any direct or indirect owner, member or partner to make any additional capitalcontributions or advance any funds to such Person;

acquire obligations or securities of its partners, members, shareholders or otherAffiliates, as applicable; or

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identify its partners, members, shareholders or other Affiliates, as applicable, as adivision or part of it.

(ii) For so long as Borrower is an Acceptable LLC, the limited liability company agreement ofBorrower (the “LLC Agreement”) shall provide that (i) upon the occurrence of any eventthat causes the last remaining member of Borrower (“Member”) to cease to be themember of Borrower (other than (A) upon an assignment by Member of all of its limitedliability company interest in Borrower and the admission of the transferee in accordancewith the Loan Documents and the LLC Agreement, or (B) the resignation of Member andthe admission of an additional member of Borrower in accordance with the terms of theLoan Documents and the LLC Agreement), any person acting as Independent Director ofBorrower shall, without any action of any other Person and simultaneously with theMember ceasing to be the member of Borrower, automatically be admitted to Borroweras a member with a 0% economic interest (“Special Member”) and shall continueBorrower without dissolution and (ii) Special Member may not resign from Borrower ortransfer its rights as Special Member unless (A) a successor Special Member has beenadmitted to Borrower as a Special Member in accordance with requirements of[Delaware] law (as applicable) and (B) after giving effect to such resignation or transfer,there remains at least one (1) Independent Director of the Borrower in accordance withSection ____ below. The LLC Agreement shall further provide that (i) Special Membershall automatically cease to be a member of Borrower upon the admission to Borrower,of the first substitute member, (ii) Special Member shall be a member of Borrower thathas no interest in the profits, losses and capital of Borrower and has no right to receiveany distributions of the assets of Borrower, (iii) pursuant to the applicable provisions ofthe limited liability company act of the State of [Delaware] (the “Act”), Special Membershall not be required to make any capital contributions to Borrower and shall notreceive a limited liability company interest in Borrower, (iv) Special Member, in itscapacity as Special Member, may not bind Borrower and (v) except as required by anymandatory provision of the Act, Special Member, in its capacity as Special Member, shallhave no right to vote on, approve or otherwise consent to any action by, or matterrelating to, Borrower including, without limitation, the merger, consolidation orconversion of Borrower; provided, however, such prohibition shall not limit theobligations of Special Member, in its capacity as Independent Director, to vote on suchmatters required by the Loan Documents or the LLC Agreement. In order to implementthe admission to Borrower of Special Member, Special Member shall execute acounterpart to the LLC Agreement. Prior to its admission to Borrower as SpecialMember, Special Member shall not be a member of Borrower or any SPE ComponentEntity (as applicable), but Special Member may serve as an Independent Director ofBorrower.

(iii) The LLC Agreement shall further provide that for so long as the Debt remainsoutstanding: (i) upon the occurrence of any event that causes the Member to cease tobe a member of Borrower to the fullest extent permitted by law, the personalrepresentative of Member shall, within ninety (90) days after the occurrence of theevent that terminated the continued membership of Member in Borrower, agree inwriting (A) to continue Borrower and

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(iv) to the admission of the personal representative or its nominee or designee, as the casemay be, as a substitute member of Borrower effective as of the occurrence of the eventthat terminated the continued membership of Member in Borrower, (ii) any actioninitiated by or brought against Member or Special Member under any Creditor’s RightsLaws shall not cause Member or Special Member to cease to be a member of Borrowerand upon the occurrence of such an event, the business of Borrower shall continuewithout dissolution and (iii) each of Member and Special Member waives any right itmight have to agree in writing to dissolve Borrower upon the occurrence of any actioninitiated by or brought against Member or Special Member under any Creditor’s RightsLaws, or the occurrence of an event that causes Member or Special Member to cease tobe a member of Borrower.

(v) If Borrower is a partnership or limited liability company (other than an Acceptable LLC),each general partner (in the case of a partnership) and at least one member (in the caseof a limited liability company) of Borrower, as applicable, shall be a corporation or anAcceptable LLC (each an “SPE Component Entity”) whose sole asset is its interest inBorrower. Each SPE Component Entity (i) will at all times comply with each of thecovenants, terms and provisions contained in Section 5.1(a)(iii) – (vi) (inclusive) and (viii)– (xx) (inclusive) and, if such SPE Component Entity is an Acceptable LLC, Section 5.1(c)and (d) hereof, as if such representation, warranty or covenant was made directly bysuch SPE Component Entity; (ii) will not engage in any business or activity other thanowning an interest in Borrower; (iii) will not acquire or own any assets other than itspartnership, membership, or other equity interest in Borrower; (iv) will at all timescontinue to own no less than a 0.5% direct equity ownership interest in Borrower; (v)will not incur any debt, secured or unsecured, direct or contingent (includingguaranteeing any obligation); and (vi) will cause Borrower to comply with theprovisions of this Section 5.1.

(vi) Independent Director.

(a) The organizational documents of Borrower (to the extent Borrower is acorporation or an Acceptable LLC), as applicable, shall provide that at all timesthere shall be at least one (1) duly appointed independent director or manager(an “Independent Director”) who shall (I) not have been at the time of each suchindividual’s initial appointment, and shall not have been at any time during thepreceding five (5) years, and shall not be at any time while serving asIndependent Director, either (i) a shareholder (or other equity owner) of, or anofficer, director (other than in its capacity as Independent Director), partner,member or employee of, Borrower or any of its respective shareholders,partners, members, subsidiaries or Affiliates, (ii) a customer of, or supplier to, orother Person who derives any of its purchases or revenues from its activitieswith, Borrower or any of its respective shareholders, partners, members,subsidiaries or Affiliates, (iii) a Person who Controls or is under common Controlwith any such shareholder, officer, director, partner, member, employeesupplier, customer or other Person, or (iv) a member of the immediate family ofany such shareholder, officer, director, partner, member, employee, supplier,customer or other Person, (II) shall have, at the time of their appointment, hadat least three (3) years’ experience in serving as an independent director and

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(III) be employed by, in good standing with and engaged by Borrower inconnection with, in each case, an Approved ID Provider.

(b) The organizational documents of Borrower shall further provide that (I) theboard of directors, managing member or manager(s) of Borrower and itsconstituent equity owners (such constituent equity owners, the “ConstituentMembers”) shall not take any action which, under the terms of anyorganizational documents of Borrower, requires a unanimous vote of the boardof directors or managers of Borrower or the Constituent Members and the priorwritten consent of the Independent Director as set forth herein unless at thetime of such action there shall be at least one (1) Independent Director engagedas provided by the terms hereof; (II) any resignation, removal or replacement ofany Independent Director shall not be effective without: (1) prior written noticeto Lender and, if a Securitization has occurred, the Rating Agencies (which suchprior written notice must be given on the earlier of five (5) days or three (3)Business Days prior to the applicable resignation, removal or replacement) and(2) evidence that the replacement Independent Director satisfies the applicableterms and conditions hereof and of the applicable organizational documents(which such evidence must accompany the aforementioned notice); (III) to thefullest extent permitted by applicable law, including Section 18-1101(c) of theAct and notwithstanding any duty otherwise existing at law or in equity, theIndependent Director shall consider only the interests of the ConstituentMembers and Borrower (including Borrower’s creditors) in acting or otherwisevoting on the matters provided for herein and in Borrower’s organizationaldocuments (which such fiduciary duties to the Constituent Members andBorrower (including Borrower’s creditors), in each case, shall be deemed toapply solely to the extent of their economic interests in Borrower exclusive of(x) all other interests (including, without limitation, all other interests of theConstituent Members), (y) the interests of other Affiliates of the ConstituentMembers and Borrower and (z) the interests of any group of Affiliates of whichthe Constituent Members or Borrower is a part)); (IV) other than as provided inSubsection (III) above, the Independent Director shall not have any fiduciaryduties to any Constituent Members, any directors of Borrower or any otherPerson; (V) the foregoing shall not eliminate the implied contractual covenant ofgood faith and fair dealing under applicable law; and (VI) to the fullest extentpermitted by applicable law, including Section 18-1101(e) of the Act, anIndependent Director shall not be liable to Borrower, any Constituent Memberor any other Person for breach of contract or breach of duties (includingfiduciary duties), unless the Independent Director acted in bad faith or engagedin willful misconduct.

(vii) Change of Name, Identity or Structure. Borrower shall not change (or permit to bechanged) Borrower’s or any SPE Component Entity’s (a) name, (b) identity (including itstrade name or names), (c) principal place of business set forth on the first page of thisAgreement or, (d) if not an individual, Borrower’s or any SPE Component Entity’scorporate, partnership or other structure, without notifying Lender of such change inwriting at least thirty (30) days prior to the effective date of such change and, in thecase of a change in Borrower’s or any SPE Component Entity’s structure, without first

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obtaining the prior written consent of Lender and, if required by Lender, a RatingAgency Confirmation with respect thereto. Borrower shall execute and deliver toLender, prior to or contemporaneously with the effective date of any such change, anyfinancing statement or financing statement change required by Lender to establish ormaintain the validity, perfection and priority of the security interest granted herein. Atthe request of Lender, Borrower shall execute a certificate in form satisfactory to Lenderlisting the trade names under which Borrower or any SPE Component Entity intends tooperate the Property, and representing and warranting that Borrower or any SPEComponent Entity does business under no other trade name with respect to theProperty.

(viii) Business and Operations. Borrower will continue to engage in the businesses nowconducted by it as and to the extent the same are necessary for the ownership,maintenance, management and operation of the Property. Borrower will qualify to dobusiness and will remain in good standing under the laws of the jurisdiction as and tothe extent the same are required for the ownership, maintenance, management andoperation of the Property.

GUA RA N TE E S ,IN D E M N ITIE S ,N O N -RE C O URS E M O RTGA GE S & C A RV E -O UTC L A US E S :A C A N A D IA N 1 P E RS P E C TIV E

(“Toto,we’re definitelynotin Kansas anymore! ”)

B yC atherine B ray,B rad H allowelland S amanthaTom of B orden L adnerGervais L L P ,Toronto,C anada

Ju ly14,2016

Gu arantees and ind emnities are frequ ently u sed in C anad ian commercial mortgage loantransactions to provid e ad d itionalassu rance to alend erthatad ebtwillbe repaid .This papergives abrief overview of the basics of gu arantees and ind emnities,d iscu sses gu arantees in thecontextof non-recou rse mortgages,and highlights some of the key issu es in d rafting,negotiationand enforcement.

A . M ortgage L oans,Gu arantees and Indemnities

There are two basic principles of acommercialmortgage.Firstly,itis apromise by the borrowerto repay the principalamou ntto the lend erin accord ance withthe terms setou tin the mortgage.Second ly,itprovid es the lend er with a secu red interestin the property,which inclu d es theassociated remed ies setou tin the mortgage in the eventthatthe borrowerd efau lts.

A “tru e”gu arantee is a second ary obligation thatis only enforceable if a valid primary d ebtobligation exists.In the contextof acommercialmortgage loan,the borrowerremains primarilyliable,while u nd er a “tru e”gu arantee,the gu arantor assu mes a second ary liability for theperformance of the borrower’s obligations. There are severald efences to a“tru e”gu arantee,some of whichare d iscu ssed below.

In contrastto agu arantee,an ind emnity is aprimary obligation in which the ind emnifierwillremain liable to the lend erregard less of whetherthe principalobligation is oris notenforceable.Und er an ind emnity,the ind emnifier assu mes an ind epend entresponsibility to perform theobligations of the borrower,whether or not the borrower performs or d efau lts on thoseobligations.W hile the d ocu ment may be called a “gu arantee”,in almost all commercialmortgage d ocu ments the gu arantee provisions create a primary obligation which acts as an

1 This paperreflects O ntario law.The laws of the othercommon law provinces are similar.H owever,Q u ebec is acivillaw,notcommon law,ju risd iction so d ifferentlaw applies exceptin the case of fed erally regu lated areas su chas bankru ptcy.

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ind emnity in law.Forconsistency,this paperwillu se the term “gu arantee”throu ghou tto mean atru e gu arantee and /oran ind emnity.2

B . Gu arantee vs.Indemnityvs.S u rety

A s gleaned from the above d escription,the main d ifference between a gu arantee and anind emnity is the natu re of the obligation.A s d escribed by the Su preme C ou rtof C anad a inCommunities Economic Development Fund v Canadian Pickles Corp:3

C ontracts of gu arantee are sometimes d istingu ished from contracts of ind emnity.In acontractofind emnity,the ind emnifierassu mes aprimary obligation to repay the d ebt,and is liable regard lessof the liability of the principald ebtor.A n ind emnifier willaccord ingly be liable even if theprincipald ebtis void orotherwise u nenforceable.The d istinction between contracts of gu aranteeand of ind emnity ou ghtnotto be overemphasized .The resolu tion of agiven case willtu rn on thecorrectinterpretation of the contractand of the intention of the parties;attempts to labelthecontractas one of gu arantee orof ind emnitymay be less than helpfu l.4

In short,if the agreementprovid es thatthe promisorwillpay only if athird party d oes not,thenthe agreementis a gu arantee;whereas if the promisor is liable to pay in any event,then theagreementis an ind emnity.

Severalcommentators in the United States have d rawn a d istinction between a su rety and agu arantor.They argu e thatasu rety is primarily ororiginally liable d irectly to the cred itoru nd erthe same contractas the principal.In contrast,acontractof gu arantee is aseparate orcollateralcontract,and the gu arantor's liability arises throu gh and is contingentu pon the liability of theprincipald ebtor.Und er C anad ian law,su rety and gu arantor are u sed interchangeably and thed istinction in terminology makes no d ifference.5 Fu rthermore,O ntario cou rts have held thatsu reties are gu arantors who agree to be personally responsible to pay the amou ntspecified if theprincipalfails to.6

C . Gu arantee of D ebtoraM ortgage

(a) Structuring a Guarantee

W hen stru ctu ringagu arantee,itmu stbe d etermined whetherthe gu arantoris gu aranteeingthed ebts of the borrowerorgu aranteeingthe mortgage.If gu aranteeingad ebt,the gu arantee willbean ‘allaccou nts’gu arantee.A n allaccou nts gu arantee is typically u sed where there are ongoingad vances on avariety of loan facilities.In contrast,if the gu arantee is foramortgage loan,thegu arantee may be inclu d ed within the mortgage itself.A gu arantee thatprotects asingle fu llyad vanced d ebt,su chas amortgage,is called aspecific gu arantee.

2 The terms “gu arantee”and “ind emnity”willbe u sed separately if the d istinction is relevant.Itis importantto notethatthe terms have slightlyd ifferentmeanings in C anad aand are interpreted d ifferentlythan in the United States.3 Communities Economic Development Fund v Canadian Pickles Corp,[1991] 3 SC R 38 8 (SC C ) [CanadianPickles] .4 Ibid at413-14.5 Abakhan v Halpen,2008 B C C A 29 atpara19.6 R v Dodson,2000 C arswellO nt49 (C A )atpara10.

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(b)Guarantee Language and Standard Charge Terms

Itis importantforthe d rafters and negotiators of gu arantees to consid erthe langu age thatis u sedin the agreement.Gu arantee langu age is often fou nd in stand ard charge terms that areincorporated by reference into mortgages in O ntario.A s aresu lt,there may be instances where aseparate gu arantee agreementand the stand ard charge term provisions relating to gu aranteesconflictwithone another.In situ ations where this occu rs,section 9(4)of the Land RegistrationReform Act7 provid es that:

9(4)W here there is aconflictbetween an express term in acharge and aterm d eemed tobe inclu d ed in the charge bysu bsection (1),the express term prevails.8

The O ntario C ou rtof A ppealalso gave effectto section 9(4)of the Land Registration ReformAct,byhold ingin Royal Trust Corp of Canada v 5027599 that:

Section 9(4)is aprovision of generalapplication.Itis astatu tory ru le of interpretationthatis triggered when acharge contains an express term thatconflicts with astand ardterm.To the extentthatthe two terms are irreconcilable,s.9(4)d ictates thatthe expressterm prevails.10

A s a consequ ence of the ju d icialinterpretation of section 9(4),d rafters and negotiators ofgu arantees mu stpay strictattention to the langu age of the express terms as they may prevailoverastand ard charge term incorporated into the mortgage.

(c) Common Law Defences to consider when Drafting or Negotiating a Guarantee

W hen d rafting or negotiating a gu arantee,itis also importantto consid er the common lawd efences to the enforcementof a gu arantee.Since a gu arantee is simply a type of contract,d efences ord inarily available to breach of contractclaims are available to agu arantorsu ch as,lackof consid eration,d u ress,u nd u e influ ence,non est factum,and materialalteration.

(i) Lack of Consideration

A s a contractu al obligation,a gu arantee mu st be su pported by consid eration.11

C onsid eration for a promise can consistof:(a) a benefitconferred on the othercontracting party;(b) a benefit conferred on a third party;or (c) a d etrimentsu ffered .12 The consid eration in su pportof agu arantee is open-end ed and is valid aslongas the consid eration has legalvalu e.A lthou ghthe consid eration may benefitthegu arantord irectly,itis notnecessarythatitd o so.13

7 Land Registration Reform Act,RSO 1990,c L 4.8 Ibid ats 9(4).9 Royal Trust Corp of Canada v 502759,2000 C arswellO nt2198 (C A ).10 Ibid atpara38 .11 Manufacturers & Traders Trust Co v Amlinger,2006 C arswellO nt5238 (Su pC t)atparas 33-35.12 Ibid atpara33.13 Bank of Montreal v 1480863 Ontario Inc,200 7 C arswellO nt2419 (Su pC t)atpara35.

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(ii) Duress

A gu arantee which is (or,atleast,originally was) otherwise enforceable may berescind ed by the gu arantorwhere itwas obtained as aresu ltof d u ress to which thecred itorwas privy.14 If acontractis obtained by d u ress itis void able.A contractingparty may have the contractsetasid e if he orshe shows thatothercontractingpartyexerted “coercive,u nfair,orexcessive pressu re thatovercame the consentorfree willnecessaryto enterinto abind ingcontract.”15

(iii) Undue Influence and Spousal Relationships

W here one party is su bjectto the u nd u e influ ence of the other,an obligation lies toensu re thatinformed and ind epend entad vice is given to the gu arantor,oratthe veryleast,to ensu re thatthe gu arantorwas ad vised to obtain su chad vice.16

In aspou salrelationshipin C anad athere is no presu mption of u nd u e influ ence.17 Inthe absence of any evid ence for u nd u e influ ence,frau d ,or other vitiating factor,failu re of the cred itor to ensu re thata spou se-gu arantor has obtained ind epend entlegalad vice before signing the gu arantee is notfatalto a claim by the cred itor.18

Some U.S.commentators have said thatspou salgu arantees are notvalid when theasset is not need ed as part of the asset base for cred it approval. Su bject toconsid erations of illegality,u nd erC anad ian law there is no legalrestriction u pon theextentto whichone person may gu arantee the d ebt,d efau ltormiscarriage of anotherperson.19

(iv) Non est factum

For a su ccessfu ld efence of non est factum (L atin for " itis not[my] d eed " ),thed efend antmu stprove thathe orshe d id notknow the actu alcontents orcharacterofthe d ocu mentthathe orshe signed .20 In ad d ition,the contents of the d ocu mentwhichthe person signed mu st be rad ically and fu nd amentally d ifferent from thecharacteristics of the type of d ocu mentthe person believed they were signing.21 Amere misu nd erstand ingof the scope of the gu arantee is notsu fficientto give rise to ad efence of non est factum.22

14 M cGu inness,Kevin,The Law of Guarantee,3rd ed (M arkham:L exisN exis C anad aInc,2013)at8 12.15 DLG & Associates Ltd v Minto Properties Inc,2014 O N SC 7 28 7 atpara98 .A greatexample of economic d u ressis fou nd in Process Automation Inc v Norstream Intertec Inc,2010 O N SC 398 7 where the d efend antcoerced theplaintiff into signing asecond contractpu rporting to red u ce amou ntowed to plaintiff u nd erthe terms of the firstcontract.16 Continental Bank of Canada v Adena Investments Ltd,[198 4] O JN o 128 1 (O ntD iv C t)atpara6.17 Bank of Montreal v Featherstone,[198 9] O JN o 613,68 O R (2d )541 at547 (O ntC A ).18 Ibid.19 Victoria-Vancouver Stevedoring Co v Grand Trunk Pacific Coast Steamship co,[1918 ] 57 SC R 124.20 Horvath v Young,[198 0 ] O JN o 118 5,15 RP R 266 (O ntH C J)atparas 35-36.21 Granville Savings & Mortgage Co v Slevin,[1992] M JN o 309,24 RP R (2d )18 5 (M an C A ),revd [1993] SC JN o121 (SC C ).22 London Trust & Savings Corp v Corbett,[1994] O JN o 1534,40 RP R (2d )135at138 (O ntGen D iv).

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(v) Material Alteration

The focu s of mostgu arantee litigation is the conceptof ‘materialalteration’.Unlessthe gu arantee states otherwise,agu arantorwillbe released from liabilityincircu mstances where the lend erand the borroweragree to amaterialalteration of theterms of the loan,su chas an increase in the rate of interestorterms forrepayment,withou tthe consentof the gu arantor.23

(d) Contracting Out of Common Law Defences

Itis well-established thatparties to agu arantee are free to contractou tof common law d efenceswhich wou ld otherwise apply.24 In Conlin,the Su preme C ou rtof C anad asu mmarized severalprinciples of interpretation applicable to contractingou tof gu arantees:

(i) any contractingou tof agu arantor's protection againstamaterialalteration of theterms of the contractof d ebtwithou this consentmu stbe clear;

(ii) whetherthe gu arantorcontracted ou tof those protections mu stbe d etermined byan interpretation of the clau ses of the agreement,throu gh aconsid eration of thetransaction as a whole, and the application of the appropriate ru les ofconstru ction;

(iii) any ambigu ity in the terms u sed in the gu arantee shou ld be constru ed againsttheparty whichd rafted itby applyingthe contraproferentem ru le;

(iv) if there is ad ou btorambigu ity as to the constru ction ormeaningof the clau sesbind ingthe gu arantor,they mu stbe strictly interpreted and resolved in favou rofthe gu arantor;and

(v) the clau ses bind inggu arantors mu stbe strictlyconstru ed .25

These principles have recently been applied in O ntario cou rts.26 In Samson,the O ntario C ou rtofA ppealheld that,“d espite the materialalterations in the u nd erlying loan arrangements,[thegu arantor’s] personalgu arantee remains enforceable given the clearand u nambigu ou s langu ageof the gu arantee and the factu alcontext.”27 In this case,the firstparagraph of the gu aranteeprovid ed thatthe gu arantorwou ld payon d emand to RB C :

… alld ebts and liabilities,presentor fu tu re,d irector ind irect,absolu te or contingent,matu re ornot,atany time owingby [SM S to RB C ] orremainingu npaid by [SM S] to the

23 Manulife Bank of Canada v Conlin,[1996] 3 SC R 415(SC C )atpara2 [Conlin] .24 Conlin,supra note 23atpara4.25 Ibid atparas.4,8 ,15 and 22.26 See Royal Bank of Canada v Samson Management & Solutions,2013 O N C A 313 [Samson] and Posocco vBattista et al,2015 O N SC 6398 [Posocco] in whichthe cou rts enforced the gu arantees d espite materialalterationsmad e to loan agreements withou tthe consentof the gu arantor,inclu d ing apostponementby the secu red cred itorwhichthen affected the abilityto be repaid from the secu rity.27 Samson, supra note 26 atpara64.

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B ank,heretofore or hereafter incu rred or arising and … incu rred by or arising fromagreementord ealingbetween the B ankand [SM S] .28

Similarly,the O ntario Su perior C ou rtof Ju stice recently ru led in Posocco thatthe gu arantorwaived their common law rightto the d efence of materialalteration.The C ou rtheld thatthelangu age of the gu arantee was “extremely broad ”and “… the terminology contained inparagraph2(iii)permittingthe cred itorto ‘vary any secu rity in whole orin part’mu stbe read toinclu d e the su bord ination orpostponementof the mortgages.”29

W hile the Samson and Posocco cases d emonstrate thatitis possible to contractou tof thematerialalteration d efence,C anad ian cou rts have notad d ressed whether other common lawd efences can be waived as well.This may d evelop into a fu tu re problem as most,if notall,stand ard form gu arantees u sed by institu tionallend ers are d rafted so thatthe gu arantorwaivesthe common law d efences.H owever,as the requ irements for waiver in Conlin d emonstrate,clau ses bind ingthe gu arantormu stbe clear,strictly constru ed ,and interpreted in favou rof thegu arantor in the eventof any ambigu ity.Therefore,itis u nlikely thatC anad ian cou rts wou ldallow gu arantors to waive their rights to the d efence of d u ress,u nd u e influ ence,or non estfactum.

(e) The Principal Debtor Clause

Gu arantees are u su ally d rafted so thatthe gu arantor assu mes a primary d ebtobligation.Thislangu age is intend ed to convertthe gu arantee into an ind emnity. A n example of a“principald ebtorclau se”is:The Guarantor shall be liable to the Lender as principal debtor and not assurety only, and will not plead or assert to the contrary any action taken by the Lender inenforcing this Agreement.

In Conlin,the Su preme C ou rtof C anad a held thata “principald ebtor”clau se converted thegu arantorinto a“fu ll-fled ged principald ebtorwithallthe d u ties and obligations whichthattermimplies”.30 In othercases,ithas been held thatsimilarlangu age was notsu fficientto create anind emnity in favou rof the lend er.31 Therefore,the mere presence of a“principald ebtor”clau seis notenou ghon its own to characterize somethingas an ind emnity.A criticalpartof the analysisthatthe cou rts u nd ertake is consid eringthe langu age u sed in the gu arantee in its entirety.Thisinvolves interpretation of the clau ses of the agreement,consid eration of the transaction as awhole,and the application of the appropriate ru les of constru ction.32

28 Ibid atpara2429 Posocco,supra note 26 atpara8 .30 Conlin,supra note 23atpara21.31 See Montreal Trust Co of Canada v Birmingham Lodge Ltd (1995),24 O R (3d )97 (C A )where the C ou rtheld thata gu arantor and a principald ebtor are mu tu ally exclu sive concepts,and that,if alend er's actions or d ocu mentscharacterize apartyas agu arantor,the lend eris thereafterpreclu d ed from seekingrecovery againstthatgu arantorasif itwere aprimaryd ebtor.32 Conlin,supra note 23atpara21.

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D . E nforcingaGu arantee

(a) Generally

A gu arantee of an institu tionallend eris u su ally d rafted u singspecific langu age and as aresu lt,enforcementis typically straightforward ,withou tmu chcontroversy.A bsentan agreementto thecontrary,it is presu med that the liability of the gu arantor arises u pon the d efau lt of theprincipal.33 The cred itoris notu nd eran obligation to the gu arantorto d o anythingotherthan callu pon the principalto perform,to acceptthe performance of the principalif tend ered ,and ,if thegu arantee is atru e gu arantee and notan ind emnity,notrequ ire the gu arantorto pay when theprincipal is not liable to pay.34 A gu arantee will generally be constru ed strictly contraproferentum so as to resolve anyambigu ityin favou rof the gu arantor.35

(b) Independent Legal Advice

A notherissu e in the enforcementof gu arantees thatlend ers shou ld be aware of is ind epend entlegalad vice.W hile there is no requ irementthatagu arantorobtain ind epend entlegalad vice inord er for the gu arantee to be enforceable,36 many lend ers now requ ire gu arantors to obtainind epend entlegalad vice atthe time of provid ingagu arantee.This is common practice where afamily home is mortgaged as secu rity foragu arantee of abu siness loan orwhere aspou se isgu aranteeingtheirspou se’s bu siness loan.

The provision of ind epend entlegalad vice increases the likelihood thatagu arantee willbe fou ndto be enforceable.The O ntario Su perior C ou rtof Ju stice held in Royal Bank of Canada v2240094 Ontario Inc37 that,“… ind epend entlegalad vice is notaprerequ isite forabankto makeaclaim againsta gu arantor;however,the presence of ind epend entlegalad vice is u sefu lto abank,becau se itprovid es ameans to negate any pleas of non est factum ormisrepresentation(also pleas of u nd u e influ ence,d u ress,frau d ,u nconscionability).”38 In ord er to actas a pre-emptive evid entiary tool,ind epend entlegalad vice mu sttru ly be ind epend ent.In Carvest CapitalInc v Starserra Homes (Riverside) Ltd,39 the ind epend entlegalad vice in aspou salgu arantee wasqu estioned becau se the lawyerwas cou nselforthe borrowerand aware of maritald ifficu lties.40

(c) Notice of Sale to a Guarantor

In cases where amortgage goes into d efau lt,the qu estion arises as to whetherthe gu arantorisentitled to be served a copy of the N otice of Sale.Und er section 31 of the Mortgages Act,persons listed on the ‘parcelregister’have an interestin the land .41 W here agu arantorhas paid aportion of the mortgage d ebt,itwillbe su brogated to the lend ers’position,and willhave an

33 M cGu inness,supra note 14 at336.34 M cGu inness,supra note 14 at349.35 Bank of Montreal v Korico Enterprises Ltd (2000),50 O R (3d )520 (C A )atpara16.36 Bank of Montreal v Featherstone (198 9),68 O R (2d )541 (C A )atpara20.37 Royal Bank of Canada v 2240094 Ontario Inc,[2013] O JN o 2600 (O ntSC J).38 Ibid atpara16.39 Carvest Capital Inc v Starserra Homes (Riverside) Ltd,2009 C arswellO nt2908 (O ntSC J).40 Ibid atpara25.41 Mortgages Act,RSO 1990,c M 40,s 31.

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interestin the property.42 A lthou gh itmay be d ifficu ltto d etermine whetherornotagu arantorhas been making payments on the charge,a pru d entlend er shou ld inclu d e gu arantors on theservice listforaN otice of Sale to avoid imperilingthe powerof sale proceed ings.43

(d)Foreclosure Proceedings

A gu arantor for a mortgage d ebtis notentitled to stand ing in foreclosu re proceed ings.Forexample,agu arantorforamortgage whose liability arises merely by covenantand who has paidnothingon the mortgage is notanecessary party to an action forforeclosu re becau se they d o nothave an interestin the property.44 In contrast,agu arantorwho has joined aco-mortgagorwiththe principald ebtororwho has paid partof the mortgage d ebtis aproperand necessaryparty.45

(e) Limitation Periods of Guarantees contained in a Mortgage

There are d ifferent limitation period s d epend ing on whether a gu arantee is a stand alonegu arantee,oragu arantee contained within amortgage.In astand alone gu arantee,the LimitationsAct, 2002,46 provid es alimitation period of two years from d emand :

4.Unless this A ctprovid es otherwise,aproceed ingshallnotbe commenced in respectofaclaim afterthe second anniversaryof the d ayon whichthe claim was d iscovered .

5(3)… the d ay on whichinju ry,loss ord amage occu rs in relation to ad emand obligationis the firstd ay on which there is afailu re to perform the obligation,once ad emand forthe performance is mad e.47

In acommercialrealestate stand alone gu arantee,there is a realrisk thatthe d isposition andrealization cou ld ex ceed the two-yearlimitation period .If the gu arantee is partof the mortgaged ocu mentitself,however,the limitation period is ten years as persection 43of the Real PropertyLimitations Act.48 A s a resu lt,a cred itor willhave ten years to pu rsu e the gu arantor for ad eficiencyin an intra-mortgage gu arantee.

(f) Need for Demand on Guarantee

The limitation period on a d emand gu arantee begins to ru n from the d ate thatd emand wasmad e.49 W hen crafting a gu arantee,parties mu std etermine whether or notitis d esirable torequ ire thatd emand be given before the d ebtis d u e.This intersection of the Limitations Act,2002 provisions on d emand obligations and the non-d emand natu re of certain gu arantees lead s to

42 Canadian Financial Co v First Federal Construction Ltd (198 2),34 O R (2d )68 1 (C A )atpara19.43 D ou gB ou rassa,“H ow to Stru ctu re P ersonaland C orporate Gu arantees In M ortgage Transactions”,C ommercialM ortgage Transactions 2013(10 September2013)at9.44 Canadian Financial Co v First Federal Construction Ltd,198 2 C arswellO nt115(C A )atpara19.45 L-Jalco Holdings Inc v Marino,2011 O N SC 7 10 atpara56 [L-Jalco] .46 Limitations Act, 2002,SO 2002,c 24,SchB .47 Ibid ats 4 and s 5(3).48 Real Property Limitations Act,RSO 1990,c L 15,s 43.49 A s noted above,the Limitations Act, 2002 creates alimitation period of two years.H owever,section 5(3)of theLimitations Act, 2002 only applies with respectto d emand obligations created on or after Janu ary 1,2004.Ford emand obligations pred atingthatperiod ,the common law position reigns,and the limitation period began to ru nfrom the momentthe loan was ad vanced .

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u nu su alsitu ations.In Skuy v Greennough Harbour Corporation,50 the O ntario Su periorC ou rtofJu stice explained how agu arantee thatd oes notrequ ire d emand may nonetheless be ad emandgu arantee:

W here the parties to agu arantee incorporate ad emand as acond ition-preced entto thegu arantor's liability,liability d oes notcrystallize u ntilaproperd emand has been mad eand the limitation period commences u pon the receiptof the d emand …

M oreover,to ad d to the complexity (and to provid e another example of the confu singnatu re of the law)some d emand obligations can be enforced withou tan actu ald emandhaving been mad e.A cred itor claiming u nd er a gu arantee is notrequ ired to make ad emand before action u nless the plain word ingof the gu arantee requ ires this to be d one.51

In Skuy,the C ou rtheld thatthe originald ebtcreated by apromissory note was statu te barred .H owever,the C ou rtfou nd thatthe gu arantors were liable on theirgu arantees of thatd ebtbecau sethere had notbeen d emand on the gu arantees,and thattherefore the limitation period had neverstarted in respectto the gu arantees.52 To complicate the situ ation fu rther,the O ntario C ou rtofA ppealhas conclu sively accepted service of a N otice of Sale as ‘d emand ’on a d emandgu arantee.53

(g) Pursuing the Borrower First

Unless the gu arantee provid es otherwise,the cred itord oes nothave to bringan action againsttheborrower before d emand ing paymentfrom the gu arantor.In a gu arantee,the rightof actionagainstthe gu arantorarises u pon the d efau ltof the principalitself.

(h) Bankruptcy of the Borrower

A s ageneralru le,if the borroweris in an insolvency proceed ing,which inclu d es bankru ptcy,receivershiporrestru ctu ringproceed ings u nd erthe Companies’ Creditors Arrangement Act54 orthe Bankruptcy and Insolvency Act,55 the enforcementof aclaim againstagu arantoris typicallynotstayed .N eitherthe bankru ptcy of the borrowernoran ord erof d ischarge in the bankru ptcy ofthe borrowerd ischarges the gu arantorfrom liability.56

Generally there is no ability foraborrowerin arestru ctu ringproceed ingu nd erthe CCAA ortheBIA to d isclaim orrepu d iate afinancing agreement(althou gh there is statu tory au thority foraborrowerto d isclaim severaltypes of execu torycontracts).

O ften if aborroweris the su bjectof an insolvency proceed ing,alend erwilllookto its secu rityagainstthe borrowerbefore making ad emand againstagu arantor. In this way,the limitationperiod againstthe gu arantord oes notstartu ntilthe d emand againstthe gu arantoris mad e.If the

50 Skuy v Greennough Harbour Corporation,2012 O N SC 6998 [Skuy] .51 Skuy,supra note 50 atparas 36-37 .52 Ibid atparas 53-54.53 Equitable Trust Co v Marsig,2012 O N C A 235atpara8 .54 Companies’ Creditors Arrangement Act,RSC ,198 5,c C -36 [CCAA] .55 Bankruptcy and Insolvency Act, RSC 198 5,c B -3[BIA] .56 Ibid ats 17 9.

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d emand were mad e atthe time of the d efau ltby the borrower,the lend ermay be statu te barredagainstthe gu arantorif itwaits too longto commence proceed ings againstthe gu arantor.

O f cou rse,if agu arantorhas given secu rity,alend ermay d ecid e to enforce the gu arantee andrelated secu rityconcu rrentlywiththe enforcementagainstthe borrower.

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(i) Bankruptcy of the Guarantor

If the gu arantorhas notprovid ed any secu rity to the lend erand the gu arantoris then the su bjectof an insolvency proceed ing,the lend er’s ability to enforce againstthe gu arantorwillbe stayedand the lend erwillneed to file aproof of claim.If the lend erhas been provid ed withsecu rity bythe gu arantor then the lend er willbe in a better position to enforce its claims againstthegu arantord epend ingon the natu re of the insolvencyproceed ing.

(j) Bankruptcy Remoteness

O ne key elementin the United States (and in C anad ain respectof M B S d eals)is requ iringtheborrowerto continu e to be anon-recou rse loan aspecialorsole pu rpose entity.In the UnitedStates,cred itors’concern overacou rtord ering su bstantive consolid ation of assets of affiliatedborrowers (and allowingallcred itors access to this aggregate poolof assets)and the (potentiallyd etrimental)impacton asecu red cred itor,has led to d ifferingtheories and lists of covenants ofborrowers to ensu re separation of the borrowerfrom its affiliated companies.

C anad ais similarto the United States in thatsu bstantive consolid ation is aresu ltof the cou rtexercisingits d iscretion in equ ity (ratherthan as aresu ltof astatu tory provision).H owever,inthe United States there are many more cases setting ou t d ifferent tests for su bstantiveconsolid ation,than there are in C anad a.In both United States and in C anad a,d ecisions areheavily influ enced by the particu lar facts.H owever,su bstantive consolid ation is mu ch lesscommon in C anad athan in the United States,particu larlywhere itwou ld preju d ice any particu larcred itor.W here it has been ord ered ,the principalsecu red cred itor has su pported it.Thisu ncertainty combined withthe riskto cred itors in the United States has resu lted in attorneys inthe United States beingrequ ested to give opinions on bankru ptcy remoteness.In talkingwithtwoof my colleagu es in bankru ptcy law,with15 and 25 years’experience respectively,only one hadbeen involved in su chan opinion and was notaware of othersu chopinions.In short,an opinionon bankru ptcyremoteness and su bstantive consolid ation is u nu su alin C anad a.

E . Recou rse vs.N on-Recou rse L oans

(a) Generally

In arecou rse loan,the d ebtmay be satisfied by pu rsu ingthe borrower’s otherassets in ad d itionto the collateralsecu ringthe loan.B y contrast,in anon-recou rse loan,the lend er’s enforcementis limited to the collateralsecu ringthe loan.In the case of amortgage,the enforcementis againstthe mortgaged property. M any commercialloans,inclu d ingmany commercialmortgage loans,remain fu llrecou rse loans. The main exceptions,where mortgage loans are non-recou rse,aremortgage loans thatwillbe secu ritized ,where the borroweris aREIT,where the borrowerhas astrong covenant,or where the valu e of the mortgaged property is mu ch higher than the loanamou nt(i.e.the loan to valu e ratio is low).

(b) Anti-Deficiency Rules

SeveralStates in the United States have anti-d eficiency statu tes thatprohibitthe ability of the

lend er to recover any d eficiency following the foreclosu re of an obligation secu red by a

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mortgage ord eed of tru st. H owever,in O ntario,there are two main enforcementmechanisms

specific to mortgages:foreclosu re orpowerof sale.P owerof sale is u sed more frequ entlyas itis

asimplerand fasterproced u re.In ad d ition,withasale u nd erapowerof sale,lend ers have the

ability to su e the borrowerand the gu arantorforany d eficiency afterasale pu rsu antto apower

of sale,57 u nless the borrowerorgu arantoris preju d iced becau se the lend erd id notcomply with

the applicable law in enforcingits powerof sale.

In foreclosu re,alend ercannotrecovery the d eficiency from the borrowerif the lend eris notin aposition to re-convey the mortgaged property to the borrowerorif afinalord erof foreclosu rehas been obtained .58 In ad d ition,in foreclosu re,a lend er can recover a d eficiency from anind emnitor (again,provid ed the ind emnitor is notpreju d iced by the lend er’s non-compliancewithapplicable law),bu tnotagu arantor(if the borrowerwou ld notbe liable forthe d eficiency).

F. C arve-ou ts to N on-Recou rse L oans (“B ad B oyC arve-ou ts”)

A n areaof concern in non-recou rse loans is whetherthe lend ershou ld be protected from losses,orbe able to make the loan fu lly recou rse,if the borrowerhas committed (by actoromission)improperacts su chas frau d ,misu se of fu nd s,allowed environmentalcontamination,ord amagedthe valu e of the mortgaged property.This issu e is often resolved by aseparate agreementsignedby the borrower,any gu arantors,and the sharehold erof the borrower,which expressly allowsrecou rse to the otherassets of the parties,if any of these acts occu r. This type of ind emnity iscommonly referred to as a “bad boy ind emnity”and the triggering events referred to as“non-recou rse carve-ou ts”.B ad boy ind emnities are often signed by the principals/sharehold ersof the borrower,in ad d ition to the borrower,to expand the poolof assets available to the lend er.

W hen actingforaborrower,itis importantto ensu re thatthe lend eris notu singcarve-ou ts toconvertthe non-recou rse loan facility into the practicalequ ivalentof afu llrecou rse loan.Thisissu e arose in the United States,mostfamou sly in Wells Fargo Bank, NA v Cherryland MallLimited Partnership.59 Cherryland,however,was su bsequ ently overru led by legislation in theState of M ichigan60 and the legislation was u pheld by the United States C ou rtof A ppeals fortheSixth C ircu itin Borman, LLC v 18718 Borman, LLC.61 A similarcarve-ou tissu e also arose inBlue Hills Office Park LLC vs JP Morgan Chase Bank62 where the C ou rtpermitted the lend ers torecoverthe “fu llamou nt”of the d eficiency after aforeclosu re,withou tregard to whetherthe

57 L-Jalco Holdings Inc v Marino,2011 O N SC 7 10 atpara7 1.58 Douglas v Mutual Life Assurance Co of Canada,[1918 ] 57 SC R 243 at58 2 and Price v Letros,(197 3)2 O R (2d )292 (O ntC A ).59 Wells Fargo Bank, NA v Cherryland Mall Limited Partnership et al,2011 W L 67 8 5393 (M ichA ppD ec 27 2011)[Cherryland] wherein the M ichigan C ou rtof A ppeald etermined thatbased on the langu age of the mortgage,failu reby the borrowerto remain solventresu lted in abreach of its covenantto maintain “specialpu rpose entity”statu s,thereby allowing fu llrecou rse to the loan worth $8 .7 million.A s aresu lt,the lend erwas able to recoverthe $2.1million d eficiencyfrom the gu arantorwhen the propertywas sold in foreclosu re.60 See section 3(1)of the Nonrecourse Mortgage Loan Act which provid es thatapost-closing solvency covenantshallnotbe u sed ,d irectly orind irectly,as anonrecou rse carve-ou toras the basis foraclaim oraction againstaborroweroranygu arantororothersu retyon anonrecou rse loan.61 Borman, LLC v 18718 Borman, LLC,7 7 7 F 3d 8 16 (6th C ir).62 Blue Hills Office Park LLC vs JP Morgan Chase Bank,47 7 F Su pp2d 366 [Blue Hills].

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covenantbreach cau sed the fu llloss.D espite these examples in the United States,comparablecases have notd eveloped in C anad awhere carve-ou ts to non-recou rse loans resu lted in the loansbeingconverted from non-recou rse into fu lly recou rse.

G. “A bove the L ine”vs.“B elow the L ine”

In the United States,carve-ou ts are generally broken into two categories:(1)above the line and(2)below the line.A bove the line carve-ou ts typically referto recou rse events by which loss,cost,d amage orexpense su ffered by the lend erbecome recou rse to the borrower(and ,in tu rn,the gu arantor).These events d o nottrigger fu llrecou rse liability for the entirety of the loan.Rather,the gu arantoris only liable forthe loss,cost,d amage orexpense su ffered by the lend erd u e to the applicable carve-ou t.Examples of above the line carve-ou ts inclu d e frau d orintentionalmisrepresentation,gross negligence,breach of environmentalcovenant,waste,andfailu re to paytaxes orotherproperty charges than can create liens on the property.

B elow the line carve-ou ts typically referto “fu llrecou rse”carve-ou ts whichmake the d ebtfu llyrecou rse u pon the occu rrence of the applicable carve-ou t.Examples of below the line carve-ou tsinclu d e,breachof cashmanagementprovisions,breachof “no sale”provisions,and bankru ptcyof the borrower.

The extentof non-recou rse carve-ou ts is more straightforward in O ntario as they are oftenlimited to an ind emnity for frau d , misu se of fu nd s, and environmental contamination.Fu rthermore,issu es thatarise in the United States respectingbankru ptcy of the borrowerwherethe assets of allrelated companies are u sed to pay allcred itors pro rata,d oes notexistin C anad aexceptin u nu su alcircu mstances where su bstantialconsolid ation may be ord ered .A s aresu ltofnarrowerbad boy ind emnities,the very strongbargainingpowerof lend ers in C anad a,and thed ifference in bankru ptcy laws,non-recou rse carve-ou ts are notas heavily negotiated in O ntarioas they are in the United States.In ad d ition,mostnon-recou rse carve-ou ts in C anad aare “abovethe line”(i.e.limited to the actu alloss and d o notmake the entire loan fu llrecou rse).

H . D rafting,N egotiatingand E nforcingC arve-ou ts to N on-Recou rse L oans

Ithas been su ggested by some United States commentators thatthere is strictconstru ction ofcarve-ou ts in the United States,often resu ltingin ru lings favou rable to the lend er.A s highlightedin Cherryland and Blue Hills,the literalinterpretation of the mortgage loans and gu arantees wasthe d eterminingfactorwhichallowed the lend ers in eachcase to enforce the carve-ou tand fu llyrecover any d eficiency.Fu rthermore,these ou tcomes occu rred d espite potentialviolations ofpu blic policy,actions beyond the gu arantor’s control,and the significantad verse impactofconvertinganon-recou rse to afu llyorpartiallyrecou rse loan.

In contrast,if Cherryland and Blue Hills had been heard in C anad ian cou rts,the ru lings mayhave been more favou rable to the borrower.This is becau se C anad ian cou rts are tasked with aplain read ing of the contract,id entifying the intentof the parties,and giving effectto it.Inad d ition,O ntario C ou rts have held thatagu arantee willgenerally be constru ed strictly in favou r

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of the borrowerorgu arantorif there is any ambigu ity.63 Itfollows thatin d raftingagu aranteewithcarve-ou ts,itis imperative thatthe word s accu ratelyreflectthe intentions of the parties.

There has been little ju d icialconsid eration of enforcing carve-ou ts to non-recou rse loans inC anad a.In Canada v McLarty,64 the Su preme C ou rtof C anad aonly mentions non-recou rse loansin passingas limitingthe cred itorto recoveryof specified secu rity.65 In absence of C anad ian caselaw d ealing with the interpretation and enforcementof carve-ou ts to non-recou rse loans,bothgu arantors and cred itors shou ld d raftcarve-ou ts thatid entifytheirintentand are plainlyword ed .

I. C onclu sion:

In C anad a,gu arantees and ind emnities in commercial mortgage loan transactions provid eassu rance to alend erthatad ebtwillbe repaid .A s this paperhas d emonstrated ,however,thefu nction of these agreements is very d ifferent.In agu arantee,the promisorwillpay only if athird party d oes not,whereas with an ind emnity,the promisoris liable to pay in any event.Tocomplicate this d istinction fu rther,itis common in C anad aforagreements labelled “gu arantee”to actin practice like an ind emnity.

To u nd erstand the complexities of d rafting and interpretation,itis importantto recognize thatgu arantees and ind emnities are interpreted in accord ance withthe principles of contractlaw.A s aresu lt,gu arantors and ind emnitors are protected by d efences ord inarily available to breach ofcontract.D espite these protections,it has become common in C anad a that a gu arantor orind emnitor willcontractou tof the protection provid ed by the common law or equ ity if thelangu age in the gu arantee/ind emnity is clearand u nambigu ou s.66 This has resu lted in gu arantorsbeingheld responsible forpaymenton amortgage loan d espite materialalterations mad e to theloan withou tthe consentof the gu arantor.In short,as long as the common law and equ itableprotections are waived and there are no othervitiatingfactors,the enforceability of gu aranteesand ind emnities is relativelystraightforward .

M oreover,the d istinction between recou rse and non-recou rse loan agreements is importantin theC anad ian context.W hen d rafting and negotiating gu arantees or ind emnities in anon-recou rseloan,lend ers may inclu d e carve-ou ts in an attemptto protectthe lend erfrom losses orto convertthe loan into afu llyrecou rse loan if the carve-ou teventoccu rs.In contrastto the Cherryland andBlue Hills d ecisions in the United States,there have been no cases in C anad awhere carve-ou ts innon-recou rse loans have resu lted in these loans becoming fu lly recou rse.A s a precau tion,however,itis importantthatgu arantees and ind emnities of bothrecou rse and non-recou rse loansbe d rafted in waythatensu res clarityand intentof the parties.

D espite the parallels between gu arantees,ind emnities,non-recou rse mortgages,and carve-ou ts inC anad aand the United States,there are u niqu e d ifferences.This paperis notexhau stive of thosed ifferences,bu tprovid es an overview of this area of law in ord er to offer clarity to both aC anad ian and A merican au d ience.B y provid ingaC anad ian perspective,itis ou rhope thatthe

63 Bank of Montreal v Korico Enterprises Ltd (2000),50 O R (3d )520 (C A )atpara16.64 Canada v McLarty,200 8 SC C 26,[200 8 ] 2 SC R 7 9 [McLarty] .65 McLarty,supra note 67 atpara29.66 Conlin,supra note 23atpara4.

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read er willbe better equ ipped to navigate the intricacies of C anad ian commercialmortgagetransactions goingforward .

TO R01:6325234:v4

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B IB L IO GRA P H Y

C anadian S ou rces

B ram C ostin,“The D efinition and Extentof L iability”,The Six-M inu te C ommercialL easingL awyer2013(26 Febru ary2013).

D ou gB ou rassa,“H ow to Stru ctu re P ersonaland C orporate Gu arantees In M ortgageTransactions”,C ommercialM ortgage Transactions 2013(10 September2013).

Iris Tam,“C anad a:‘B ad B oy’C arve-O u ts”,B lake,C assels & Grayd on L L P (5O ctober2010).

Kevin M cGu inness,The Law of Guarantee,3rd ed (M arkham:L exisN exis C anad aInc,2013).

L en B aranek,“L imited Recou rse M ortgages and C arve-ou tC lau ses”,C ommercialM ortgageTransactions 2014 (16 September2014).

Tom Zverina,“Gu arantees –Unenforceable Und erlyingO bligations”,B u siness L aw Su mmit.

W alterM .Trau b,“L imited and N on-Recou rse Gu arantees”,The Six-M inu te RealEstate L awyer2006 (15N ovember2006).

A merican S ou rces

GaryA .Good man & SabrinaJ.Khabie,“The Enforcementof N on-Recou rse C arveou ts inC M B S L oans:A RecentH istory”,P ratt’s Jou rnalof B ankru ptcy L aw (2012).

H aynes and B oone L L P ,“The fallou tfrom C herryland –willthe non-recou rse carve-ou tgu arantyeverbe the same again?”(1 Ju ne 2012).

John G.W harton,“N egotiatingC arveou ts to N on-Recou rse L oan D ocu ments (W ithForm)”,TheP racticalRealEstate L awyer(N ovember1997 ).

John C .M u rray,“Enforceabilityof C arveou ts to N onrecou rse L oans:RecentC ases”,FirstA merican Title (2012).

John C .M u rray& Rand allL .Scott,“Enforceability of C arveou ts to N onrecou rse L oans:A nEvolu tion”,RealP roperty,Tru st& Estate L aw Jou rnal(Fall2013)

Joshu aGorsky,“W ait… W hatD o IO we Y ou ?Searchingforthe Tru e M eaningof N on-Recou rse FinancingA fterC herryland v.W ells Fargo”,eRepository@ Seton H all(2015).

KarlE.Geier,“L oan C arve-O u ts ForN onrecou rse Financing”,C ommercialM ortgage Insight(2009).

L owenstein Sand lerL L P ,“W hen non-recou rse isn’treallynon-recou rse atall:the C herrylandd ecision –fu llrecou rse enforcementof anon-recou rse loan”(2 Ju ly2012).

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M arshallTracht,“God zillaL ives! O r,N onrecou rse C arveou ts Ru n A mok”,P ratt’s Jou rnalofB ankru ptcy L aw (A pril2012).

Richard D .Flexner,“United States:N on-Recou rse C arveou ts –C ommon M isconceptions”,Stites & H arbison P L L C (7 A pril2015).

Su san G.Talley,“N egotiatingC arve-ou tGu aranties forthe B orrower–A bove the L ine,B elowthe L ine,orC rossingthe L ine?”A B A Section of RealP roperty,Tru stand Estate L aw andA merican C ollege of RealEstate L awyers.