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Presenting a live 90-minute webinar with interactive Q&A

Non-Recourse Carve Outs, Bad-Boy Guaranties,

and Personal Liability: Latest Developments Avoiding or Resolving Lender and Guarantor Disputes in and Outside of Bankruptcy

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

THURSDAY, DECEMBER 1, 2016

Thomas W. Coffey, Senior Counsel, Tucker Ellis, Cleveland

James H. Schwarz, Partner, Benesch Friedlander Coplan & Arnoff, Indianapolis

Daniel K. Wright, II, Partner, Brouse McDowell, Cleveland

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Moderator:

Daniel K. Wright, II, Esq.

Partner

Brouse McDowell

Cleveland, Ohio

Panelists:

Thomas W. Coffey, Esq. Chair, Bankruptcy Group Tucker Ellis LLP Cleveland, OH James H. Schwarz, Esq. Partner Benesch Friedlander Coplan & Aronoff LLP Indianapolis, IN

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• “Springing Recourse” and “Bad-Boy Guarantys” – Recent Cases and Legislation – Daniel K. Wright, II, Esq. and Thomas W. Coffey, Esq.

• Recent Trends - Non-Recourse Carve-Outs – James H. Schwarz, Esq.

• Discussion of Case Study – New Market Center

• Bankruptcy Perspective – Thomas W. Coffey, Esq.

• Conclusion – Practice Tips

OVERVIEW:

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“SPRINGING RECOURSE” AND “BAD-BOY” GUARANTEES – RECENT CASES AND LEGISLATION

Daniel K. Wright, II, Esq. Thomas W. Coffey, Esq. Partner Chair, Bankruptcy Group

Brouse McDowell Tucker Ellis LLP

Cleveland, OH Cleveland, OH

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• Wells Fargo Bank, N.A. v. Cherryland Mall Ltd P’shp,

• Borman LLC vs. 18718 Borman LLC and Joseph Schwebel (U.S. Sixth Circuit, 2015)

• Michigan’s and Ohio’s Non-Recourse Mortgage Loan Acts

• In Re: General Growth Properties, Inc. et al., Debtors (2009)

• In Re: Lake Michigan Beach Pottawattamie Resort LLC (2016)

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Michigan’s Non-Recourse Mortgage Loan Act [2012 Public Act 67]

• Passed through the Michigan Legislature in record time. • Characterizes inclusion or enforcement of a post-

closing solvency covenant as an unfair trade practice. • Prohibits a post-closing solvency covenant from being

used as a non-recourse carve out. • Applies statue retroactively. • Constitutionality of the Non-Recourse Mortgage Loan

Act is now beyond doubt.

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“What good is an allegedly “nonrecourse” obligation, if it is only nonrecourse until default? In other words, as long as the borrower is paying, the borrower is not liable for the debt; but as soon as the borrower stops paying, the borrower and the guarantor are liable. This is like a roof that keeps the house dry, except when it rains…

Dan Schechter, Professor of Law at Loyola Law School, Los Angeles, California in 2012 Comm. Fin. News. 4. – 1/9/2012

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RECENT TRENDS IN NON-RECOURSE CARVE OUTS

James H. Schwarz, Esq. Partner

Benesch Friedlander Coplan &

Aronoff LLP

Indianapolis, IN

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• Non-recourse loan is a secured loan that allows lenders to attach only to the collateral, and not the borrower’s personal assets, if not repaid.

• It behooves the lawyer to see what constitutes the Mortgaged Property.

• If a secured loan is entered into by a special purpose entity, by its very nature it is a non-recourse loan.

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• Borrower expects to be able to walk away from the loan the Mortgaged Property is foreclosed upon.

• Lender needs a way to keep the “deep pocket” principal of the Borrower interested if the Mortgaged Property is falling in value so that the Lender can obtain possession of the Mortgaged Property in a quick and cost efficient manner with no interference by the Borrower if an Event of Default exists.

• The solution is to have the “deep pocket” principal enter into a Non-Recourse Carve-Out Guaranty.

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• The “Fatal Four” which cause full recourse springing liability to a Guarantor:

1. Voluntary bankruptcy filing

2. Involuntary Bankruptcy caused by collusion between Borrower and unsecured creditors

3. Entry into additional indebtedness

4. Making of prohibited transfers

• Failure to maintain Special Purpose Entity Status-Should this impose full recourse liability if “no harm no foul”? Is the test a determination by a court that the assets should be consolidated with an entity that did become bankrupt?

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Liability limited to actual loss suffered by the Lender for certain “bad boy” acts:

1. Fraud or material misrepresentation

2. Gross negligence or willful misconduct of Borrower

3. Breach of environmental indemnification

4. Misapplication of insurance proceeds or condemnation awards

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5. Misapplication of Rents following an Event of Default

6. Misapplication of Security Deposits

7. Physical waste intentionally caused by Borrower

8. Borrower unsuccessfully setting forth a defense following a monetary Event of Default

9. Reimbursement of Enforcement Costs and Expenses incurred by Lender prior to delivery of possession

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Drafting Considerations

1. Don’t negotiate the carve-outs in the Loan Documents. Make sure that they are spelled out in the term sheet.

2. The Guaranty should terminate not when Guaranteed Obligations are fully satisfied but when Loan has been fully paid or fully defeased or when foreclosure has been completed.

3. Make sure any Distributions to Members are not subject to claims for “recapture”. Only time when Distributions are at risk should be when Lender has provided written notice to the Borrower than an Event of Default exists.

4. As to be discussed, watch out for any language which requires an obligation to maintain adequate capital or not to become insolvent in the loan covenants.

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Case Study

• New Market Center (Borrower) is a special purpose entity.

• Doe & Roe are members and guarantors.

• New Market Center operates a 60,000 square foot shopping center near a large regional mall.

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Case Study

• New Market Center borrowed $5.5 million with interest at 7% for 10 years.

• Loan matured December 31, 2011.

• Principal balance was $4.8 million at maturity.

• Non-recourse, except for “bad boy” carve outs.

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Case Study

• Loan has hyper-amortization feature which extends maturity for 20 years with interest at 11% p.a. and a “hard” cash trap.

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Case Study

• Guaranty was intended to be limited to “bad boy” carve outs.

• However, the following language appears at the end of the Guaranty: “Guarantor shall be liable for any deficiencies in the event the full amount of the indebtedness owing under the loan documents is not received by the lender after the receipt of all payments or foreclosure of the mortgage.”

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Case Study

• Anchor tenant Short Circuit closed all stores nationally, filed bankruptcy, and left the center at the end of 2009.

• Borrower attempted to re-lease the store to new tenants, but the servicer refused to approve the proposed tenants.

• This resulted in several co-tenancy defaults, all of which impaired cash flow. Guarantors have made up the difference to a point.

• Servicer also refused to allow use of a $480,000 leasing reserve escrow to finance improvements proposed for the new tenants.

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Case Study

• Finally, the Guarantors said “enough is enough” and stopped their capital contributions to the project.

• Lender has referred the loan to a special servicer.

• Special servicer has declared a default, and has sent demand letters to borrower and guarantors.

• General credit conditions do not allow refinancing at this time.

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Case Study

• Special servicer has obtained an appraisal of the shopping center that sets the value at $2.8 million dollars.

• Special servicer has commenced a foreclosure action and scheduled a non-judicial sale.

• Special servicer has indicated it will use the $2.8 million dollar appraisal figure as its bid at the non-judicial sale.

• Special servicer has advised guarantors that it will seek to collect the remaining $2 million dollars from them under their guaranty.

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BANKRUPTCY PERSPECTIVE – POSSIBILITIES AND OPTIONS

Thomas W. Coffey, Esq. Chair, Bankruptcy Group

Tucker Ellis LLP

Cleveland, Ohio

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1. Best Case

Conclude a successful plan of reorganization whereby the remaining first mortgage debt is amortized over the remaining 20 year “hyper amortization” period, but at a (lower) current market interest rate.

2. Worst Case

Provide for an orderly liquidation in bankruptcy, thus avoiding a distress sale at foreclosure. A liquidation in bankruptcy will (in theory) provide for better market exposure and a disposition under better conditions, yielding a higher sales price (and a lower deficiency claim against the guarantors).

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3. Benefits

a) Stops a foreclosure sale – the borrower gains time to re-tenant and refinance the property.

b) Gives the borrower more control over the future of the property.

c) Postpones the establishment of a deficiency against the guarantors. This may be helpful in a recovering market.

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4. Impediments to Reorganization

a) The “bankruptcy remote” provisions in the borrower’s organizational documents.

b) Relatively few creditors/lack of an “impaired accepting class” of creditors who are not insiders.

c) Single Asset Real Estate provisions in the Code require certain payments or a plan of reorganization promptly, upon pain of stay relief.

d) “Bad Faith Filing” issues (not subjective bad faith, but characterization of case as dispute with a single creditor) provide an avenue for the lender to seek dismissal of the case.

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Discussion

1. Remediating Defaults

2. Interpretation of the loan documents

3. Cooperation with the lender

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Discussion

4. Pre-negotiation agreements

5. Leasing

6. Transfers

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Discussion

7. Distributions

8. Deficiency Judgment

9. Options for Resolution

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Best Course of Action

a. Settlement/Extension?

b. Foreclosure/Litigation?

c. Bankruptcy?

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Possible Solutions

a) Standing: Determine if the REMIC Trustee “holds” the original promissory note and guaranty. The borrower does not want to pay twice!

b) Amend organizational documents. c) Find a class, even if small, of creditors other than the lender. d) Make payment of interest or file a plan in accordance with Section

362(d)(3). e) Move quickly and seize the upper hand with a fast plan and

disclosure statement. f) Obtain a pre-petition loan to: i. Create a small but independent “impaired accepting class.” ii. Fund shortfall in cash flow to pay interest due the

mortgagee during the Chapter 11 proceeding.

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Possible Solutions

g) Obtain control of Leasing Reserve Escrow. h) Consider possible court intervention in leasing process to

obtain approval of leases. i) “Term out” existing indebtedness over 20-year “hyper

amortization” period. j) Reduce the interest rate to a (lower) market rate

• Resulting reduction in debt service/increase in cash flow. k) Right to prepay at any time without penalty or premium. l) Negotiated resolution of guaranty issues.

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Possible Solutions

m) Negotiated resolution of default interest, late fees, attorneys’ fees, and other amounts.

n) Reinstatement of the loan. o) Mutual covenant not to sue – a fresh start. p) No adverse tax consequences. q) Preservation of the borrower’s ability to file a second

bankruptcy.

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Bring the Mortgagee to the Table

a) “Cram down” will be objectionable to the mortgagee. b) Dismissal or conversion is very objectionable to the Debtor. c) A wide range of middle ground exists between these two

extremes. d) A consensual plan affords certainty and is appreciated by the

Court. e) Avoiding the cram down fight is so beneficial that it has been

described as the “settlement imperative.”

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Pro-Forma Market Center

Pre-Bankruptcy Post-Bankruptcy Difference

Income $ 280,476 1 $ 580,000 2 $ 299,524

Expenses $ (161,644) $ (161,644) $ -0- NOI $ 118,832 $ 418,356 $ 299,524 Interest $ (350,000) (@7%) $ (294,788) (@5.9%) $ (55,212) Principal $ (121,965) $ (61,784) $ (60,181) Repair and TI Escrows $ (51,180) $ (61,784) $ 10,604 Net $ (404,313) $ -0- $ 404,313

1 Includes Shoe Circus at reduced rent due to failure of co-tenency. Excludes Old Army (expired).

2 Includes Shoe Circus at full rent, new Old Army lease, and new Betty Ann lease.

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Economic Summary

• Borrower keeps the Center;

• Cash flow increases by over $400,000;

• The value increases by $2.9 Million from $2.8 to approximately $5.7 Million; and

• The Guarantors avoid all liability

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Conclusion

•Practice tips

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Jim Schwarz

• Don’t negotiate the carve-outs in the Loan Documents. Make sure that they are spelled out in the term sheet.

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Daniel K. Wright, II

• Get releases upon a deed in lieu.

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Tom Coffey

• Do not do anything that makes anyone else the master of your

destiny.

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QUESTIONS?

Thank you!

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