Michigan became the focus of national attention in the world of commercial real estate finance in December, when the Michigan Court of Appeals and the federal district court for the Eastern District of Michigan each determined that lenders could pursue remedies against borrowers and guarantors of loans when the borrowerproperty owners became insolvent and failed to make required loan payments, notwithstanding the fact that the loans were styled as nonrecourse obligations. The decisions, Wells Fargo Bank NA v. Cherryland Mall Limited Partnership, (Case No. 304682, Michigan Court of Appeals, currently on appeal to the Supreme Court of Michigan) ("Cherryland Mall") and 51382 Gratiot Avenue Holdings, LLC v. Chesterfield Development Co., LLC (Case No. 2:11-CV-12047, E.D. Mich) ("Chesterfield") caused consternation both in lending circles and among borrowers because the courts' interpretations of the loan documents would have created potential liability for borrowers and guarantors of virtually all commercial mortgage-backed securitization ("CMBS") loans, when those loans had been marketed as "nonrecourse" obligations that would not result in personal liability for borrowers and guarantors except for certain limited "bad boy acts" such as fraud, misappropriation of rents, waste on the property, or similar issues.
The decisions had been characterized as "disastrous" and "terrifying" by industry observers, as more than an estimated $1 billion of loans in Michigan could have been affected by the decisions, with many more dollars at stake if courts across the country adopted the Michigan courts' rationale. At the same time, many market commentators noted, as each of the court's opinions did, that the language in the loan documents, which was largely standardized for loans of this kind, clearly indicated that insolvency of the borrower violated "single purpose entity" covenants contained in the loan documents, and that such violations were a trigger for recourse against the borrower and guarantors of the loans.
The legislative solution, the Nonrecourse Mortgage Loan Act, signed into law by Governor Snyder on March 29, 2012, specifically prohibits lenders from using insolvency of the borrower as a basis for any claim against such borrower or guarantor in the context of nonrecourse commercial real estate loans. The legislation recognizes that "it is inherent in a nonrecourse loan that the lender takes the risk of a borrower's insolvency" and "the parties do not intend that the borrower is personally liable for payment of a nonrecourse loan." The law states in its enacting language that using insolvency as a nonrecourse carveout "is inconsistent with ... the nature of a nonrecourse loan; is an unfair and deceptive business practice and against public policy; and should not be enforced."
The Act applies to the enforcement and interpretation of all nonrecourse loan documents in existence now or which will be entered into in the future under Michigan law. Challenges to the statute on constitutional grounds are expected, so it may be some time before the controversy is fully resolved.
Even with the passage of this new law, lenders and borrowers alike should carefully negotiate the carve-out provisions in loan documents. As the Cherryland Mall court noted, "it is not the job of this Court to save litigants from their bad bargains or their failure to read and understand the terms of a contract."
The Cherryland Mall and Chesterfield decisions represented a substantial departure from the perceived structure and meaning of non-recourse debt, and therefore drew a dramatic legislative response - a response that itself may be subject to further challenges. Rigorous enforcement of other nonrecourse carveouts is a certainty in today's market, and it is in the best interest of both borrower and lenders to assure that the allocation of risk between the parties is clearly understood and negotiated when necessary.
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