In a much-followed action, Michigan Gov. Rick Snyder recently
signed into law the Nonrecourse Mortgage Loan Act, MCL Sec.
445.1591, et seq., which seeks to overturn two Michigan court
decisions that interpreted and applied certain special purpose
entity (SPE) and nonrecourse "carve-out" loan provisions
in a manner that appeared to favor lenders and was outside of the
expectations of commercial borrowers.
The Act states, in pertinent part, that:
(1) A post closing solvency covenant shall not be used, directly
or indirectly, as a non-recourse carve-out or as the basis for any
claim or action against a borrower or any guarantor or other surety
on a non-recourse loan, and
(2) A provision in the documents for a non-recourse loan that
does not comply with subsection (1) is invalid and
MCL Sec. 445.1593. The Act became effective March 29, 2012.
The reason for the Act was to overturn two Michigan court
decisions (colloquially known as the Cherryland/Chesterfield cases)
that were a point of consternation for all sides of the real estate
industry since they were decided last December. The result of those
cases was to convert what most lenders and borrowers understood as
a "bad-boy" carveout guaranty into a full recourse
guaranty any time that an SPE became insolvent – despite
the fact that the borrowers/guarantors did not engage in any
malfeasance, or take any act to cause the insolvency, seek
bankruptcy protection, or otherwise hinder or delay the
lender's remedies against the property (i.e., no "bad
acts" occurred). The borrower's cash flow troubles and
underwater property were simply the result of the troubled real
estate market and steeply declining values.
These case rulings hinged on the language in two key loan
provisions: (i) the non-recourse carve-out section, which created a
recourse event if the borrower failed to comply with the SPE
provisions of the mortgage; and (ii) the SPE section itself, which
had as one of its compliance obligations that the borrower
"shall not become insolvent or fail to pay its debts and
liabilities from its assets as the same shall become due."
Based on the "unambiguous" language of the mortgage, the
courts determined that when the borrower became insolvent (i.e.,
when the mortgage debt exceeded the value of borrower's assets
and/or when the borrower failed to pay its debt when due by
defaulting on the mortgage loan), the recourse provisions were
triggered because of the breach of the SPE covenant. Thus, the
borrower and, most importantly, the guarantor, were liable for the
full mortgage debt.
The court rulings appeared to be a stroke of good fortune for
lenders and dreadful news for borrowers and guarantors of mortgage
loans in the CMBS market – while the Act appears to be
the opposite, by restoring the generally understood parameters of
nonrecourse carveouts to a standard familiar to borrowers and
Despite the passage of the Act, the rulings in the
Cherryland/Chesterfield cases may well continue to have impact, and
it remains to be seen which side of the lender-borrower equation
will truly benefit over the long run. As noted by a variety of
sources, the effects felt from the Cherryland/Chesterfield
decisions may include:
Encouraging bankruptcy filings by borrowers and guarantors and
contested foreclosures because some guarantors (almost invariably
the principals or parent company of the borrower) will have nothing
to lose if they are already full recourse obligors.
Intertwining the borrower with its guarantor to such an extent
that the argument for substantive consolidation of the borrower
with a guarantor is more likely, thus defeating the purpose of
having an SPE borrower in the first place.
Calling into question the value and accuracy of tightly
reasoned non-consolidation opinions given over the years.
Raising the specter of lenders reopening old foreclosed
transactions against guarantors previously considered
"safe," which in turn has implications for lenders of
subsequent loans that were counting on such guarantors' net
worth and liquidity.
Raising accounting concerns and a possible rethinking of
reporting requirements on guarantors' balance sheets and
financial statements as probable liabilities.
Stay tuned, as this story is not likely to be over. The
possibility of a successful court challenge to the Act on
constitutional grounds still exists (because of its retroactive
effect and its interference with contract). And there is some
political spice in the mix here as well, as the brother of the
Michigan GOP chairman was a Cherryland guarantor who was the first
beneficiary of the Act.
This article is presented for informational purposes only
and is not intended to constitute legal advice.
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