United States: "Bad Boy Guarantees" May Cause Nonrecourse Loans To Be Treated As Recourse For Tax Purposes

In a recent IRS Memorandum from the Office of the Chief Counsel (ILM 201606027, the "Memorandum"), the IRS concluded that common "bad boy guarantees" may cause otherwise nonrecourse loans to be treated as recourse loans for tax purposes. Such treatment may prevent non-guarantor investors in real estate development and other partnerships from being allocated losses in excess of their invested capital that they otherwise would have expected and could, if retroactively applied, result in adverse tax consequences to such investors. 1

A partner's tax basis in a partnership interest includes the partner's share of partnership liabilities, and the partner's share of partnership losses includes its allocable share of deductions attributable to such liabilities.2 A partner's share of partnership liabilities for these purposes depends in large measure on whether the liabilities are treated as recourse (i.e., where one or more partners bear the economic risk of loss through a guaranty or otherwise) or nonrecourse for such purposes. Tax basis and losses attributable to recourse liabilities generally are allocated to the partners who bear the associated economic risk of loss, while such basis and losses attributable to nonrecourse liabilities generally are allocated among the partners in proportion to the partners' invested capital or interests in profits.

Example: X and Y contribute $9 million and $1 million, respectively, to a partnership. The partnership borrows an additional $40 million and acquires a depreciable asset for $50 million. If the liability is nonrecourse, then X typically would be allocated 90% of all partnership losses. However, if Y (and not X) is treated as bearing the economic risk of loss with respect to the liability, then X would be allocated 90% of the first $10 million of losses, but Y would be allocated all losses in excess of $10 million.

The Memorandum presents a possible change in the IRS's thinking about the impact of bad boy clauses on a loan's character as a nonrecourse liability. Under applicable regulations, if a partner's obligation is subject to contingencies that make it so unlikely that the obligation will ever be discharged, then the obligation is disregarded and the loan is effectively treated as nonrecourse debt. Historically, taxpayers have treated otherwise nonrecourse loans as nonrecourse for basis and loss allocation purposes even if there was a bad boy guarantee (e.g., guarantees typically given by a developer and certain others which provide for personal liability against the borrower, a guarantor or both upon the occurrence of certain enumerated "bad" acts). This was based on the view that the events creating liability under customary bad boy guarantees were contingent obligations that were so unlikely to occur that they should be disregarded when determining who bore the economic risk of loss.

In the Memorandum, the IRS disagrees with the view that certain customary bad boy events were "not so unlikely to occur" as to be disregarded. Therefore, the IRS concludes that the guaranteeing partner bore the risk of loss and should be allocated the entire basis from the debt.3 The events triggering recourse under the facts of the Memorandum were:

  1. "the co-borrowers fail to obtain the lender's consent before obtaining subordinate financing or transfer of the secured property,
  2. any co-borrower files a voluntary bankruptcy petition,
  3. any person in control of any co-borrower files an involuntary bankruptcy petition against a co-borrower,
  4. any person in control of any co-borrower solicits other creditors to file an involuntary bankruptcy petition against a co-borrower,
  5. any co-borrower consents to or otherwise acquiesces or joins in an involuntary bankruptcy or insolvency proceeding,
  6. any person in control of any co-borrower consents to the appointment of a receiver or custodian of assets, or
  7. any co-borrower makes an assignment for the benefit of creditors, or admits in writing or in any legal proceeding that it is insolvent or unable to pay its debts as they come due."

The Memorandum also concludes that the right of the guaranteeing partner to effectively seek reimbursement from the other partners is not sufficient to make the non-guaranteeing partners personally liable with respect to the obligation such that they would be deemed to bear some of the economic risk of loss with respect to the debt, because the other partners could have their ownership interests diluted in lieu of providing cash reimbursement to the guarantor partner and thus their contribution obligations were not fixed. However, if a reimbursement obligation of the non-guarantor partners is fixed and not optional (unlike the facts in the Memorandum, as interpreted by the IRS), then the liability should be treated as recourse to each partner to the extent of the reimbursement obligation.4

The Memorandum is an informal document which does not have the force of law and is not precedential. However, it may be reflective of the IRS's current position on this issue. The Memorandum has been highly criticized by the tax community, and we understand that members of the tax community have engaged the IRS in discussions on this matter. At this time, we expect that transactions will go forward as in the past as we await further guidance from the IRS. However anyone contemplating (or who already has) a structure with bad boy guarantees should be aware of this potential issue.


1  References to partnerships and their partners include limited liability companies (and other entities) treated as partnerships for tax purposes and their members.

2  Deductions generally are attributable to partnership liabilities to the extent of net losses in excess of the partners' invested capital.

3  The Memorandum's analysis was premised on accepting the taxpayer's contention that the guarantor would be liable for repayment only if one of the enumerated bad acts were to occur. However, the Memorandum notes that in its view the guarantor was liable for repayment in all events even if one of the enumerated events did not occur.

4  The IRS has issued proposed regulations that set forth certain net worth and other requirements for a guaranty or reimbursement obligation to be given effect in determining who bears the economic risk of loss..

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Similar Articles
Relevancy Powered by MondaqAI
McDermott Will & Emery
Lowndes, Drosdick, Doster, Kantor & Reed, P.A.
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
McDermott Will & Emery
Lowndes, Drosdick, Doster, Kantor & Reed, P.A.
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions