BAD BOY GUARANTEES

Ok I know we don’t need to worry about Guarantees…………………………

NON-RECOURSE DEBT – BAD BOY GUARANTEES AND DRAFTING CONSIDERATIONS

I have had occasion in the recent “recovery” to advise a number of clients regarding debt and equity for new acquisitions and development.  These have included negotiating the scope and definition of “bad boy carve outs” in loan documents and LLC operating agreements where individual joint venture partners agree to guarantee future LLC debt with customary “bad boy carve-outs.”  Most of our clients have been thrilled to obtain the low rate non-recourse debt even if required to provide a “bad boy” guarantee; after all, they have no intention of committing the “bad boy” acts.

However, a Michigan Court rocked our comfortable “ bad boy” world in Wells Fargo Bank, N.A. v. Cherryland Mall, L.P., et al. (2011 Mich.App. LEXIS 2360).  In a badly decided case, later fixed by legislation, the Cherryland Court in effect made all non-recourse loans with bad boy guarantees recourse to the guarantor(s) by finding that the bad boy guarantor’s failure to keep the single-purpose entity solvent was a bad boy event triggering personal liability.  Needless to say, the Cherryland decision caused a lot of consternation in the industry.

Cutting to the bottom line, if you are required to guarantee non-recourse debt with the customary “bad boy” carve-outs, the following language, will eliminate any “Cherryland” problems (obviously check the definitions/section references in your document):

“The carve outs/exceptions to non-recourse nature of the subject loan, are to be construed narrowly in favor of the guarantor(s).  Neither the Borrower nor the subject Guarantor(s) are required to contribute any additional capital to the borrower, to maintain its solvency or take any other affirmative action with respect to the Borrower or the conduct of its business.  Guarantor(s)’s liability under this section is limited to direct violations of the express bad boy acts/carve-outs set forth herein.”

Sophisticated lenders will not object to my Cherryland fix, although they may not agree to my proposed “construed narrowly” and “limited to direct violation” try fors.

The bottom line when agreeing to “bad boy” carve-outs is to make sure your liability is limited to your contributed capital and true bad acts by you which are under your control – remember 2008? An ounce of prevention is truly worth a pound of cure with respect to guarantees.  Gregory N. Weiler is a partner in Palmieri’s Real Estate Practice Group.