Bad Boys and Bad Acts
As part of our Commercial Real Estate Finance and Option Practice we see a wide variety of loan documents. In the past, we have written about various ways in which non-recourse loans (i.e., loans for which the borrower does not have personal liability) quickly slip into full recourse loans (i.e., a loan in which the borrower fully guarantees its repayment). See full piece here. This has been, and continues to be a great concern, as borrowers who make the calculated decision to seek out non-recourse loans do so for good reason and typically pay more for them through higher interest rates and satisfying other underwriting criteria.
By way of a quick overview – even with a “non-recourse” loan, however, lenders will often have some form of recourse beyond the primary real estate that serves as the main collateral for the loan in cases where borrowers are behaving badly. And to accomplish this, lenders often require that a principal party (or parties) guarantee so-called “bad acts” through a non-recourse carve-out guarantee, referred to colloquially as a “bad boy guaranty”. In this article, we focus on the ways in which lenders are creatively continue to expand the scope of the carve-outs to allow for not only the “bad acts” of the borrower and guarantor, but also acts of any other parties as a way to expand the personal liability of the non-recourse guarantor.
As a general principal, “bad boy” liability should only arise when one acts badly. Seems straight forward enough. Bad acts can include, by way of example, fraud or misrepresentation, misappropriation of funds, or physical waste to the property. The question, however, is the actors that can give rise to this liability. Is it the borrower (which could be an entity), the guarantor itself or can it be anyone acting on behalf the borrower or guarantor – even without the knowledge of the guarantor.
To that end, recently, we have seen bad boy guaranties broadly written to include a long laundry list of other parties including, principals, directors, officers, employees, beneficiaries, shareholders, partners, members, trustees, agents or affiliates of borrower or any affiliate of any of the foregoing, or any successors or assigns of any of the foregoing. Doing so casts the net so wide, it cannot be said with any certainty how far-reaching liability could extend.
At some level, expanding the carve-outs for which a guarantor will have liability under a non-recourse loan to include the acts of parties other than the borrower or itself (even for bad acts) becomes contrary to the underlying concept of the non-recourse loan.
Lenders often counter that the borrower should have control over “their people” and not hire bad actors, but that is beside the point and should not result in personal liability for the guarantors. The broader the carve-outs in the bad boy guaranty, the more likely it is that a non-recourse loan is one in name only. And, in our view, acts by third parties should not trigger any liability under a non-recourse loan. And, if they, are, then the guarantors will likely want to put mechanisms in place to control how those other actors behave – lest the guarantor risk the expanded liability.
Bad boy guaranties should be closely reviewed prior to executing at closing. We routinely review and negotiate loan documents, and can advise parties regarding which “bad acts” should trigger liability under a non-recourse loan and propose middle-ground positions to narrow the scope of the recourse carve-outs. For more information as to how we can be of service, please call (480) 889-8948, send an email to firstname.lastname@example.org or visit www.SteinLawPLC.com.