Earlier this month, the New York Supreme Court issued a decision upholding the enforceability of a springing recourse guaranty given in connection with a commercial real estate loan that provided for a full "blow-up" upon voluntary bankruptcy. [Author's Note: the decision can still be appealed: New Yorkers tend to call their trial court the "Supreme Court", their supreme court the "Court of Appeals", their front steps the "Stoop" and their minor league team the "Mets".] Most of our readers are, at this point, intimately familiar with the "bad boy" guaranty and the leverage it provides a lender once the loan hits the fan. Conversely, our readers are also keenly aware of the degree to which sponsors were able to erode the scope of recourse carve outs and isolate liability in poorly capitalized shell entities during the go-go years. The most famous example, of course, being GGP’s ability to run an end-around the bad boy guaranty by filing borrowers and gurantors alike into bankruptcy in 2009 – leaving the holders of $ billions of CMBS paper without practical recourse.
Still, the bad boy guaranty (together with amendments to the Bankruptcy Code rendering single-asset bankruptcies less attractive to borrowers) did, in fact, work to reduce the number of bankruptcy filings during this most recent downturn and provided lenders with a measure of dry powder when seated at the negotiating table. A warm-body guarantor is often thought of as the gold-standard of behavior modification – no one wants to explain to their children how their college fund was paid over to a CMBS trust. Of course, a high-net worth entity can be equally as effective – so long as its assets extend beyond the subject real estate. Lenders’ confidence should be bolstered by the recent Empire State decision, which is in line with the majority of legal precedent on this issue:
● Blue Hills Office Park LLC v. J.P. Morgan Chase Bank - Massachusetts court applies plain language of guaranty to uphold claim arising from misapplication of settlement proceeds;
● CSFB 2001-C-4 Princeton Park Corporate Center, LLC v. SB Rental I, LLC – New Jersey court rejects argument that recourse guaranty constituted an unenforceable liquidated damages provision;
● GCCFC 2006-GG7 Westheimer Mall, LLC v. Edward H. Okun - New York court finds guarantor liable for full amount of the loan after voluntary bankruptcy petition; and
● Diamond Point Plaza L.P. v. Wells Fargo Bank, N.A. – Maryland court holds guarantor responsible for full amount of loan after misapplication of rents and failure to maintain SPE status.
Recent vintage loans are, generally, including expanded carve-outs that are supported by stronger credit (indeed, the CREFC model representations and warranties include a specific representation on the presence of a recourse guaranty). Moreover, there has been a significant push by 2.0 issuers and rating agencies to require foreclosing mezzanine lenders to provide a substitute guaranty from credit-worthy entities - in some cases, that meet objective asset and shareholder equity thresholds - as a condition precedent to foreclosure (whether or not the existing guarantor is released).
Alternatively, sophisticated borrowers – themselves weary from the battles of the past half-decade – are now insisting that mortgage loan guaranties burn-off after they’ve been removed from control as a result of mezz foreclosure. Telling the kiddies that the tuition is gone because your mezz lender filed the property into bankruptcy is a different conversation altogether.
By Matthew Clark