A few weeks ago Crunched Credit previewed a (now enacted) bit of Michigan legislation entitled the “Nonrecourse Mortgage Loan Act”, which, in fewer than 800 words, seeks to ringfence recourse guarantors’ assets from attack in connection with the enforcement of post-closing solvency covenants. The legislation was signed by Governor Rick Snyder in the wake of two controversial Michigan decisions regarding the non-recourse nature of mortgage loans. The Cherryland/Chesterfield decisions garnered two opposing, but equally reasonable, reactions amongst industry folk. The first saw the claim for deficiency as mere sophistry – the enforcement of a loan that was non-recourse only to the extent it was repaid (i.e. “that can’t possibly mean what it says”). The second saw a simple contract case – the imposition of contractual recourse liability for violation of SPE covenants pursuant to contracts that imposed recourse liability for violations of SPE covenants (i.e. “words matter”). A majority of Great Lakes State politicians apparently find themselves in the first camp. This Bay Stater tends to find himself in the second.

Michigan is not alone in its efforts to protect recourse guarantors from their obligations under bad boy guaranties. The least furtive (and most, well, obnoxious) attempt by State politicians to shield their constituents from liabilities under recourse guaranties recently emerged in Georgia. In late February, the Georgia State Senate unanimously passed the “Small Business Borrower Protection Act", a bill targeting carpet-bagging distressed-debt investors in Georgian real estate loans. The bill sought to limit recovery under bad boy guaranties to the amount paid for the loan plus accrued interest from the date of purchase; effectively eliminating any economic incentive for distressed-debt investment in the State.

The history here harkens to Georgian banks and borrowers alike being particularly hard hit by loan sales conducted by the FDIC after taking receivership of regional banks. Many Georgian bankers were unhappy because they, too, owned positions in many of the loans that were being auctioned. The FDIC’s sale set a market value for these positions that, we can only assume, landed well short of the lenders’ internal marks. Borrowers were unhappy as the distressed-debt investors sought to resolve the loans to their favor Cap’m Charlie Croker-style.

Common reaction from the real estate industry to the proposed legislation was visceral. As a result, in March, the Georgia House Banking Committee devised a watered-down proposal – limiting the scope of the bill to loans purchased from federal bank regulators and by non-bank investors. Ultimately, the revised bill never met with a vote and died on the floor at the end of the legislative session.

In each of these cases, the legislation was retroactive in effect, a concept that raises questions both of constitutionality and policy; should a State legislature be overriding the effect of privately negotiated contracts among sophisticated parties with tersely-written, quickly-enacted laws? This conversation is only beginning: $700 billion is coming due in the next 24 months and the first piece of paper lenders look at upon maturity default is the bad boy guaranty. And words matter.

By: Matthew Clark with Dave Pildis