Last month, Federal District Court Judge Milton I. Shadur (a long-time Federal Judge and something of a legal legend in Illinois) held a guarantor liable for a deficiency claim brought in connection with a Georgia foreclosure – notwithstanding the fact that the deficiency could not be pursued under Georgia law. The case – Inland Mortgage Capital Corporation v. Chivas Retail Partners, LLC, et. al., Case No. 1:11-CV-06482 (N.D. Ill. 2012) – arose in connection with a defaulted construction loan relating to a retail shopping center outside of Atlanta and is the latest in a series of decisions shaping the legal landscape for guarantors of real estate loans.
As I discussed last spring, this year has seen a series of attention-grabbing decisions as lenders sharpen their pencils when looking to enforce guaranties in defaulted deals. Foremost among these cases were two Michigan decisions (Wells Fargo Bank, NA v. Cherryland Mall and 51382 Gratiot Avenue Holdings v. Chesterfield Dev. Co.) that found recourse liability based on the failure of a borrower to comply with SPE capitalization covenants. These were scary decisions for lots of property owners, and resulted, in some states, in hastily passed legislation aimed at keeping nonrecourse loans nonrecourse (see this piece on Michigan’s “Nonrecourse Mortgage Loan Act”).
While the Inland case has received less attention, it nonetheless reinforces the central lesson of Cherryland – be very sure of what you are promising when borrowing money. The litany of boilerplate waivers contained in these guaranties often goes un-remarked upon when deals are negotiated – from time to time I recall good borrowers’ counsel commenting on waivers of notice (I’ve caved on this one – I’ve always found it difficult to defend asking someone to waive a defense to payment based on the premise that I’ve failed to notify them of how much to pay). In Inland, the lender had auctioned the property after default, taking title after winning with a credit bid of $7 million (in Georgia, foreclosure is customarily accomplished through non-judicial power of sale). The $7 million auction price was substantially short of the principal balance of debt (something like $63,000,000 short), leaving the lender with a significant deficiency (which was guaranteed by the guarantors).
Deficiency judgments are tricky business, however, in non-judicial jurisdictions, as statutory schemes and judges are wary of hastily auctioned properties that are sold at depressed prices – with the borrower left to pick up the tab. In Georgia, for instance, the deficiency (the difference between the auction price and the OPB) can only be obtained if a court confirms that all notices and other pre-requisites were followed and that the price reflects the “true value of the property." The lender was unable to meet its burden before a Georgia court to show that the true value of the property had been obtained – and therefore, under Georgia law, a deficiency claim was disallowed.
Boilerplate waivers are similarly tricky business, however. Let’s move 800 miles or so north to Illinois, the locus of law that governed the guaranty in question. Here, Judge Shadur held the guarantor liable for the disallowed Georgia deficiency based on two waivers included in the text of the guaranty. Specifically, the guarantors had agreed to pay any post-sale deficiency even if lender had lost its rights to collect from the borrower. Further, the guarantors had specifically waived the statutory provision by which Georgia courts approve foreclosure sales (leading to Judge Shadur’s query as to why the lender had bothered to pursue a deficiency claim in Georgia at all).
The experience of the credit crunch has had a significant impact on the role of guaranties in real estate lending. Lenders have toughened their stances with respect to the need for a pocket to reach into in the event of misbehavior. Borrowers have sought relief from guaranties in the event that they lose control of the property to mezzanine lenders. Cherryland led to almost immediate attempts by borrowers to limit recourse in the event that SPE covenants are breached. I would expect the Inland decision to similarly result in an increased level of scrutiny afforded the boilerplate waivers contained in guaranties.
By: Matthew Clark