By: Lance T. Denha, Esq.
The current downslide in the commercial real estate market has led some borrowers of commercial mortgage-backed securities loans (CMBS) into delinquency, which, in the case of some borrowers with non-recourse loans, can trigger full-recourse provisions to guarantors under what was thought to be non-recourse guaranties. Put another way, imagine being surprised with a personal guarantee on a deal you never signed a personal guarantee for!
To gain an understanding of the difference between recourse and non-recourse loans, the essential difference between a recourse and non-recourse loan has to do with which assets a lender is able to pursue should the borrower fail to repay the loan. Borrowers will typically always favor non-recourse loans while lenders prefer recourse loans. In a recourse loan, lenders can pursue a borrower’s other assets or file lawsuits to have the borrower’s wages garnished should any money remain unpaid after a lender exercises collection efforts or is still owed to the lender after the collateral is seized after a borrower’s default. In a non-recourse loan, the lender does not have the ability to pursue the borrower for any personal assets after any seizure of the collateral or if collection efforts yield an amount less than that owed.
Recently, Michigan law was turned upside down in a case involving Wells Fargo Bank, NA v. Cherryland Mall Limited Partnership, No. 304682 (Mich. Ct. App. Dec. 27, 2011). In this case, a lender was allowed to foreclose on a defaulted non-recourse CMBS mortgage loan and then also recover a deficiency (the excess of the debt over the foreclosure sale price of the property) from the borrower merely because the borrower failed to maintain solvency. What does solvency mean in this case? If the collateral experiences a market decline in value to an amount less than the amount owing on the loan then this “insolvency” event triggers a default. How did this result occur? The document literally provided for this event. Needless to say, many in the real estate community panicked and for good cause.
Immediately following this decision, the Michigan Legislature wasted no time in adopting Michigan’s “Nonrecourse Mortgage Loan Act” in an effort to counter the decision rendered in the Cherryland case.
A summary provided by Legislative Analyst Patrick Affholter on the Michigan Senate’s web site summarizes the Nonrecourse Mortgage Loan Act as follows:
• Prohibit a post closing solvency covenant from being used as a nonrecourse carveout or as a basis for any claim against a borrower, guarantor, or other surety on a nonrecourse loan.
• Specify that a noncompliant provision in loan documents would be invalid.
• Specify that the Act would not prohibit a loan secured by a mortgage from being fully recourse to the borrower or guarantor, if the loan documents did not contain nonrecourse provisions.
“Nonrecourse loan” would mean a commercial loan secured by a mortgage on real property located in Michigan and evidenced by loan documents that do any of the following:
• Provide that the lender will not enforce the liability or obligation of the borrower by an action or proceeding in which a money judgment is sought against the borrower.
• Provide that any judgment in any action or proceeding on the loan is enforceable against the borrower only to the extent of the borrower’s interest in the mortgaged property and other collateral security given for the loan.
• Provide that the lender will not seek a deficiency judgment against the borrower.
• Provide that there is no recourse against the borrower personally for the loan.
• Include any combination of those provisions or any other provisions to the effect that the loan is without personal liability to the borrower beyond the borrower’s interest in the mortgaged property and other collateral security given for the loan.
It is widely expected that the lender in Cherryland Mall plans to challenge the constitutionality of the new law as this is an ongoing issue that has yet to be fully resolved. Stay tuned.