In a decision issued on February 3, 2015, the United States Court of Appeals for the Sixth Circuit affirmed the dismissal of a complaint challenging the validity of Michigan’s Nonrecourse Mortgage Loan Act, M.C.L. § 445.1591, et seq. (the “NMLA” or the “Act”). In doing so, the court rejected claims that the NMLA violated the contract clause, substantive due process, and separation of powers provisions of the federal and state constitutions. The court then affirmed the dismissal of the complaint, holding that “[t]he district court committed no error in concluding that the NMLA bars [plaintiff’s] deficiency action.” Borman, LLC v. 18718 Borman, LLC, Joseph Schwebel, __ F.3d __, Case No. 14-1419, slip op. at p. 10 (6th Cir. Feb. 3, 2015). Dykema represented defendants 18718 Borman LLC and Joseph Schwebel.

In Borman, defendant 18718 Borman, LLC (“Borrower”) defaulted on a commercial mortgage loan secured by a mortgage on real property. The plaintiff, Borman, LLC (“Borman” or “Purchaser”), purchased the property and acquired the rights of the original lender at a post-foreclosure auction.

The loan at issue in Borman was a Commercial Mortgage-Backed Securities (“CMBS”) loan. These loans are fairly standardized across the industry—among other things, they are generally nonrecourse in nature, which means that unless the borrower commits one of the enumerated “bad boy” acts, the lender’s sole recourse for a borrower default is to foreclose on the property.

In a typical CMBS loan, in exchange for the nonrecourse obligation, the borrower is required to maintain a bankruptcy remote, single purpose entity (“SPE”). The purpose of the SPE is to hold the property as its sole asset, and to insulate the CMBS pool from a borrower bankruptcy. The CMBS loan documents set forth various bad boy acts which, if committed, could result in recourse liability. Among those acts is the failure to maintain the SPE.

In 2011, the Michigan Court of Appeals shocked the commercial lending industry when it issued its opinion inWells Fargo Bank, N.A. v. Cherryland Mall Limited Partnership, et al, 295 Mich. App. 99; 812 N.W. 2d 799 (2011) (“Cherryland I”). In Cherryland I, the Michigan court held, for the first time, that a borrower’s insolvency and failure to pay its mortgage payments when due constituted a breach of the SPE provisions, thereby converting a nonrecourse CMBS loan into a full recourse loan. The court reached its opinion despite testimony by all parties to the loan that such was contrary to the original intent of the parties. In this regard, the Michigan Court of Appeals noted:

We recognize that our interpretation seems incongruent with the perceived nature of a nonrecourse debt and are cognizant of the amici curiae’s arguments and calculations that, if accurate, indicate economic disaster for the business community in Michigan if this Court upholds the trial court’s interpretation. Nevertheless, the documents at issue appear to be fairly standardized nationwide, and defendants elected to take that risk—as did many other businesses in Michigan and nationwide. It is not the job of this Court to save litigants from their bad bargains or their failure to read and understand the terms of a contract.

Cherryland I, 295 Mich. App. at 126.

The Michigan legislature accepted the court’s invitation to act, and while Cherryland was pending before the Michigan Supreme Court it passed, without opposition, the NMLA. The NMLA provides, among other things, that a post-closing solvency covenant shall not be used, directly or indirectly, as a non-recourse carve-out or as the basis for any action against a borrower or guarantor on a non-recourse loan. M.C.L. § 445.1593.  Any provision to such effect in a loan was declared to be against Michigan’s public policy and thus invalid and unenforceable. Id.

Although many applauded the passing of the NMLA, some, including the plaintiff in Cherryland I, continued the fight to convert all CMBS loans into recourse liabilities. On remand back to the Michigan Court of Appeals, the plaintiff challenged the NMLA on constitutional grounds, arguing that the Act violated the contracts clauses of the federal and state constitutions, as wells as principles of substantive due process and separation of powers. 

On April 9, 2013, the Michigan Court of Appeals rejected each of these arguments. See Wells Fargo Bank, N.A. v. Cherryland Mall Limited Partnership, et al. (on remand), 300 Mich. App. 361; 835 N.W. 2d 593 (2013) (“Cherryland II”). Backtracking from its previous decision in Cherryland I, the court concluded that the lender’s claim was barred under the provisions of the NMLA: “the guaranty provisions are invalid and unenforceable under the [Act], and… the constitutional challenges to the Act must fail.” Cherryland II, 300 Mich. App. at 370.

Recognizing that Cherryland II and the NMLA sealed its fate, the plaintiff in Borman decided to test its luck in a different venue—instead of bringing its claim in a Michigan state court, Borman filed suit in federal district court where, of course, the state court precedence on federal constitutional issues would not be binding. 

Borman raised a number of issues. First, Borman challenged whether the loan was even a nonrecourse loan within the meaning of the Act. According to Borman, once the foreclosure occurred, the mortgage ceased to exist and, therefore, the loan was no longer a nonrecourse mortgage loan within the meaning of the NMLA. The Sixth Circuit held that the district court properly rejected this argument. “Although the NMLA defines nonrecourse loans as ‘secured by a mortgage on real property,’ the statute includes no caveat that this state of affairs must obtain beyond the effective date.” Borman, slip op. at 9. 

Second, Borman argued that the SPE provisions were not post-closing solvency covenants within the meaning of the Act because they do not “relate solely to the solvency” of the Borrower. The district court properly rejected this argument as well, finding that Borman’s interpretation was contrary to the intent of the Michigan legislature and the Michigan Court of Appeals’ decision in Cherryland IIId. at p. 10.

Third, Borman argued that the NMLA violated the contracts clauses of the state and federal constitutions, as well as principles of substantive due process and separation of powers. The court rejected each of these arguments, finding that the NMLA was not a substantial impairment of Borman’s reasonable expectations under the contract. Id. at pp. 14-15.  Likewise, the court rejected Borman’s due process claim finding that the concerns facing the Michigan public in the wake of Cherryland I were real and significant, and the legislature was required to act to “protect[] developers third-party assignees seeking windfall benefits…” Id. at p. 16. Finally, the court held that the NMLA did not create a separation of powers problem because “the [NMLA] does not ‘interpret’ the contract or direct this Court or any court to do anything.” Id. at p. 17 quoting Cherryland II, 835 N.W.2d at 606.    

The Sixth Circuit’s opinion in Borman is notable for several reasons. The decision confirms that the NMLA—a narrowly tailored act passed by the Michigan legislature to address a specific harm—does not violate the contract clause, substantive due process, or separation of powers provisions of our state or federal constitutions. The decision also upholds the legislative intent in passing the NMLA to bring a sense of security to commercial developers by confirming that their original intent in entering into nonrecourse CMBS loans is upheld.