Given the substantial declines in commercial property values that have occurred in recent years, mortgage lenders have become more aggressive in trying to impose personal liability upon borrowers and guarantors based on the so-called “bad boy carve-out” provisions in non-recourse loans. Many of the courts that have addressed these lender tactics have upheld the lender’s efforts to expand recourse, even where the default that allegedly triggered the recourse liability was not material or caused no harm to lender. See, e.g., CSFB 2001-CP-4 Princeton Park Corporate Center, LLC v. SB Rental I, LLC, 410 N.J. Super. 114 (N.J. Super. Ct. App. Div. 2009). The additional recourse imposed under these carve-out provisions usually falls into two categories: recourse to the borrower or guarantors for any damage suffered as a result of the “bad” act, or conversion of the loan to a full recourse liability loan so that the borrower/guarantors are liable for all of the obligations under the loan.

In a decision last week, however, a New York court rejected an attempt by a lender to pressure a guarantor through assertion of a full recourse liability claim where a fair reading of the loan agreement did not support the imposition of recourse liability. In ING Real Estate Finance (USA) LLC v. Park Avenue Hotel Acquisition LLC, No. 601860/09 (N.Y. Sup. Ct., Justice Yates, Feb. 24, 2010), in which Fried Frank represented the borrower and certain guarantors of the non-recourse mortgage loan, lender claimed that borrower’s nineteen-day delay in paying less than $300,000 of property taxes, which temporarily caused a tax lien to be placed on the property, triggered full recourse liability causing the borrower and guarantors of the loan to be personally liable for the $145 million loan. In its decision, the Court granted the borrower and the guarantors’ motion to dismiss the claims seeking full recourse liability, finding that the agreement was clear that the guarantors were entitled to 30 days notice and the right to cure before recourse liability could be imposed based on a lien, and that it would be impermissible under New York law to permit an outcome whereby the entire debt of $145 million would be fully recourse to the borrower and the guarantors based on the temporary imposition of a relatively modest tax lien on the property.

Opinion

The Court framed the question on the motion to dismiss as “whether, by the terms of the contract, the nineteen-day tardiness in paying less than $300,000 in property taxes triggers a full recourse obligation by the Guarantors.”

The Court first confronted the question of whether a provision of the Credit Agreement that provided for a 30 day cure period prior to full recourse liability in the case of impermissible “Indebtedness,” such as a tax lien, controlled over a provision providing for full recourse liability without an express opportunity to cure, for breaches of the loan’s “Single Purpose” covenants. The Court found that the provision providing for 30 days notice and the right to cure “provides specific direction as to how Indebtedness should be treated” and controlled over the “Single Purpose” default provision, which covered a “broad array of nearly twenty separately delineated covenants.” The Court determined that the lender’s interpretation would effectively read out the notice and cure provision in the Credit Agreement.

The Court also determined that multiple other provisions of the Credit Agreement were inconsistent with lender’s claim of automatic full recourse liability, including a provision providing for 45 days to cure a lien before an Event of Default would occur and a provision that allowed the borrower to contest a tax lien, which would have become “meaningless verbiage under [lender’s] interpretation.” Next, the Court held that under New York law, “the terms of a guaranty are to be strictly construed in favor of a private guarantor,” and that therefore any inconsistency between two provisions of the Credit Agreement “should be resolved in favor of the Guarantors, entitling the Guarantors to a thirty-day cure period.”

Finally, the Court held that it was not reasonable to interpret the Credit Agreement as providing for “immediate liability for the entire debt” based on the delinquent payment of a relatively small amount of taxes. Taken to its logical conclusion, “plaintiffs would have moving defendants potentially liable for the entire debt of up to $145 million if the Borrower is just one day delinquent in paying a dollar in property taxes.” The Court found that “[s]uch an unlikely outcome could not have been intended by the parties, sophisticated commercial borrower and lenders aided by competent counsel at the time of drafting and is impermissible under New York law.”