The Superior Court of New Jersey, Appellate Division, confirmed that non-recourse carve-outs in commercial mortgage loans are enforceable in New Jersey.

In CSFB, a commercial mortgage borrower granted a $400,000 second mortgage on real property collateral without obtaining the consent of the existing first mortgage lender. The borrower satisfied the subordinate debt in full after only seven months. The first mortgage loan was generally “non-recourse;” however, following an uncontested foreclosure of the first mortgage more than a year later, the first mortgage lender asserted that the subordinate financing triggered a non-recourse carve-out provision in the loan documents, resulting in the borrower and guarantors’ becoming personally liable for the approximately $5 million loan balance remaining after the foreclosure sale. The court agreed.

In an attempt to invoke a judicial inquiry into the “reasonableness” of the result, the borrower argued that the carve-out provision was a liquidated damages clause and that the application of personal liability for the full amount of the debt constituted an unenforceable penalty. The court rejected that argument, finding that such non-recourse carve-outs are not liquidated damages provisions because they “operate principally to define the terms and conditions of personal liability, and not to affix probable damages.” Also, the court found that such carve-out provisions provide only for actual damages, namely the deficiency on the loan following the sale of the collateral at foreclosure. Such an amount is “fixed by the terms of the loan” and is therefore neither “speculative nor incalculable.” The court was not swayed by the defendant’s “cure” of the breach by satisfying in full the subordinate financing long before the foreclosure on the first mortgage.

The CSFB decision follows in the footsteps of pro-lender decisions by federal courts in Illinois and Massachusetts. See Heller v. Lee, 2002 WL 1888591 (not reported in F.Supp.2d) (N.D. Ill. 2002); Blue Hills Office Park LLC v. J.P. Morgan Chase Bank, 477 F.Supp.2d 366 (D.Mass. 2007). The decisions in CSFB, Heller, and Blue Hills suggest that courts may not require a lender to show substantial, direct harm resulting from the triggering of a carve-out provision before relying on same to assert full personal liability against a borrower or guarantor.