Borrowers and guarantors undoubtedly remember that in Wells Fargo Bank, NA v. Cherryland Mall Ltd. P’ship, et al (December 27, 2011) the Michigan Court of Appeals found “springing recourse” liability because the borrower in Cherryland violated a solvency covenant which triggered the nonrecourse carveouts found in the loan terms (which were typical of those found in CMBS loans nationwide). The court noted that its interpretation was contrary to the perceived nature of nonrecourse debt and recognized that its decision might “indicate economic disaster for the business community in Michigan.”

In response, the Michigan legislature passed the Nonrecourse Mortgage Loan Act (the “Act”) with broad, bipartisan support. The Act prohibits post-closing solvency covenants from being used as nonrecourse carveouts or being a basis for any claim against a borrower, guarantor, or other surety on a nonrecourse loan. Under the Act, any such provision in a nonrecourse loan is invalid and unenforceable. The Act was immediately effective upon its signing on March 29, 2012 and was given retroactive effect.

When the Act was passed, the Cherryland case was on appeal to the Michigan Supreme Court. Rather than ruling on the case, the Michigan Supreme Court directed the Court of Appeals to reconsider its decision in light of the Act. At the Court of Appeals, the lender argued that (i) under the language of the guaranty, the guarantor had waived any future defenses and statutory rights regarding the invalidity and unenforceability of any agreements; and (ii) the Act is unconstitutional because it violates the Contract Clauses and the due process protections of the U.S. and State constitutions and the separation of powers doctrine.

In a published decision issued earlier this week, the Michigan Court of Appeals rejected all of the lender’s arguments. The court noted that the Act provides that a “post closing solvency covenant shall not be used, directly or indirectly as a nonrecourse carveout….” The court held that the provisions of the guaranty that purported to impose liability on the guarantor were at least indirectly related to a post-closing solvency covenant and are therefore invalid and unenforceable.

On the constitutional issues, the court held that the Act did not violate the Contract Clauses because the Act is an appropriate remedy which serves the legitimate and public purposes of avoiding the collapse of nonrecourse lending in Michigan and avoiding a negative impact on tax revenues and foreclosures. The court held that the retroactive nature of the Act did not violate due process protections because the legislative action was a rational approach to addressing a legitimate public purpose.