Commercial real estate lending has always had a “bad boy” guaranty to protect lenders from an individual borrower’s waste, misuse of security deposits, and becoming insolvent. The idea was always to protect lenders from the bad acts of borrowers by making the individual personally liable. The following article discusses how two recent court decisions have thrown the Commercial Backed Mortgage Securities industry into an upheaval and what the State of Michigan has done in response.
The article discusses a court ruling that when the value of the property falls below the then outstanding principal amount of the mortgage, the borrower is deemed insolvent and the “bad boy” guaranty is triggered. So despite doing nothing wrong, this particular borrower faced personal liability for a potentially huge deficiency. In interpreting the “bad boy” clause, the court determined that no willful act was required, just that the borrower failed to stay solvent. Although recognizing that this seemed to go against the very nature of non-recourse debt, the court was constrained by the clear and unambiguous language in the contract.
Thankfully, the State of Michigan stepped in and enacted legislation the effectively set aside these court decisions. We would hope that other states will follow suit here to ensure individuals are protected. However, we wouldn’t suggest waiting around to be the guinea pig case. If you find your commercial real estate investment to be under water, with no hopes of a turnaround, you should seek out a law firm to help you assess your situation to see if you have a way to be relieved of this debt through a settlement. Don’t wait to see if the court finds you to be a “bad boy” for an economic slump you had no control over.