The real estate financing market took an unexpected turn in 2011 when a Michigan court rendered a decision which called into question whether a non-recourse loan was truly non-recourse. The court in that case held that a lender could foreclose on a defaulted non-recourse CMBS loan and then recover a deficiency against the borrower and its guarantor simply because the borrower failed to make mortgage payments. How will this affect loans moving forward? A recent decision sheds light on the future of recourse in commercial real estate lending.

That influential court case was Wells Fargo Bank, N.A. v. Cherryland Mall Limited Partnership , 295 Mich.App. 99 (2011).  The distinction between recourse vs. non-recourse lending is key here.  A recourse loan permits a lender to foreclose on the collateral and seek a deficiency against a borrower (as the court in Cherryland Mall permitted).  Most secured commercial real estate transactions in the U.S are non-recourse, which means that in the event of a default, the lender can enforce on the collateral only (with no personal recourse against the borrower or any guarantor). Under most non-recourse loans, the loan remains non-recourse except in the case of certain “bad boy” carve-outs listed in the loan documents.  The carve-outs usually require some bad act such as waste, fraud or bankruptcy – certainly something more than not making a mortgage payment.  At least, that is what we thought.

In non-recourse lending, the lender usually requires “separateness” so that the borrower remains separate and distinct from any of its parents or affiliates.  This separateness, referred to as being “bankruptcy remote”, is beneficial to the lender if the borrower or an affiliate of the borrower files bankruptcy.  Violating the separateness requirements or filing bankruptcy are customarily within the bad boy carve-outs and make a non-recourse loan recourse to the borrower and to any guarantor.

The court in Cherryland Mall  accepted the lender’s argument that the borrower’s failure to make mortgage payments resulted in the borrower’s insolvency, proving a breach of the “separateness” covenant in the loan documents, which made the loan fully recourse.  As there was no proof of any of the traditional “bad boy” acts by the borrower, the borrower’s only documented bad act was failure to make mortgage payments.

Immediately after the Cherryland Mall case was decided, the Michigan State Lesgislature responded by passing the NonRecourse Mortgage Loan Act of 2012 (“NMLA”).  The NMLA rendered solvency covenants in nonrecourse loans unenforceable, declaring them, among other things, against public policy.  Though NMLA brought much relief to the real estate market, it left us asking whether NMLA could affect existing loans because of the general rule against retroactive legislations.  Gratefully, just days ago, the Sixth Circuit answered this question in Borman, LLC v. Borman, LLC at 2015 WL 424548 (6th Cir. Feb. 3, 2015), finding that NMLA applied retroactively to loans existing prior to 2012 when NMLA was passed.

The Borman case certainly brings more clarity to the issue, however, no courts in California have published decisions, accepting or rejecting the analysis and conclusions of Cherryland Mall.  Until they do, we will not know whether here, in California, a nonrecourse loan is still truly “nonrecourse.”

We will have to stay tuned.