Recent Case Turns Non-Recourse Lending Into Recourse

Categories: Commercial Litigation, Class Actions & Collective Action

By Kenneth F. Silver

Over the course of the last dozen years or so, many owners of commercial properties have taken advantage of a program known as CMBS (Commercial Mortgage Backed Securities) to obtain non-recourse financing at very favorable rates. The program dried up for a few years during the recession but started making a comeback in the past year or two.

The loans were built upon the notion of non-recourse lending except with respect to certain “bad acts.” These acts included such things as distributing money when the loan was past due, not paying taxes, misrepresentations etc. One of the bad acts was not maintaining the “single purposes entity” status of the Borrower. This was always understood to include things like acquiring other assets, merging and so on. However, in the case of Wells Fargo Bank, NA v Cherryland Mall Ltd. Partnership, decided by the Michigan Court of appeals on December 27, 2011, it was determined that not paying the mortgage was a breach of the SPE covenants requiring a solvent entity and thus a violation of the bad acts which then made the loan fully recourse.

What this means is that the thousands of CMBS loans which have been closed over the past several years, all of which were obtained precisely because these loans were non-recourse, are all fully recourse. Under the Cherryland case, every time a borrower fails to make a monthly payment, the SPE covenants are violated. This turns the entire notion of a non-recourse loan completely upside down and fully defeats the purpose of the entire loan program. Thousands of borrowers are affected involving billions of dollars. Simply put, this is a disaster for the commercial real estate community. Borrowers are now left with the prospects of paying prepayment premiums to re-finance, or just holding their breath hoping their properties continue to perform. Hopefully, the case will be appealed and or the situation will be addressed with legislation or a replacement loan program.

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