Developing Law on Commercial Mortgage-Backed Securities Loans

By Jennifer A. Lifschitz, Esq.

Beware of providing a personal guaranty for a seemingly non-recourse commercial mortgage-backed securities (“CMBS”) loan.  A recent opinion by the Court of Appeals of Michigan could potentially have a significant negative effect on guarantors of non-recourse CMBS loans if adopted by other jurisdictions.  The general intent behind CMBS loans is to limit recourse on the loan to the actual property securing the loan, while seeking recourse on the loan from guarantors only after specific and egregious “bad acts” of a borrower. In Wells Fargo Bank, NA v. Cherryland Mall Limited Partnership, the court concluded that a mortgage unambiguously required a borrower to remain solvent in order to maintain its single purpose entity (“SPE”) status. Lenders often require borrowers to maintain SPE status to protect the lender’s collateral from other potential creditors of the borrower. Having admittedly become insolvent due to its failure to make payments on the loan, the borrower violated the SPE requirements of the loan, and Wells Fargo sought repayment on the loan from the guarantor.  This is an issue that should be watched closely in and out of Michigan. As the law continues to develop on this matter, guarantors should be aware of the implications of guaranteeing a seemingly non-recourse CMBS loan and ensure that the terms of any non recourse carve-out guarantees securing such a loan are properly negotiated to protect their interests.

In October 2002, Cherryland obtained an $8.7 million non-recourse CMBS loan using property as collateral. David Schostak, a principal of Cherryland, acted as guarantor of the loan.  Wells Fargo eventually purchased the loan. In 2009, Cherryland failed to make a mortgage payment and Wells Fargo eventually commenced a foreclosure action and was the successful bidder.  There was a deficiency of about $2.1 million.  Wells Fargo filed litigation against Cherryland to enforce the loan documents and added Schostak as a defendant as the guarantor of the loan.  Wells Fargo filed a motion which sought judgment against Schostak as guarantor for the entire loan deficiency based on the fact that Cherryland’s insolvency was a failure to maintain its SPE status.  These actions seemed contrary to the intent of the CMBS loan which was to limit recourse on the loan to the property, absent extenuating “bad acts.”

The court’s willingness to allow a lender to enforce the insolvency requirement of the SPE provisions of a loan and seek repayment from a guarantor for the borrower’s “bad acts” is a troubling development for guarantors of CMBS loans.  In the current economic climate, it is not uncommon for borrowers to miss payments on a loan and be deemed insolvent. Lenders can too easily point to the “bad acts” of the borrower in failing to maintain SPE status and seek repayment from the guarantor for the balance of the loan.

In response to this troubling decision, the Michigan legislature passed the “Nonrecourse Mortgage Loan Act” (the “Act”) on March 29, 2012.  The Act prevents a post closing solvency covenant to be used as the basis for any claim or action against a borrower or any guarantor on a nonrecourse loan and thus invalidates the Cherryland decision discussed above. This is an issue to watch closely and to be aware of before undertaking to act as a guarantor in a CMBS loan.

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