California Commercial Mortgage Loans and the Bad Boy Carve Out Guaranty; How It Works, And Whether A Tenant Who Abandons Property Can Trigger Liability

A typical California commercial mortgage loan requires the borrower and/or its principals to execute a “bad boy guaranty” (a/k/a recourse carve out guaranty). This which provides for personal liability against the borrower and principals of borrower if certain listed ‘bad acts’ are committed by the borrower and its principals. It can change a non-recourse loan into a recourse loan. Potential guarantors will want to be sure to understand the carve outs, and may want to consult an experienced Sacramento and El Dorado real estate attorney.

If triggered by one of bad acts, bad boy guarantees require the guarantor to be personally liable for damages to the lender, or alternatively, converts an otherwise non-recourse loan into a full-recourse loan as against the borrower or guarantor. Lenders then have the right to seek personal liability against the borrower and guarantors. Some of the bad can acts include Fraud, Misapplication of funds, Unauthorized transfers of the mortgaged property or other collateral; or filing bankruptcy.

In a recent case the lender tried to claim that, because a tenant abandoned the premises, the bad boy was triggered and the guarantor was liable. Plummer Street Office LP v. NRFC Holdings involved a loan of $44 million to buy two office buildings in Chatsworth. The loans included a bad boy guaranty. The buyer leased the buildings to Washington Mutual.

The guaranty had a provision that it was triggered if, without consent of the Lender, any lease was terminated. Washington Mutual abandoned the property, the owner defaulted on the loan, the lender foreclosed, and brought this action to recover against the guarantor. The lender claimed that the tenants breach terminated the lease, citing Civil Code 1951.2, which provides that if the tenant abandons the property, the lease is terminated. However, the lease provided that” it is the intention of the parties…the lease shall not be terminated for any reason by Lessee…” (This was probably added to the lease to prevent triggering the guaranty)

Also, the lender ignored section 1951.4, which, on abandonment, allows the Landlord-owner to treat the lease as ongoing. Based on the lease provisions the court concluded that the guaranty was never triggered. The lender further argued that the guaranty was not really a ‘bad boy’ guaranty, but was really an absolute guaranty because full recourse is triggered regardless of whether the lease is terminated by the tenant or the landlord. However, the court noted that, in this case, only the borrower-landlord had a right to terminate, and it never did so.

(photo: http://www.flickr.com/photos/68751915@N05/6869769579/)