Enforcing ‘Bad Boy’ Guarantees In Nonrecourse Financings

Author:Mr James Gadsden
Profession:Carter Ledyard & Milburn
 
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The Second Department's recent decision in G3-Purves Street v. Thomas Purves1 clarifies New York law on the enforceability of “ bad boy” guarantees in nonrecourse loans.2 To protect themselves against the risk of default on the nonrecourse loans that are frequently used to finance commercial real estate development, lenders frequently bargain for limited personal guarantees by the principals to be effective if specific events, termed “springing recourse events” or “nonrecourse carve outs,” occur. These events generally include failing to maintain the property, permitting the property to become encumbered by other liens, interfering with the lender's enforcement of its rights against the property, or filing a bankruptcy petition by a borrower in what is intended to be a bankruptcy “remote” structure.3 Courts in other jurisdictions have generally upheld the enforceability of bad boy guarantees.4 New York law was less certain, and in one recent New York County Supreme Court case5 the court declined to enforce a bad boy guarantee for what the court considered an immaterial default from a delay in paying taxes when due. In G3-Purves Street, the Second Department upheld the enforceability of the bad boy guarantee and rejected the guarantors' argument that a bad boy guarantee was essentially a liquidated damages provision that imposed an unenforceable penalty. Thus, it now appears that New York courts will also enforce nonrecourse carve outs against the guarantors, a welcome development for both lenders and borrowers in the commercial context. This article explores the court's reasoning in G3-Purves Street and discusses the practical implications of this decision. Factual Background In G3-Purves Street, Thomson Purves financed the development of a property in Long Island City, N.Y., through a $13,000,000 mortgage-backed loan from G3-Purves Street.6 The loan was supported by a Guaranty of Recourse Obligations executed by Baruch Singer and David Weiss, the principals of the borrower. The liabilities under the loan agreement were generally nonrecourse to Singer and Weiss, except upon the occurrence of enumerated “springing recourse events,” which included the mortgaged property becoming subject to other liens, the borrower incurring other debt, or the borrower or guarantors failing to pay debts as they became due. Under the guaranty, the guarantors agreed to pay all of the debt due to the lender if a springing recourse event occurred. The loan agreement and guaranty contained no materiality threshold for the springing recourse events. Thus, for failing to pay even a relatively modest real estate tax, the guarantors could become liable for the entire loan. The borrower allegedly violated the terms of the agreement by failing to pay approximately $90,000 of real estate taxes, failing to pay two Environmental Control Board liens of $650, and failing to pay a mechanics claim of $148,000. Based upon these defaults involving $238,650, the lender accelerated the debt and commenced an action to foreclose on its mortgage and recover a deficiency judgment against the guarantors. Although the original loan balance was for $13,000,000, the lender sought $20,000,000 for the principal, unpaid contract interest, default interest, exit...

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