Daily Development for Wednesday, April 27, 2010
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Husch Blackwell Sanders
Kansas City, Missouri
dirt@umkc.edu
MORTGAGES; GUARANTEES; “BAD BOY” CLAUSE:” N.Y. court construes springing guarantee narrowly in favor of guarantors, saving them $60 million deficiency. Court further suggests that not all events that literally would trigger a “bad boy” clause will do so - it depends upon expectations of the parties.
ING Real Estate Finance (USA) LLC v. Park Avenue Hotel Acquisition LLC, 2010 Westlaw 653972 (2/24/10) (Unpublished)
This unreported New York case is important because, in the context of a major financing with professionally negotiated and prepared documents, a court will not give the lender the benefit of a springing guarantee as an exception to the non-recourse nature of the original debt where the events triggering the guarantee are of little consequence, short duration, and do not injure the interest of the guarantor.
The main part of the case, however, focused on an interpretation of the interaction between the “cure” provisions of the loan agreement and the “bad boy” clause. The “bad boy” clause listed a large number of events that might trigger recourse liability, among them the incurring of any additional debt or a lien obtaining priority over the secured lien. A separate default clause, which also prohibited additional debt and liens obtaining priority, provided a cure opportunity - in this case 30 days.
Following default on the $145 million mortgage, the borrowers also failed to make a tax payment in the amount of $279,000. Lenders promptly pointed to this event as a trigger for recourse liability under the “bad boy” clause. But the borrowers paid the taxes, with accrued interest, in less than 30 days. Lenders claimed that this didn’t matter, since the “bad boy” clause provided for no cure.
The court held that it was necessary to reconcile the default clause, which permitted cure, with the “bad boy” clause, which didn’t. It stated that under New York law “the terms of a guaranty are to be strictly construed in favor of a private guarantor.” The court concluded that necessarily the cure periods provided elsewhere in the agreement controlled whether the events to which they applied could be used as a trigger for the “bad boy” clause. Thus, since the tax defalut had been cured within 30 days, and the senior lien thereby removed within 45 days, there could be no claim of recourse liability.
The court also noted that New York will not attempt to collect on a tax lien for at least a year, so lender’s position was in scant jeapordy.
This was the holding - but additional language in the opinion is also worthy of considerable note - even though it represents only the view of one judge. This is because it follows the New Jersey appeals court decision in CSFB 2001-CP-4 Princeton Park Corporate Center, LLC v. SB Rental I, LLC, A-6307-07T2, 2009 WL 2431530. (N.J. Super. App. Div. 2009); August 11, 2009, which delighted lenders when it held that a relatively inoffensive event two years before default nevertheless triggered the bad boy clause in that loan - following the language of the documents exactly and finding no forfeiture or penalty problems.
Here, the closing language of the New York court expresses a quite different view:
“Finally, "[a] commercial agreement, of course, should not be interpreted in a commercially unreasonable manner or contrary to the reasonable expectations of the parties" . . . . Immediate liability for the entire debt is not a reasonable measure of any probable loss associated with the delinquent payment of a relatively small amount of taxes. Here, pursuant to [the bad boy clause], plaintiffs would have moving defendants potentially liable for the entire debt of up to $145 million if the Borrower is just one day delinquent in paying a dollar in property taxes or any other debt for which a lien may be imposed. Such an unlikely outcome could not have been intended by the parties, sophisticated commercial borrowers and lenders aided by competent counsel at the time of the drafting, and is impermissible under New York law]. . . ["The rule is now well established. A contractual provision fixing damages in the event of breach will be sustained if the amount liquidated bears a reasonab
le proportion to the probable loss and the amount of actual loss is incapable or difficult of precise estimation. If, however, the amount fixed is plainly or grossly disproportionate to the probable loss, the provision calls for a penalty and will not be enforced."] [citations omitted] .
Comment 1: The editor believes that the fundamental objective of “bad boy” clauses is to enforce behavior rather than to insure that the lender is fully paid. As a consequence, the editor believes that as against the mortgagor, “bad boy” language acts as a penalty for default and should be evaluated by liquidated damages analysis.
Comment 2: The problem is more acute when it comes to guarantors. Such parties may or may not have any control over the behavior of the lender leading to behavior subject to a “bad boy” clause, and thus, the clause may have no impact on protecting the lender from the prohibited acts. Still, the guarantor gets stung with a potentially huge liability. The editor has believed that courts in general are not particularly sympathetic to guarantors, and so he’d pretty much concluded that the invocation of “bad boy” liability was just viewed by the courts as a gamble that was lost. But the court’s far more protective language here may give guarantors some hope based upon close reading of the documents with the intent of the parties in mind, even though the editor still has a hard time seeing a penalty in the case of guarantors.
Items reported here and in the ABA publications
are for general information purposes only and
should not be relied upon in the course of
representation or in the forming of decisions in
legal matters. The same is true of all
commentary provided by contributors to the DIRT
list. Accuracy of data and opinions expressed
are the sole responsibility of the DIRT editor or
individual contributors and are in no sense the
publication of the ABA.
Parties posting messages to DIRT are posting to a
source that is readily accessible by members of
the general public, and should take that fact
into account in evaluating confidentiality
issues.
ABOUT DIRT:
DIRT is an internet discussion group for serious
real estate professionals. Message volume varies,
but commonly runs 5 to 15 messages per work day.
DIRT Developments are posted periodically, as supply dictates.
To subscribe, send the message
subscribe Dirt [your name]
to
listserv@listserv.umkc.edu
To cancel your subscription, send the message
signoff DIRT to the address:
listserv@listserv.umkc.edu
for information on other commands, send the message
Help to the listserv address.
DIRT has an alternate, more extensive coverage that includes not only
commercial and general real estate matters but also focuses specifically upon
residential real estate matters. Because real estate brokers generally find
this service more valuable, it is named “BrokerDIRT.” But residential
specialist attorneys, title insurers, lenders and others interested in the
residential market will want to subscribe to this alternative list. If you
subscribe to BrokerDIRT, it is not necessary also to subscribe to DIRT, as
BrokerDIRT carries all DIRT traffic in addition to the residential discussions.
To subscribe to BrokerDIRT, send the message
subscribe BrokerDIRT [your name]
to
listserv@listserv.umkc.edu
To cancel your subscription to BrokerDIRT, send the message
signoff BrokerDIRT to the address:
listserv@listserv.umkc.edu
DIRT is a service of the American Bar Association
Section on Real Property, Probate & Trust Law and
the University of Missouri, Kansas City, School
of Law. Daily Developments are copyrighted by
Patrick A. Randolph, Jr., Professor of Law, UMKC
School of Law, but Professor Randolph grants
permission for copying or distribution of Daily
Developments for educational purposes, including
professional continuing education, provided that
no charge is imposed for such distribution and
that appropriate credit is given to Professor
Randolph, any substitute reporters, DIRT, and its sponsors.
All DIRT Developments, and scores of other cases, arranged topically, are reported in hardcopy form in the ABA Quarterly Report. This is a limited subscription service, available to ABA Section Members, ACMA members and members of the NAR. Qualified subscribers may Subscribe to this Report ($30 for Two Years) by Sending a Check to Ms. Bunny Lee, ABA Section on Real Property, Trust & Estate Law, 321 N. Clark Street, Chicago, Il 60610. Contact Bunny Lee at (312) 988-5651, Leeb@staff.abanet.org ABA members also can access prior and current editions of this report on the ABA RPTE section website.
DIRT has a WebPage at:
http://dirt.umkc.edu/
*************************************
Your e-mail address will only be used within the ABA and its entities. We do not sell or rent e-mail addresses to anyone outside the ABA.
To change your e-mail address or remove your name from any future general distribution e-mails you can call us at 1-800-285-2221, or write to: American Bar Association, Service Center, 321 N Clark Street, Floor 16, Chicago, IL 60610
If you are an ABA member, log in to the ABA Web site at http://www.abanet.org/abanet/common/MyABA/home.cfm to edit your member profile. Otherwise, complete the form located at https://www.abanet.org/members/join/coa2.html
To review our privacy statement, go to http://www.abanet.org/privacy_statement.html.
If you have any problems, please contact the list owner at
dirt-dd-request@mail.abanet.org.