When engaging in real estate loan transactions, insurance company lenders often undertake a robust underwriting process that focuses on the value and marketability of the real property that serves as collateral for the loan. As a result, many insurer-lenders are comfortable providing non-recourse loans to borrowers (particularly when no construction activity will occur at the property).
Although the loans are described as non-recourse, most insurance company lenders require some form of guaranty (from a creditworthy entity or individual) that covers certain exclusions from the non-recourse clause in the mortgage securing the loan. These exclusions — sometimes called “bad boy” carveouts — historically included certain deliberate actions taken by a borrower that have the effect of reducing the value of the real estate collateral. For example, losses attributed to the borrower’s fraud or misrepresentation in obtaining the loan, any intentional waste committed by the borrower, the misappropriation of funds received by the borrower or the violation of environmental laws were often excluded from the overall non-recourse nature of the loan transaction. The guaranty would permit lenders to recover from the guarantor any loss or damage related to such carveouts.
Over time, non-recourse carveouts have become broader and now often extend beyond the “bad acts” of the borrower. Further, lenders frequently take the position that guarantors should be responsible not merely for the loss or damage related to such carveouts, but for the principal amount of the loan in the event of the borrower’s breach of the non-recourse covenants — a “springing” recourse guaranty. Put simply, the exceptions to the non-recourse provisions in the loan documents have, in many instances, gutted the non-recourse nature of the loan.
Given this history and the changing marketplace, non-recourse guaranties can have a wide variety of provisions depending on the lender, the borrower’s economic leverage, the type of real estate collateral and when the loan was made. Many current non-recourse carveouts contain provisions that permit the lender to recover from the guarantor under one or more circumstances. While each of the following events can result in a non-recourse carveout guaranty being interpreted to impose liability on the guarantor, there are additional considerations due to the COVID-19 pandemic.
- The borrower files for bankruptcy protection, or admits in writing its inability to pay its debts as they become due — If a borrower files for bankruptcy protection, it may come as no surprise that the non-recourse guarantor might be responsible for the obligations of the borrower to the lender. But a guarantor could also have liability if, for example, the borrower sends an email to the lender stating that the COVID-19 pandemic has reduced its income (whether from rent payments made by tenants or from its own inability to operate) to the point where it “cannot pay” the monthly loan payment due. Such an email could constitute the borrower’s “inability to pay its debts as they become due,” thus triggering liability under a carveout guaranty.
- For rental properties, the borrower enters into a modification, termination or cancellation of any lease of all or any portion of the mortgaged property without the lender’s prior written consent — Many landlords — whether they own shopping centers or office buildings — have received a barrage of requests for rent relief from their tenants. Agreeing to a rent concession with one or more tenants may constitute the modification of a lease, potentially generating liability under a non-recourse carveout guaranty.
- The borrower is in default under any lease of all or any portion of the mortgaged property — Some tenants don’t request rent relief from their landlord as a result of the COVID-19 pandemic. Rather, they assert that the landlord is in default under the lease (under a wide variety of theories), and that, as a result, the tenant isn’t obligated to pay rent under the lease. To the extent that tenants are able to prevail on any of these theories, this may trigger liability under a non-recourse carveout guaranty.
- The borrower makes a voluntary “transfer” of any interest in the mortgaged property in violation of the terms of the loan — As noted above, many non-recourse loans contain provisions stating that, with certain exceptions, the “transfer” by the borrower of any interest in the “mortgaged property” is a violation of the terms of the loan that will result in the imposition of liability on the guarantor. The “mortgaged property” usually includes not just the real estate, but also any rents derived from the real estate. Potentially, any lease amendments (including COVID-19 related concessions) agreed to by a landlord that are not specifically permitted under the terms of the loan documents, and for which the landlord has not obtained consent from its lender, can be a breach of the loan documents and result in liability under a non-recourse carveout guaranty.
In brief, insurance company lenders should carefully review their loan portfolios, with a particular focus on the terms of any non-recourse carveout guaranties. Such lenders may have more leverage than they expected because of the terms of a broadly-worded guaranty.