Last year in this space we reported on a pair of Michigan court decisions (51382 Gratiot Avenue Holdings, Inc. v. Chesterfield Development Company (Chesterfield) and Wells Fargo Bank, N.A. v. Cherryland Mall (Cherryland), which each held that a CMBS borrower’s insolvency could trigger personal liability on the part of its non-recourse carve-out guarantor. Those decisions spelled catastrophe for the subject guarantors, and threatened a cataclysmic reconfiguration of the scope of limited recourse liability throughout the CMBS universe. Now, the same Michigan appeals court that handed down the Cherryland decision has relied on a new state law, hastily enacted in the wake of that decision, to reverse itself and rule in favor of the guarantor.
Almost before the ink dried on the initial Cherryland opinion, the Michigan legislature rushed to enact the Nonrecourse Mortgage Loan Act (NMLA). The NMLA, signed into law by Gov. Rick Snyder in March 2012, prohibits lenders from pointing to the solvency requirement in a loan agreement’s single-purpose entity provision as a basis for invoking a guarantor’s non-recourse carve-out obligations. Most significant, the NMLA was enacted to apply retroactively. This retroactive component of the NMLA not only underscored to real estate developers the benefits of having good friends in government, but it also led the Cherryland court to an about-face on its initial decision. The court ruled earlier this month that, in accordance with the NMLA, the foreclosing lender could not target the guarantor’s assets to satisfy a $2.1 million post-sheriff’s sale deficiency.
While the Cherryland borrower and its guarantor celebrate this fortuitous turn of events, CMBS lenders still have cause for worry. With a new precedent set for rapid-response legislative intervention into contracts between sophisticated lenders and borrowers, the actual worth of important credit enhancements like non-recourse carve-out guarantees has been thrown into doubt. Although some observers suggest that other states are unlikely to adopt NMLA-type laws (though Ohio has already enacted such a statute), a wise lender will be well-advised to keep Cherryland in mind as it negotiates loan documents going forward. As to what lenders can do about their limited recourse loans already on the books, it appears the answer to that question may float on the ever-shifting political winds.
Note: Chesterfield is making its way through Michigan’s federal courts, and attorneys are weighing the prospects for an appeal to the U.S. Supreme Court.