Bad Boy Non-Recourse Carve Outs

by Ron Holmes

Be careful what you sign! Most, if not all, non-recourse real estate loans have socalled “bad boy carve outs” which either render the Borrower and/or Guarantor liable for damages to the Lender or causes the non-recourse loan to become full recourse to the Borrower and/or Guarantor.

While most reasonable people think of bad boy carve outs as fraud, theft, embezzlement and other intentional or perhaps grossly negligent acts, there is no “typical” definition of bad boy carve outs. Consider this: a “typical” bad boy carve out is the failure to pay ad valorem taxes or maintain the property. If the Borrower and/or Guarantor (typically a Single Purpose Entity) runs out of money, then it cannot pay the ad valorem taxes or maintain the property, in which event the Borrower and/or Guarantor will become liable either for the Lender’s damages or, depending upon the language, the full amount of the loan.

And consider this: the failure to pay ad valorem taxes or maintain the property could occur after a Lender takes possession of the property either through foreclosure or appointment of a Receiver, under either of which circumstances the Borrower and/or Guarantor have no control over the application of cash flow from the property.

Be sure to have your attorney negotiate the bad boy carve outs so you can reduce your risks or know exactly what risks you may incur.