Real Estate Tip: Non-Recourse Financing May Not Limit Liability
Nearly all real estate developers, landlords and their guarantors express a preference for non-recourse financing if they can get it. After all, limiting one’s liability to the specific real estate being developed or leased protects the other assets of the borrower and guarantor from being attached and sold in the event of a default or foreclosure. At least that’s the theory. Typically, a so-called single purpose entity, a company whose sole purpose is to develop this particular property, is the borrower. Its principals assume some protection from liability because of the entity itself, and assume the entity’s non-recourse financing will provide further protection.
However, many non-recourse mortgages require the borrower, the special purpose entity, to remain solvent, failing which, the lender can seek the full amount of the mortgage from the borrower and its guarantors. This was the result in 51382 Gratiot Avenue Holdings, LLC v. Chesterfield Development Co. 835 F. Supp 2d 384 (E.D. Mich 2011), where Gratiot foreclosed and sued Chesterfield for the deficiency. Making matters worse from the borrower’s viewpoint, the court took a very strict view of the insolvency test, saying that even though the single purpose entity had enough assets to pay its debts, it was not able to pay those debts as they became due, and was therefore insolvent.
The insolvency test is one of a number of so-called carve-outs that can be found in mortgages and loan agreements that are otherwise non-recourse. Whether you are the borrower or the lender, identifying those carve-outs and negotiating them properly, requires the assistance of experienced real estate counsel.
Today’s real estate tip is brought to you by Rick Smith, a LEED Accredited Professional and member of Bernstein Shur’s Real Estate Practice Group and Green Building Team. Stay tuned for more useful tips for real estate professionals.
For more information, contact Rick at firstname.lastname@example.org or 207 228-7228 or at 603 665-8829.