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Lenders 360

Recourse Carve-outs

Posted in Guaranty Issues, Tough Times for Lenders

Real estate financing in recent times has generally involved non-recourse loans. While this is virtually a given in a conduit loan situation – the regular portfolio lenders often found it necessary to offer non-recourse loans to compete. A corollary to this basic market term, is the recourse carve-out – circumstances which trigger an exception to the otherwise non-recourse nature of the loan.

Each recourse carve-out will turn on the specific language included in your loan documents – so review them carefully. But, some general overview points are helpful to the review of your unique situation.

"Extent of loss" carve-outs
Some recourse carve-outs impose liability to the extent of a loss caused to the note holder. Review your loan document carefully to understand which these are. These carve-outs are usually associated with fraud or misrepresentations, waste, improper handling of rents (particularly unearned/future rents), improper handling of insurance claim proceeds and improper handling of condemnation proceeds. For the last items on this list, the concept of a limited extent of loss and a direct causal connection is relatively easy to see and measure. For fraud claims, the issue can get much more complicated. What if the fraud occurred before the loan closed? Is the entire unpaid balance the "extent" of your loss? Each of these claims will involve its own story and will stand or fall on the strength of the particular facts. And for each, two questions come in to play – 1) did the recourse trigger cause a loss, and 2) how much?

Springing recourse liability
Some recourse carve outs convert the loan obligation from non-recourse to full recourse. If one of these recourse events occurs – the result is more like the true "I promise to pay" language of the standard note. In that event, there is no issue about the amount of the loss – it is the full unpaid debt. Also, there is no issue about the cause of the loss – the issue is simply one of an agreement to be fully liable. These recourse triggers commonly arise upon breach of covenants restricting transfer of the collateral without the lender’s consent, the filing of a bankruptcy involving the collateral or obligated parties and, sometimes, the failure of the borrower to maintain Single Purpose Entity status.

Do your homework
If a loan default is pending – do your homework. Get some background information and start developing your case for recourse – if the facts are there.