Courts Broaden Exposure Under Certain “Bad Boy” Guarantees

January 11, 2012

Two December 2011 court decisions interpreting Michigan law have challenged widely held expectations about the extent to which guarantors may be liable under so-called “bad boy” guarantees. These guarantees, frequently employed in structured financings and particularly commercial mortgage-backed securities (CMBS) transactions, were usually thought to spring into existence only if the guarantor performed a wrongful act prohibited by the loan documents.

Nevertheless, the courts in 51382 Gratiot Avenue Holdings, L.L.C. v. Chesterfield Development Company, LLC, Case No. 2:11-CV-12047, 2011 U.S. Dist. LEXIS 142404 (D. Mich. Dec. 12, 2011), and Wells Fargo Bank NA v. Cherryland Mall Limited Partnership and David Schostak, No. 304682, 2011 Mich. App. LEXIS 2360 (Ct. App. Mich. Dec. 27, 2011), found that under the applicable loan provisions, the insolvency of the borrower, alone, triggered the guarantee and thus subjected the guarantor to full recourse on any deficiency after the lender’s sale of collateral. Each court, affirming summary judgments in favor of the lender, approached its analysis by ascertaining the parties’ intent from what it considered the unambiguous language of the springing guarantee.

The U.S. district court in the 51382 Gratiot case specifically rejected the argument of the borrower that the “insolvency” exception to the nonrecourse nature of the loan would “swallow” all the other exceptions based on wrongful conduct. Neither court was persuaded by public policy arguments advanced by the borrowers.

Although there is considerable uniformity in the language used in “bad boy” guarantees, especially in CMBS loans, slight alterations in the language could lead to different results.