Savvy commercial real estate (CRE) borrowers and lenders seeking to minimize downside exposure pay close attention to the triggers for nonrecourse carveout (NRC) guaranty liability. Many CRE loans are structured as "nonrecourse," meaning that after a default, the lender may only look to the collateral property itself for repayment of the loan, with no personal liability of the borrower entity and no credit support or payment guaranties from a borrower's owners. This lack of personal liability raises moral hazard issues, with little downside to a distressed CRE borrower filing for bankruptcy to prevent a foreclosure or otherwise hinder its lender's exercise of remedies. To limit these types of risks—and incentivize borrower parties to cooperate with their lender's exercise of remedies after a default—CRE lenders often look to NRC guaranties, under which a credit-worthy principal or parent entity may become partially or fully liable for a borrower's obligations upon the occurrence of specified trigger events. In other words, a list of recourse liability triggers is "carved out" from the otherwise nonrecourse nature of the loan. NRC liability triggers are highly negotiated and raise a host of potential issues for both lenders and guarantors looking to protect themselves from financial distress.
Commercial real estate cycles are testing the interpretations and limits of liability triggers in nonrecourse loans. Doug Rosner, Tim Carter, and Jonathan Hayden discuss in The Wall Street Journal.
The current CRE cycle continues to test the interpretation and enforceability of the growing list of bad boy carveouts in nonrecourse mortgage loans. Understanding their purposes and limits should help parties formulate workout strategies and limit exposure on underperforming loans.
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