Is Cherryland Still Relevant? n April 7, 2014, the United States District Court for the Southern District of New York decided CP III Rincon Towers, Inc. v. Richard Cohen3. The question before the court was whether or not real estate owner’s association (“REOA”) and mechanic’s liens triggered full recourse under a non-recourse carveout guaranty. Concluding that these were involuntary liens, the court found that these liens did not result in full recourse under the guaranty. The court also found these items did not trigger loss recourse as a violation of the loan documents’ SPE covenants. As many loan documents are governed by New York law regardless of the location of the mortgaged property, Rincon is a significant decision. In one context, it has already been cited as authority directing courts how to identify contractual ambiguities4. Viewed in the context of “bad boy” guarantees and CMBS loans, Rincon sheds light on whether courts are going to subscribe to the line of analysis adopted by the Court of Appeals of Michigan in its 2011 decision in Wells Fargo Bank, N.A. v. Cherryland Mall5. In this latter context, Rincon suggests that the shadow cast by the Cherryland decision, already limited by legislative action in two states, may also be limited in judicial consideration of similar issues. The Cherryland Backdrop In December of 2011, the Court of Appeals of Michigan rendered its seminal decision in the Cherryland case. The court found a guarantor responsible for full recourse for a deficiency judgment exceeding 2 million dollars for violating an SPE covenant that the borrower remain solvent and pay its debts as they become due. When the market deteriorated in 2009, the Cherryland borrower stopped making payments under the loan and was rendered insolvent. The borrower’s solvency covenant was unconditional. Without finding an overt “bad boy” act by the borrower or its principals as the underlying cause, the court found the solvency covenant to have been breached and the guarantor fully responsible under its guaranty. As the court stated, “…any failure to remain solvent, no matter what the cause, is a violation.”6 CRE Finance World Winter 2015 26 For those who viewed Cherryland in its most disruptive form, the implication was that a Borrower faced with an unconditional solvency covenant must bring fresh capital to a project when the cash flow no longer supports its debt service. The alternative is to confront liability under the guaranty. Either way, the obligation would be difficult to quantify and this would prevent investors from being able to gauge their financial commitment to a project. Market participants feared the pall such uncertainty would cast over real estate investments going forward. Rincon Rincon is one of the first clarifications of New York law regarding non-recourse guarantees since Cherryland. Rincon involved a $110 million dollar loan on a 320 unit high-rise apartment building to be constructed. The defendant, Richard Cohen, was the President of the borrower and the non-recourse carveout guarantor. The plaintiff, CP III Rincon Towers, Inc., was a special purpose entity formed to purchase the debt originated by Bear Stearns in 2007. From 2008 to 2012, several REOA liens and mechanic’s liens were filed against the property. Under the loan documents, it appeared there were four avenues of potential recourse against Cohen. Full recourse could have been triggered under three separate provisions on the basis that the Borrower: (i) placed a voluntary “Lien” against the property; (ii) failed to obtain the lender’s consent to a “Transfer”; and (iii) placed “Indebtedness” on the property without the lender’s consent. The fourth potential avenue was that loss recourse could have been triggered under an SPE covenant prohibiting liens “of any nature”. The loan documents defined the terms “Lien”, “Transfer” and “Indebtedness”. The term “voluntary” was not defined. In the course of negotiating the loan documents, the reference to mechanic’s liens had been deleted from the loss recourse provisions, but mechanic’s liens were still included in the definition of “Lien”. The court was left to resolve the internal inconsistencies in the loan documents and attempted to avoid rendering any of them superfluous. O Andrew E. Walsh Of Counsel Ballard Spahr LLP2 Michael Pollack Of Counsel Ballard Spahr LLP1
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