Pursuing Defaulting Tenants — Careful What You Wish For
Law360, New York (May 07, 2012, 12:49 PM ET) -- In a recent decision, the Court of Appeal of the State of California, for the Second Appellate District, underscored that now, more than ever, transactional and litigation counsel representing real estate clients must have a comprehensive understanding of all of the agreements affecting a property. In the wake of the collapse of the real estate markets, lenders will look to all means possible to enforce personal guaranties and attempt to recover deficiencies when the secured real property is insufficient to satisfy the underlying debt. Unless counsel is aware of all the potential triggers to a guaranty, the so called “nonrecourse” or “bad boy” carve outs, they may unwittingly turn a nonrecourse loan into a substantial liability for their clients. In GECCMC 2005-C1 Plumber Street Office Limited Partnership v. NRFC NNN Holdings LLC, the court held that the guarantor, NRFC NNN Holdings LLC (Northstar) was not liable to the lender, GECCMC 2005-C1 Plummer Street Office (“GE”) on a commercial guaranty which was only triggered on the happening of certain agreed upon events. In particular, the loan at issue contained a provision that there would be recourse to Northstar if a lease with Washington Mutual, the primary tenant of the property, were terminated or canceled “without the prior written consent of [GE] …” It is well-documented that Washington Mutual failed in September 2008. As a result, the borrower (a subsidiary of Northstar) ceased making its mortgage payments to GE in February 2009. Thereafter, in May 2009, GE foreclosed and took title to the property. After completing the foreclosure, GE commenced suit against Northstar for an approximately $42 million deficiency owed on the mortgage. The principal issue was whether Washington Mutual’s cessation of rental payments constituted termination of the lease, an event that would trigger the “bad boy” provisions of the guaranty. In California, the termination of a lease due to abandonment has a highly technical meaning. California Civil Code section 1951.4 provides that, if requisite language is contained in the lease, a lease may continue to be in effect even after the lessee’s breach, and the lessor may sue for rent as it becomes due. In contrast, under Section 1951.2, a lessor may treat a lease as “abandoned” which would then permit the landlord to recover the balance of the rent due for the term of the lease. Similarly, in the context of residential leases, many states have adopted the language of the Uniform Residential Landlord Tenant Act which contains words to the effect that, in the case of abandonment, “If the landlord rents the dwelling unit for a term beginning before the expiration of the rental agreement, it terminates as of the date of the new tenancy.” (URLTA § 4.203.)
In GECCMC, the borrower recognized that treating the lease as abandoned and effectively terminating the lease would almost certainly result in an enormous obligation under the guaranty. As a result, Northstar never took affirmative steps to treat the lease as abandoned, re-let the premises or otherwise “terminate” the lease. Nonetheless, GE argued that any termination of the lease without GE’s consent, by the borrower or Washington Mutual, triggered the guaranty causing the loan to become full recourse to Northstar. The court rightly recognized that the triggering event was limited to the borrower’s termination of the lease, and not the tenant’s termination. As a result, GE could not pursue Northstar for the deficiency. For practitioners, the GE case provides several important lessons. In practice, if a tenant does vacate the premises or cease paying rent, a landlord will frequently terminate the lease and pursue the tenant for the balance of the rent owed under the term. This is because it is not practical to bring suit for rent “as it becomes due.” However, had Northstar’s counsel pursued this path, Northstar would have been hit with $42 million in guaranty liability. Additionally, it is not unusual for landlords to retain separate counsel to handle complex lender-related litigation issues and, what are often viewed as less-complicated, landlord-tenant litigation issues. However, counsel in both capacities must be fully aware of the potential to trigger guaranty liability under the interwoven loan documents. Even if counsel is retained for a simple unlawful detainer matter, they should familiarize themselves with other agreements surrounding the property to properly counsel their client and avoid potential guarantor liability. Transactional counsel must also recognize that leases and lending documents may have provisions which trigger potential guarantor liability. As such, it is critical that they fully apprise themselves of the terms of lending documents when drafting leases, and vice versa. Further, in negotiating the carve-outs which will cause an otherwise nonrecourse loan to become recourse, borrower’s counsel should carefully craft provisions to ensure that the “bad boy” events are within the control of the borrower. Thus, if the parties want the loan to remain nonrecourse unless the landlord affirmatively terminates a lease without the lender’s consent, borrower’s counsel would be wise to follow the language utilized in the loan documents in the GECCMC transaction and add a provision that such a termination must be by the landlord. --By H. Mark Madnick, Robins Kaplan Miller & Ciresi LLP Mark Madnick is an associate in the Los Angeles office of Robins Kaplan Miller & Ciresi. He practices in the areas of real estate litigation and business litigation. The opinions expressed are those of the author and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
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