What are Bad Boy Carve-Outs & What do they Include?

In a non-recourse commercial mortgage loan, the lender generally has no recourse against the borrower or property owner personally in the event of a default. Instead, the lender's only recourse is the property itself. However, "bad boy carve-outs" can create liability for the property owner in certain circumstances.

A "bad boy carve-out" (also known as a "non-recourse carve-out" or "springing recourse") is a provision in a non-recourse loan agreement that allows the lender to pursue the property owner personally for damages in certain situations. These provisions are often included to protect lenders from borrower misconduct that could threaten the value of the property and the lender's security interest in it.

Common bad boy carve-outs include:

1. Fraud or Misrepresentation: If the borrower or property owner engages in fraud or misrepresentation in connection with the loan, the lender may have the right to pursue the property owner personally.

2. Waste or Environmental Violations: If the property owner causes damage to the property or violates environmental laws, the lender may have the right to pursue the property owner personally.

3. Unauthorized Transfer of the Property: If the property is sold or transferred without the lender's consent, the lender may have the right to pursue the property owner personally.

4. Bankruptcy Filing: If the borrower or property owner files for bankruptcy, the lender may have the right to pursue the property owner personally.

If any of these bad boy carve-out events occur, the lender may seek damages from the property owner. This could include the full amount of the outstanding loan, as well as any expenses or losses incurred by the lender as a result of the bad boy carve-out event.

It is important for property owners to carefully review the terms of any non-recourse loan agreement and understand the potential risks associated with bad boy carve-outs. In certain circumstances, a borrower may be better off accepting a full recourse loan, which would make the borrower personally liable for the loan in the event of default.

In addition to the common bad boy carve-outs mentioned earlier, other provisions that may create liability for the property owner include:

1. Prohibited Activities: The loan agreement may prohibit certain activities on the property, such as the manufacture of illegal drugs or the operation of a strip club. If the property owner engages in these prohibited activities, the lender may have the right to pursue the property owner personally.

2. Hazardous Materials: If hazardous materials are found on the property and the property owner fails to remediate the issue, the lender may have the right to pursue the property owner personally.

3. Property Damage: If the property is damaged and the property owner fails to repair the damage, the lender may have the right to pursue the property owner personally.

It's important to note that bad boy carve-outs can vary from one loan agreement to another, and the specific terms of a loan agreement will dictate when a property owner may be liable. Property owners should review their loan agreements carefully and work with their legal advisors to fully understand their obligations and potential liability under the agreement.

If you have any questions about this article or would like to discuss a scenario of your own with our team, please feel free to contact Colin Dubel at colin@harborwestcommercial.com or 949-735-6415.