Buying Or Investing In Commercial Real Estate? Make Sure You Understand Any Bad Boy Guarantees First
Many commercial real estate loans make reference to certain "standard recourse carve-out provisions" that can go into effect if you end up defaulting on the loan, which can affect you whether you're the actual business owner/operator or just a passive investor looking to make a profit by backing a thriving business. Here's what you should keep in mind about these carve-out provisions, also known as "bad boy guarantees."
What does a bad boy guaranty do?
When buying commercial real estate, both non-recourse and recourse loans are available, depending on things like your available down payment, the size of the loan, your financial history, and the perceived viability of the commercial property itself.
If you're the borrower or the investor that's backing a business, a non-recourse loan is safer for you. If the business goes under, the bank essentially agrees to limit its recovery on the defaulted loan to whatever it can get by foreclosing on the property and selling it. A recourse loan, by comparison, allows banks to reach into the personal funds of borrowers and backers and go after money or resources that make up any deficiencies left once the property is liquidated.
A bad boy guaranty, or recourse carve-out provision, puts the teeth back into what is supposed to be a non-recourse loan. Once triggered, it allows banks to demand fulfillment of the entire loan at once and authorizes the foreclosure and liquidation of the commercial real estate that's been purchased with the loan. After that, the bad boy guaranty then permits lenders to go after the personal assets of the borrower and his or her backers.
Why do people agree to that?
Standard-recourse carve-out provisions were designed solely to protect banks against so-called "bad boy" behavior–the intentional wasting of resources and underhanded actions that purposefully drain the equity out of a property while knowing that the business is about to go bankrupt. It was a way to ensure that business owners act ethically and do their best to protect the business, instead of treating the property as if it were a personal piggy bank that could be tapped dry at will.
People investing in commercial real estate agree to the provisions simply because they have no intention of doing anything illicit that would hurt the value of their business property or defraud the business. Their goal is to use the real estate in a way that makes everyone money.
Why are the guarantees a problem?
The problem that commercial real estate buyers and backers run into is that not all banks are transparent about what can push the bad boy guaranty into action. If the provisions are not specifically spelled out, a temporary cash-flow problem in the business or a simple mistake could set the carve-out provision into motion. Any number of perfectly legitimate actions or honest mistakes could trigger it:
- a missed property tax payment
- failure to perform maintenance and repairs due to a cash flow problem
- necessary reorganization of the business through bankruptcy
- late payments on the loan
- theft or fraud by employees other than the owner
These represent just a few of the possibilities that could come into play if the exact boundaries of a bad boy guaranty aren't clearly defined. This makes it extremely important not to agree to any carve-out provisions until you've reviewed them with your attorney. Your attorney can also attempt to negotiate for a guaranty that's more favorable to you. Contact a company like Law Office of Richard D. Saba, P.A. for more information.