Recourse Remorse: Careful with Carve-outs

A New Jersey borrower has learned that violating a non-recourse carve-out can make a loan fully recourse even when the violation is cured before the loan goes into default.

In CSFB 2001-CP-4 Princeton Park Corporate Center LLC v. SB Rental I, LLC, a case noted by the Superior Court of New Jersey, Appellate Division (Docket No. A-6307-07T2) as one of first impression in New Jersey, the non-recourse carve-out guarantors of a conduit loan secured by a commercial property in South Brunswick were held fully liable for the unpaid principal balance of the loan after borrowing a second mortgage loan in violation of the non-recourse carve-outs.

The twist is this: the second mortgage loan had been fully repaid eighteen months before the first mortgage loan went into default, and the Court cites no evidence that the repayment had any effect on the borrower's ability to repay the first mortgage loan.

The guarantors argued that imposition of full liability under these circumstances was an unenforceable liquidated damages provision, where the penalty bore no relation to the injury suffered by the lender: in other words, no harm, no foul. The Court disagreed, finding that the non-recourse carve-out provision simply fixed liability rather than damages, and hence was fully enforceable. Key to the Court's reasoning is that the guarantors were held liable not for some pre-set amount, as in a standard liquidated damages provision, but for the unpaid principal balance of the loan, the contractually agreed amount of the lender's damage.

With the commercial mortgage market in its present perilous state, it is critical that borrowers obey their loan documents to the letter, as sins which might have been overlooked in better times may now be used by desperate lenders to attack the assets of the borrower's principals. The eighteen month gap in the present case between repayment of the second mortgage loan and default under the first raises the specter of lenders looking backwards through the history of a loan to find any excuse for imposing recourse liability.