A s a result of the fjnancial crisis of the past commercial real - - PDF document

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The Essential Resource for Today’s Busy Insolvency Professional

Lien on Me II

BY RICHARD J. CORBI1

New York State Court Enforces “Bad Boy” Guaranty Provisions

A

s a result of the fjnancial crisis of the past four years, the enforceability of many types

• f loan and contract provisions have been
• litigated. In particular, “bad boy” provisions, or

guaranty agreements in loan agreements, have been hotly litigated. A bad boy guaranty provision in loan agreements provides for personal liability against the borrower and principals of the borrower upon the occurrence of certain enumerated bad acts com- mitted by the borrower or its principals, including commencing bankruptcy proceedings.2 This article examines a recent case by the New York State Supreme Court that addressed enforceability of a bankruptcy trigger of a bad boy provision. Although this decision is not a bankruptcy decision, it illus- trates how a bankruptcy fjling will affect other par- ties to a loan agreement that are not involved in the related bankruptcy case. Recently, the New York State Supreme Court, in Bank of America NA v. Lightstone Holdings LLC (Lightstone),3 granted Bank of America’s summary- judgment motion pursuant to N.Y. CPLR 3213 with respect to a guaranty agreement in the amount of $100 million. In Lightstone, the plaintiffs consist- ed of Bank of America NA, Wachovia Bank NC, Merrill Lynch Mortgage Lending Inc., U.S. Bank National Association as trustee for Maiden Lane Commercial Mortgage Backed Securities Trust 2008-1, Debt II ESH LP, Debt-U ESH LP and Key Bank National Association.4 The defendants consisted of David Lichtenstein, a residential and commercial real estate developer, and Lightstone Holdings LLC, of which Lichtenstein was the sole managing member.5

Facts

In June 2007, the defendants purchased the Extended Stay Hotels (ESH) hotel chain for approx- imately $8 billion,6 of which, $1.9 billion was raised through fjve mezzanine loans to various companies that indirectly owned ESH.7 As security, the defen- dants guaranteed the mezzanine loans.8 Specifjcally, section 1.1 of each guaranty agreement provided that the “Guarantor hereby irrevocably and uncon- ditionally covenants and agrees that it is liable for the Guaranteed Obligations as a primary obligor.”9 Section 1.2 of the guaranty agreement defined “Guaranteed Obligations” to include “the obliga- tions or liabilities of Borrower to Lender under Section 9.4 of the Loan Agreement.”10 Section 9.4(b) of each of the mezzanine loan agreements stated that if the “Mortgage Borrower, an Operating Lessee, a Mortgage Principal, the Borrower, a Senior Mezzanine Borrower or the Property Owner (as the terms are defined in the mezzanine loan agreements) files a voluntary petition under the Bankruptcy Code, the debt due under the mezza- nine loans becomes fully recourse to the Borrower as well as immediately due and payable.”11 Subsequently, on June 15, 2009, the borrower, mortgage borrower and property owner fjled vol- untary bankruptcy petitions.12 The indebtedness under the mezzanine loans became fully recourse

1 The views expressed in this article are those of the author do not reflect the views of the firm or any of its clients. 2 See,฀e.g., Kevin Baum, “Whatcha Gonna Do: After Credit฀Suisse฀v.฀Boespfmug Enforces a ‘Bad Boy’ Guaranty, It May Be What the Bank Wants You to Do,” 8 Amer.฀Bank.฀Inst.฀ Young฀&฀New฀Members฀Comm.฀Newsletter 1 (March 2010), available at www.abiworld.

• rg/committees/newsletters/Young/vol8num1/bad_boys.html (discussing definition of

“bad boy” provisions in case analysis). 3 32 Misc.3d 1244(A), 938 N.Y.S.2d 225 (Table), 2011 WL 4357491 (Sup. Ct. N.Y. Cty., July 14, 2011). 4 Lightstone฀Holdings, 2011 WL 4357491 at *1.

Richard฀Corbi฀is฀ an฀associate฀in฀ Lowenstein฀Sandler฀ PC’s฀Bankruptcy,฀ Financial฀ Reorganization฀and฀ Creditors’฀Rights฀ Department฀and฀ Specialty฀Finance฀ Department’s฀ Private฀Equity฀ Group฀in฀New฀York.฀ He฀also฀serves฀ as฀a฀coordinating฀ editor฀for฀the฀ ABI Journal and฀ co-authored฀Debtor- in-Possession Financing: Funding a Chapter 11 Case (ABI,฀2012).฀

5 Id. at *1. 6 Id. at *1. 7 Id. at *1. 8 Id. at *1. 9 Id. at *1. 10 Id. at *1. 11 Id. at *1. 12 Id. at *1.

44฀Canal฀Center฀Plaza,฀Suite฀400฀฀•฀฀Alexandria,฀VA฀22314฀฀•฀฀(703)฀739-0800฀฀•฀฀Fax฀(703)฀739-1060฀฀•฀฀www.abiworld.org and exceeded $100 million, while the obligations under the guaranty agreement were capped at $100 million.13 On June 16, 2009, the plaintiffs notifjed the defendants of their $100 million obligation under the guaranty agreements.14 On Aug. 27, 2009, the plaintiffs moved for an order granting summary judgment in lieu of a complaint pursuant to N.Y. CPLR 3213 with respect to the guaranty agreements. N.Y. CPLR 3213 provides, “[w]hen an action is based on an instrument for the payment of money only or upon any judg- ment, the plaintiff may serve with the summons a notice of motion for summary judgment and the supporting papers in lieu of a complaint.”15 The defendants argued that the guaran- ty agreements were not subject to a N.Y. CPLR 3213 motion, but the court disagreed for seven reasons.

Seven Reasons for Disagreement

First, the defendants argued that the guaranty agreements were not instruments for the payment of money only, as they contained obligations other than the payment of money, such as representations in connection with making the loan, indemnifjcations and environmental laws.16 The court dis- missed this argument because section 9.4(a) of the loan agreement did not obligate the defendants to perform any provision of the lease. Rather, it described the conditions under which the borrower became liable for actual damages and it did not require additional performance as a condition precedent to payment. As a result, it did not affect the plain- tiff’s ability to pursue a N.Y. CLPR 3213 motion.17 Second, the defendants again asserted that the guaranty agreements were not instruments for the payment of money because they depended on future events or external documents to trigger an obligation to pay.18 The court again dismissed this argument because “there is a signifjcant distinction between a condition precedent that is well defjned ‘within the four cor- ners of the debt instrument’ and a condition precedent that requires something outside the agreement to determine what constitutes this condition, for example, a judicial proceed-

• ing. The latter condition does not qualify for the N.Y. CPLR

3213 motion.”19 The court explained that the condition prec- edent here was the voluntary bankruptcy fjling, an obligation “specifjcally contemplated within the four corners of the debt instrument.”20 The court continued that “it is perfectly clear what constitutes a voluntary fjling for bankruptcy,” and there- fore, no reason existed to deny a N.Y. CPLR 3213 motion.21 Third, the defendants argued that the N.Y. CPLR 3213 motion was not proper because the guaranty agreements did not state a “sum certain,”22 which was dismissed by the

• court. The court stated that “a guarantee may be the proper

subject of a motion for summary judgment in lieu of com- plaint whether or not it recites a sum certain.”23 The defen- dants did not dispute that the amount in question was $100 million; rather, they objected because the amount could be less than $100 million.24 The court explained that the defendants were wrong because the plaintiffs pursued their claims under § 9.4(b) of the guaranty agreements.25 Section 9.4(b) triggered full recourse and was limited to $100 mil-

• lion. As a result, the sum certain was readily ascertainable.26

Fourth, the defendants asserted that a confmict existed between the commands of section 9.4(b) of the guaranty agreements, which stipulated that ESH not commit waste and not fjle for bankruptcy.27 Again, the court rejected this argument because of the contract’s clear and unambigu-

• us language. Section 9.4(a)(ii) triggered liability if the

borrowers committed “intentional damage to or physi- cal waste of” their properties,28 which was not a blanket command to not commit waste, according to the court. Section 9.4(a)(xiv) triggered liability for actual damages if the borrower fjles for bankruptcy, and section 9.4(b) converted the loan to full recourse status in the event of a voluntary fjling of a bankruptcy petition.29 These clauses did not create substantive obligations; rather, according to the court, they stated the conditions under which the bor- rowers became liable for actual damages or the conversion

• f the loan to full recourse.30

Fifth, the defendants argued that § 9.4 contained other ambiguities precluding summary judgment.31 The court rejected this contention because the alleged ambiguities “amount[ed] to no more than variations on the theme that there is a confmict between 9.4(xiv) and 9.4(b),” which the court had already discussed and dismissed.32 Sixth, the defendants argued that the guaranty agree- ments were void as a matter of public policy,33 which the court rejected for two reasons: (1) The defendants waived their right to assert a public policy defense pursuant to sec- tion 1.4 of the guaranty agreement, and (2) no public pol- icy existed that would authorize the defendants to “walk away” from their contractual obligations.34 Furthermore, the court noted that because the defendants consisted of sophisticated real estate investors, and because the guar- anty agreement is a lender’s assurance against a borrower from being permitted to take certain actions is a common feature in commercial mortgage loans, such guarantees uniformly contain language that makes them uncondi- tional and waives the borrower’s right to assert certain

• defenses. As a result, courts have upheld such features as

valid fjnancing arrangements.35 Seventh, the defendants argued that the plaintiffs breached the guaranty or mezzanine loan agreements and/or frustrated the defendants’ performance by not accepting a tender of collateral in the form of ESH and its properties.36 The court rejected that argument because the “plaintiffs were under no obligation to accept a tender

• f collateral or to exercise any particular remedy upon a

13 Id. at *1. 14 Id. at *1. 15 Id. at *1. 16 Id. at *2. 17 Id. at *2. 18 Id. at *2. 19 Id. at *3 (internal citations omitted). 20 Id. at *3 (internal citations omitted). 21 Id. at *3. 22 Id. at *4. 23 Id. at *4 (citations omitted). 24 Id. at *4. 25 Id. at *4. 26 Id. at *4. 27 Id. at *4. 28 Id. at *4. 29 Id. at *4. 30 Id. at *4. 31 Id. at *4. 32 Id. at *4. 33 Id. at *5. 34 Id. at *5. 35 Id. at *5 (relying on UBS฀Commercial฀Mortg.฀Trust฀2007-FLI฀v.฀Garrison฀Special฀Opportunities฀Fund฀LP, Index No. 652412/2010, 2011 WL 900949 (Sup. Ct. N.Y. Cty., March 8, 2011)). 36 Id. at *5.

44฀Canal฀Center฀Plaza,฀Suite฀400฀฀•฀฀Alexandria,฀VA฀22314฀฀•฀฀(703)฀739-0800฀฀•฀฀Fax฀(703)฀739-1060฀฀•฀฀www.abiworld.org default.”37 The court then rejected the defendants’ breach

• f the implied covenant of good faith and fair dealing

because the defendants made conclusory statements and cited irrelevant case law.38 For all the foregoing reasons, the court rejected each of the defendants’ asserted defens- es and granted the plaintiff’s motion for summary judg- ment pursuant to N.Y. CPLR 3213.

Conclusion

The Lightstone decision illustrates that courts enforce contracts entered into by sophisticated parties who under- stand the implications of their agreements. With the continu- ing deterioration of the real estate market, courts will con- tinuously confront litigation over the enforceability of bad boy provisions in fjnancing agreements. abi Reprinted฀with฀permission฀from฀the฀ABI฀Journal,฀Vol.฀XXXI,฀No.฀ 11,฀December/January฀2013. The฀American฀Bankruptcy฀Institute฀is฀a฀multi-disciplinary,฀non- partisan฀organization฀devoted฀to฀bankruptcy฀issues.฀ABI฀has฀ more฀than฀13,000฀members,฀representing฀all฀facets฀of฀the฀ insolvency฀fjeld.฀For฀more฀information,฀visit฀ABI฀World฀at฀www. abiworld.org.

37 Id. at *5. 38 Id. at *5.