During the last downturn in the economy, many real estate investments no longer made financial sense and real estate was given back to the lenders on the real estate. For the first time, borrowers were expected to sign personal guarantee provisions and the marketplace became very nervous about this change.
Lenders still loaned proceeds on a non-recourse basis, but included recourse provisions within the loan documents that resulted in full-recourse liability to the borrower and guarantor.
If the borrowers did not comply with the provisions spelled out within the loan documents, known as “Bad Boy Carve-Outs”, and they became personally liable for the loss associated with the non-compliance or the existing balance of the loan, depending on the provision that was broken.
The negotiation for “Bad Boy Carve-Outs” should be a borrower’s top priority when negotiating prospective loan documents with lenders.
There are two types of Bad-Boy Carve-Outs – Loss Items & Full Recourse Items.
The “Loss Items” state that if a borrower does not comply with one of these provisions, they are personally liable for the loss that is incurred related to the provision. An example of a Loss Item is if a borrower fails to pay taxes, they are now personally liable to pay the taxes and any charges or fees associated with being paid late.
The “Full Recourse Items” state that if a borrower does not comply with one of these provisions, they are personally liable for the existing balance of the loan.
Notable and frequently used Bad Boy Carve-Outs is for example; failure to disclose a material fact to a lender, failure to pay taxes, and/ or perhaps failure to maintain insurance as required in the loan documents. If a borrower contaminates or sets fire to the property as a criminal act, bankruptcy, Failing to pay the first full monthly debt service amount when due. And the list goes on and on.
Strong borrowers that have invested a large amount of equity into properties can typically negotiate the language within the Bad Boy Carve-Outs.
“Bad Boy Carve-Outs are loan documents written in order to protect a lender and hold a borrower responsible for running a property in a dishonest manor.