Lenders located in Michigan and Ohio that are engaging in nonrecourse loans will want to become familiar with a recent change in the law which will have an impact on the use of certain carve-outs in nonrecourse loans.
On March 27, 2013, the Ohio Legacy Trust Act (the “Act”) became effective. The Act was passed in response to the 2011 Michigan appellate case, Wells Fargo Bank, N.A. v. Cherryland Mall Limited Partnership, in which the court upheld the use of a nonrecourse loan carve-out that caused the loan to become fully recourse to the guarantor upon the insolvency of the borrower. This type of provision is referred to in the Act as a “Postclosing Insolvency Covenant.” Michigan, in response to the Cherryland decision, passed the Nonrecourse Mortgage Loan Act which became effective in March of 2012. The Act’s sections related to Postclosing Insolvency Covenants are nearly identical to their counterparts in the Michigan Nonrecourse Mortgage Loan Act.
The Act prohibits the use of, and renders invalid and unenforceable, any Postclosing Insolvency Covenant in a nonrecourse loan. ORC 1319.08. A Postclosing Insolvency Covenant is defined as “any provision of the loan documents for a nonrecourse loan . . . that relates solely to the solvency of the borrower, including, without limitation, a provision requiring that the borrower maintain adequate capital or have the ability to pay the borrower’s debts, with respect to any period of time after the loan is initially funded.” ORC 1319.07(D). Importantly, a Postclosing Insolvency Covenant does not include “a covenant not to file a voluntary bankruptcy or other voluntary insolvency proceeding or not to collude in an involuntary proceeding.” ORC 1319.07(D). Full recourse loans are not affected by this change. ORC 1319.09. The goal of the Act appears to be to permit lenders to carve out “bad boy behavior” such as a borrower voluntarily filing bankruptcy or colluding in an involuntary filing, but to render unenforceable a carve-out that would be triggered by the simple insolvency of a borrower or the borrower being forced into bankruptcy by a creditor.
The following is an example of an insolvency carve-out revised in accordance with the Act:
“The Borrower declaring bankruptcy or seeking bankruptcy protection under any provision of federal law, or Borrower colluding in an involuntary bankruptcy proceeding filed against Borrower.”
We are monitoring this development and look forward to working with you to ensure your Ohio and Michigan loans are in compliance with this new requirement. For any questions or updates, please do not hesitate to contact us.