Commercial Mortgage Quick Reference Guide

"Bad Boy" Carve-Outs

“Bad Boy” Carve-Outs are used in commercial real estate non-recourse loans. Essentially these carve-outs provide the borrowing entity the ability to not be “on-the-hook” personally in the event of a default on the terms of the note, thereby being non-recourse, but leave investors protected in the event the borrower has conducted himself as, well, a “bad boy.”

What constitutes a “bad boy?” Well the same way the borrower wants a non-recourse loan to protect himself, the investors in that loan will want a way to be protected in the event the borrower goes out of his way to conduct himself poorly. For example, if financial statements or tax returns are fraudulently prepared so as to represent the borrower or the property as stronger financially than it actually is. A more frequent example may be doing something now allowed in the loan terms, like perhaps raising subordinate financing without the approval of the primary lender, and thereby over-leveraging the property as per the terms of the note.

The bottom line is that all non-recourse loans, traditionally, carry some level of recourse in the capacity that if the borrower is a “bad boy,” he is no longer protected by the non-recourse provisions in the loan and becomes fully responsible for the entirety of the note and all of its terms. In the event of default that borrower is responsible for any loses the bank incurs. Unfortunately there are new trends where lenders are extending their "Bad Boy" Carve-Outs to include things like not sending financial reports on time, not paying real estate tax on time, or not having proper insurance on the property. Because of this it is absolutely crucial that borrowers are reading the carve-out clauses slowly and carefully because editions like this make a loan that seems to be non-recourse, actually a full recourse financial instrument.