Commercial Mortgage Quick Reference Guide
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"Bad Boy" Carve-Outs
ADR: Average Daily Rate
Commercial Bridge Loans
CMBS and Conduit Loans CTL: Credit Tenant Lease Debt Service Coverage Ratio Debt Coverage Ratio Debt Yield
Gross Rent Multiplier
Gross Potential Rent
GLA: Gross Leasable Area
LIHTC Loan Constant
Recourse Loans TI/LC: Tenant Improvements/Leasing Commission
Skin In The Game
"Bad Boy" Carve-Outs
“Bad boy” carve-outs are used in commercial real estate non-recourse loans. Essentially, these carve-outs give the borrower the ability to not be personally “on the hook” in the event of a default on the terms of the note—thereby being non-recourse—but leave investors protected if the borrower has conducted themselves as, well, a “bad boy.”
So, what makes the borrower a “bad boy”? Well, in the same way that the borrower wants a non-recourse loan to protect themselves, the investors in that loan will want a way to be protected in the event that the borrower goes out of their way to conduct themselves poorly. An example of this is if financial statements or tax returns are fraudulently prepared so as to represent the borrower or the property as financially stronger than they actually are. Another, more common, example may be doing something not allowed in the loan terms, like raising subordinate financing without the primary lender's approval, and thereby over-leveraging the property as per the terms of the note.
The bottom line is that traditionally, all non-recourse loans carry some level of recourse in the event that if the borrower is a “bad boy,” then they are no longer protected by the non-recourse provisions in the loan, and become fully responsible for the entirety of the note and all of its terms. So, in the event of default, that borrower is responsible for any losses that 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. It's crucial that borrowers read carve-out clauses very carefully, because additions like these make a loan that seems to be non-recourse actually a full-recourse financial instrument.