Editor: David Reiss
Brooklyn Law School

April 23, 2013

Cherryland, Very Strange

By David Reiss

I looked at the Cherryland decision yesterday. Law360 ran a story (behind a paywall) about it today, quoting me and others.  To recap, the original Cherryland case appeared to unexpectedly open up many commercial borrowers in Michigan to personal liability. The most recent Cherryland opinion reversed this result as a result of Michigan’s newly passed Nonrecourse Mortgage Loan Act.

The story reads in part:

Cherryland and Schostak reaped the benefits of the NMLA. But many CMBS loan documents are similarly written, and other borrowers and guarantors “may not have the saving grace of a politically connected developer getting a law passed very rapidly,” said Brooklyn Law School professor David Reiss.

“If I was an existing borrower [or borrower’s counsel], I would look at this very carefully,” Reiss told Law360. “And new borrowers should try to negotiate new language that protects for this, saying that becoming insolvent is not something that is going to trigger the bad boy guarantee.”

After the initial decision was handed down last year, attorneys say they and their colleagues all took a hard look at the language in their clients’ nonrecourse loan documents to be sure that if they found themselves in a similar situation they would be protected without the cover of a law like Michigan’s NMLA or Ohio’s Legacy Trust Act, which followed shortly thereafter.

In fact, experts say they don’t believe many other states will likely follow suit with their own guarantor-protecting statutes. So even though Wells Fargo lost out in the Cherryland row, lenders will likely keep the case in mind when considering deals.

Although “most people believe that the [pre-NMLA] decision in Cherryland was not what was intended by virtue of the documents,” said Schulte Roth & Zabel LLP real estate partner Jeff Lenobel, the solvency covenant was drafted in a way that allowed it to be read as a bad boy trigger.

This has led many who represent borrowers and guarantors to seek more due diligence and spend more time making sure loan language is just right.

More than $1 trillion in CMBS loans are coming due over the next several years, and Lenobel said he wouldn’t be surprised to see the issue come up again in a different court.

While the Cherryland case is all but over, another similar suit — Gratiot Avenue Holdings LLC v. Chesterfield Development Co. LLC — is making its way through Michigan’s federal courts. And attorneys aren’t ruling out the possibility of an appeal to the U.S. Supreme Court to ultimately determine the responsibilities of a guarantor in a nonrecourse loan.

“It may be a very smart move by the lending industry to appeal to the Supreme Court,” Reiss said.

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