An ongoing Michigan state case, Wells Fargo Bank, N.A. v. Cherryland Mall L.P. et al.,  has been generating a lot of heat over an obscure but important issue for commercial mortgage borrowers, the scope of carveouts from standard nonrecourse provisions in loan documents.  And now the most recent opinion issued in the case raises important constitutional issues as well.

This case (as well as the similar Chesterfield case (a federal court case also in Michigan)) took many in the real estate industry by surprise by reading language in the loan documents at issue in those cases so as to gut their nonrecourse provisions.  Michigan (as well as neighboring Ohio) quickly passed legislation to return the nonrecourse language to how it was commonly understood.

The Michigan courts’ interpretations of the language in the loan documents was inconsistent with how such provisions were typically understood in the industry.  While the new statutes returned things to how they were commonly understood to be before the cases were decided, they did so in a way that raises more fundamental issues.  Most importantly, such statutes potentially violate the Contracts Clause of the United States Constitution which bars the “impairing” of “the Obligation of Contracts.”

The most recent Cherryland opinion upheld the constitutionality of the new Michigan statute and rightly notes that the Contracts Clause is not read literally. This has been true at least since the Depression era U.S. Supreme Court case of Home Building & Loan Association v. Blaisdell did not invalidate Minnesota’s mortgage moratorium.  The U.S. Supreme Court had thereby given states some leeway pursuant to their police power to remedy social and economic problems, notwithstanding the text of the Contracts Clause.   The situation in the Cherryland case is less sympathetic than that in Depression-era Blaisdell, where many, many homeowners were being foreclosed upon.  The Cherryland borrower, in contrast, is a politically-connected real estate developer. But the point remains that the Contracts Clause is not an absolute bar to legislative revision of privately negotiated contracts.  How politically connected, you might ask.  The court indicates that

defendant [David] Schostak is co-chief executive officer of defendant Schostak Brothers & Company, Inc., and that Robert Schostak is co-chairman and co-chief executive officer.  . . . Robert Schostak is “a high ranking Republican Party leader in Michigan, with many years of involvement in assisting the party’s candidates to gain election in the legislature.” We note that Robert Schostak has been chairman of the Michigan Republican Party since January 2011, was finance chairman through the 2010 election cycle, and had served on campaign fundraising teams for prominent Republicans. (8, note 3)

The borrowers here are as well positioned to get helpful legislation passed as anyone. There is much to chew over here, not the least of which is the Court’s finding that the statute was not “intended to benefit special interests.” (8)

There are also important practical aspects to the case. For instance, it is quite possible that courts in other jurisdictions will read the typical CMBS nonrecourse language similarly to how the Michigan courts read it.  Lenders will want to take a look at their loan documents to determine whether they mean what they say and say what they mean. And borrowers should read the language in their loan documents carefully before signing on the dotted line. They have been warned.