This is a most compelling subject, although rarely adjudicated in reported cases so that when a new decision issues, it is worthy of note. [D.B. Zwirn Special Opportunities Fund, L.P. v. SCC Acquisitions, Inc., 74 A.D.3d 530, 902 N.Y.S.2d 93 (1st Dept. 2010)]
Our readers involved with commercial mortgages will be familiar with the subject so this review should have considerable meaning for them. Those handling residential matters may not have encountered the subject, but it can be enlightening; a few words of introduction then.
In the “usual” situation, certainly in the home loan arena, the borrowers sign a note (promissory note or mortgage note) which is the promise to pay the debt – the loaned funds. The mortgage is the pledge of security – the property — to secure that debt. Having promised to pay, the borrowers are personally liable for that debt. They can be sued for the money without resort to a foreclosure or, as is far more common, they can be pursued for any deficiency at the conclusion of a foreclosure if the property was worth less than the mortgage debt. It should be noted that even in an elemental home loan scenario, there could be co-signers or guarantors who are also liable for the debt.
The key observation in this regard is that personal liability for the mortgage debt is typical – almost invariable — in the home loan transaction. Perhaps just as typically, this is not the case with the commercial loan. There, the borrower is often a single purpose entity (an LLC or a corporation for example), created or existing solely to own the property. Thus, while the borrower entity will be liable for the debt, because its only asset was the property foreclosed upon, personal liability of the entity has little or no practical consequence.
Of course, the lender could ask the borrower’s principals to personally guaranty the debt, but then what was in essence a non-recourse loan becomes recourse. That does happen, but what is more common is the subject of this excursion – carveout liability.
In short there is a non-recourse mortgage loan but it becomes recourse to guarantors upon the happening of certain delineated events. Examples include failure to pay real estate taxes, committing waste at the property, neglect to pay insurance, misappropriation of rents, among many others. [For a more complete list with discussion, see 3 Bergman on New York Mortgage Foreclosures §34.02[a], LexisNexis Matthew Bender (rev. 2010)]. There is nuance here as well. The act, or defalcation can elicit liability only to the extent of the consequences of that act, or the provision could be written to create full recourse upon the happening of that event.
While it is reasonable to assume that contractual provisions are to be enforced as written, there can be room for ambiguity or imprecision in language, public policy considerations and various fact patterns. This means that guidance from case law is helpful.
Given the few decisions, here is what we do know in New York. Carveout liability will be enforced for:
In the new case mentioned which elicited this alert, the court’s answer to imposition of recourse liability was “no”. There, where recourse was to be triggered upon actual admission in writing of insolvency or inability to pay debts when they became due, a mere conclusion by a lender plaintiff that the borrower’s financial reports demonstrated the insolvency was insufficient to invoke personal liability.
Mr. Bergman, author of the four-volume treatise, Bergman on New York Mortgage Foreclosures, LexisNexis Matthew Bender (rev. 2017), is a partner with Berkman, Henoch, Peterson, Peddy & Fenchel, P.C. in Garden City, New York. He is also a member of the USFN, The American College of Real Estate Lawyers, The American College of Mortgage Attorneys, an adviser to the New York Times on foreclosure issues and writes a regular servicing column for the New York Law Journal. He is AV rated by Martindale-Hubbell, his biography appears in Who’s Who In American Law and he has been for years listed in Best Lawyers In America and New York Super Lawyers.