An appellate court in Michigan upheld a lower court’s ruling that will allow debt holders to recover money from landlords who foreclose on commercial property. Bondholders are now able go after the personal wealth of commercial real estate owners to recover loans. In the past, lenders had no other recourse once the keys to the property were handed over.

A so-called “bad boy” clause in loan documents in this deciding case is being used as fodder for going after the property owner. It allows creditors to seek personal money from the landlord if the property owner takes prohibited actions like filing for bankruptcy protection when investments in a special-purpose entity crumble. Others argue that the provision is too far-reaching and was never meant to be used as a recourse loan. In the wake of the Michigan appellate court ruling, debt holders in other states are using the same argument to obtain additional money from the borrower.

This type of provision and language is not unheard of in loans bundled and sold under commercial mortgage securities. The ruling on similar language in loans across the country could have an impressive effect on commercial real estate loans maturing without being honored.

In response to the appellate court ruling, the Michigan state legislature took action to protect commercial property owners. Last week law makers passed the Nonrecourse Mortgage Loan Act to prevent creditors from going after the personal assets of commercial real estate owners. Attorneys for the debtors say they are going to challenge the constitutionality of the new law.

Source: The Wall Street Journal, “Michigan Case Puts a Chill in the Air,” Eliot Brown, April 3, 2012