By Jon J. Pinney

To respond to the impact of COVID-19, the federal government has launched several financial relief programs for businesses and individuals. Despite being one of the hardest hit sectors, the commercial real estate industry has seen very little relief. Recently, the Federal Reserve announced it was pumping an additional $2.3 trillion into the capital markets that will direct hundreds of billions of dollars in loans to mid-sized business, as well as much-needed support for states and large counties. This new stimulus also includes support for the commercial mortgage backed securities (CMBS) markets through the Term Asset-Backed Securities Loan Facility (TALF).

While TALF is expected to help stabilize the CMBS market, it is unclear what specific protections for current CMBS borrowers or guarantors will exist. To date, the Treasury Department has only issued a two-page term sheet stating that “Loans made under the TALF are made without recourse to the borrower, provided the requirements of the TALF are met.” What those requirements are have not yet been released and it can be expected that CMBS lenders will follow their normal playbooks when issuing “nonrecourse” financing.

Typically, CMBS loans are nonrecourse—meaning that the lender can only recover the real estate secured by the loan rather than the remaining amount due on the loan or hold the borrower or a guarantor personally liable. However, most CMBS loans require an individual to execute a personal guaranty. Guarantors are led to believe that the guaranteed obligations are limited to “bad boy” provisions and told that CMBS loans are “nonrecourse.” But as some CMBS borrowers and guarantors learned the hard way in the aftermath of 2008, CMBS loan documents almost always contain provisions that lenders can use to trigger full-recourse provisions under the guaranties. These nonrecourse carve-outs include “bad boy” provisions or events for which a borrower and any guarantor(s) assume personal liability under the loan documents.

There are two categories of nonrecourse carveouts:

  • “above-the-line carve-outs,” which make the borrower and any guarantor(s) personally liable for the lender’s losses resulting from certain bad acts and events, and
  • “below-the-line carve-outs,” which make the borrower and any guarantor(s) personally liable for the entire amount of the debt.

As nonrecourse financing evolved, the nonrecourse carveouts expanded. As a result, two states—Ohio and Michigan—passed limited but helpful CMBS borrower protection statutes that are generally obscure and unknown. This Alert will focus on those statutes to educate borrowers and guarantors on the protections afforded them under these statutes.

Ohio and Michigan’s Nonrecourse Carveout Act

Under Ohio’s and Michigan’s statutes, the following nonrecourse carveouts are potentially invalid as a matter of law:

  • Special Purpose Entity (“SPE”) Solvency Provisions: CMBS loan documents generally mandate that the borrower form a single-purpose, bankruptcy-remote entity that is specifically designed to hold one asset and to prevent that asset from being involved in external bankruptcy proceedings. The related requirements often contain a mandate that the SPE remain “solvent” and be capable of paying its bills as they come due. A violation of these SPE requirements triggers full-recourse liability since it is a “below-the-line carveout” under the guaranty. Ohio and Michigan’s statutes squarely render these types of SPE post-closing solvency covenants invalid.
  • Transfer Violations: Carveouts for transfer violations (including the definition of “transfer” used in connection with the SPE requirements) are typically extremely broad, capturing inadvertent and immaterial transfer violations as well as involuntary transfers such as mechanic’s liens or other encumbrances. Since these requirements require the borrower to maintain adequate capital or have the ability to pay the borrower’s debts, they are potentially invalid under Ohio and Michigan’s statutes.
  • Solvency & Capital Requirements: Any solvency, adequate capital or other monetary covenants are potentially invalid under Ohio and Michigan’s statutes.

Practical Guidance in Dealing with Tenant Defaults and Rent Relief Requests

As a result of COVID-19, tenant delinquency rates have increased dramatically and many tenants are requesting rent relief. Under CMBS loan documents, borrowers (and guarantors) are prohibited from granting such relief in many instances and should consult their advisors prior to taking any steps. Borrowers and guarantors with properties that have been adversely impacted by COVID-19 should also consider the following:

  • Pre-Negotiation Agreements: CMBS lenders (and other sophisticated lenders) often require borrowers and guarantors to execute pre-negotiation agreements that contain broad releases (among other provisions) in favor of the lender. Borrowers and guarantors should insert provisions to preserve their statutory rights and protections afforded under state and federal law, including any specific COVID-19 relief that may be passed.
  • Avoid CMBS Traps: Borrowers and guarantors with properties that have been adversely impacted by COVID-19 should avoid the following CMBS “traps” that can trigger exposure under the loan documents and guaranty:
    • Ensure that real estate taxes and insurance premiums are timely paid
    • Do not allow any liens or other encumbrances to be placed on the property
    • Do not apply for any federal or state relief programs (such as an SBA loan under the Cares Act) without lender consent
    • Before making a forbearance request to a loan servicer, factor in that doing so could trigger cash management or a lockbox
    • Consult your legal advisors prior to making any further distributions of cash held in operating accounts

CMBS loans are highly-complex debt structures that require careful analysis and consideration during this challenging period. Please consider consulting your legal advisor if your CMBS property has been adversely impacted by COVID-19. If you have any questions about CMBS loans or would like to discuss further, please contact Jon J. Pinney at or via mobile at 216.538-8695.