Opinion ID: 2775945
Heading Depth: 3
Heading Rank: 1

Heading: CMBS Loans

Text: In a nutshell, CMBS loans provide commercial real estate developers with project financing through capital markets. See Wells Fargo Bank, NA v. Cherryland Mall Ltd. P’ship (Cherryland I), 812 N.W.2d 799, 802 (Mich. Ct. App. 2011) (per curiam) (citing Am. Br. of Commercial Mortg. Sec. Assoc. & Mortg. Bankers Assoc. at 4–14, In re Gen. Growth Props., Inc., 409 B.R. 43 (S.D.N.Y. 2009)). Commercial real estate developers obtain CMBS loans to finance individual projects. The developer mortgages the property being developed as security for the CMBS loan. Lenders issue a number of CMBS loans and then pool the resulting mortgages into a trust. Finally, the trust issues securities backed by the cash flow from the developers’ loan payments. CMBS financing attracted new sources of capital to the commercial real estate market and “played a major role in leading the country out of the nationwide real estate depression caused by the savings and loan crisis of the late 1980s.” Id. (punctuation omitted). To attract these non-traditional investors, such as pension funds and individual bond investors, lenders structured CMBS loans to limit the risk that one developer’s failed project might “drag the entire securitized mortgage pool into bankruptcy.” (R. 51, Summ. J. Order at 3.) And bankruptcy proceedings could hamper foreclosure by the trust and jeopardize timely payment to bondholders. CMBS loans contain two “bedrock elements” to limit the risks posed by bankruptcy. Cherryland I, 812 N.W.2d at 802 (citation omitted). No 14-1419 Borman, LLC v. 1878 Borman, LLC Page 3 First, CMBS loans are nonrecourse. When a borrower defaults on a nonrecourse loan, the lender may foreclose on the asset and any other prearranged security, but the borrower and its guarantors do not become personally liable for any deficiency. In return for nonrecourse liability, the borrower promises to refrain from certain “bad boy” acts: financial behavior likely to increase the risk of default and bankruptcy. These covenants against “bad boy” acts constitute the second bedrock principle of CMBS loans. In general, the covenants require the borrower to maintain single-purpose-entity status. To achieve this, the developer “ring fences” the mortgaged property’s operations from his other projects, usually by creating a separate legal entity concerned solely with managing the mortgaged property to act as the borrower. This way, a developer’s personal financial difficulty resulting from his other, more risky projects will not affect the trust’s ability to foreclose on the mortgaged property and—more importantly—its ability to make scheduled payments to bondholders. Relevant to this case, the CMBS loan covenants commonly include a so-called solvency covenant, a promise that the borrower “shall not . . . fail to remain solvent or pay its own liabilities (including, without limitation, salaries of its own employees) only from its own funds.” Cherryland I, 812 N.W.2d at 803 (citation omitted). Many in the CMBS loan industry intended solvency covenants to serve as a promise against filing for bankruptcy or colluding in an involuntary bankruptcy. (See R. 40-14, Mins. Mich. Senate Econ. Dev. Comm. at 22–23.) For if “insolvent” meant simply the loss of cash flow resulting in default, then defaulting on a CMBS loan due to adverse market forces would expose a borrower—and its developer-principal—to personal liability, effectively obviating the first bedrock principle of nonrecourse liability.