Bad Boy Carveout: A provision in a non-recourse loan that converts the debt to full recourse—making the guarantor personally liable—if the borrower commits specific prohibited acts (fraud, waste, unauthorized transfers).
"I want a non-recourse loan because I don't want to risk my personal assets."
We hear this every day. It's a sensible goal. But it's based on a misunderstanding of what "non-recourse" actually means in commercial lending. There is no such thing as a loan where walk away consequence-free.
Agency loans (Freddie Mac SBL, Fannie Mae) are "limited recourse." The specific limitations are defined in the Guaranty and the Loan Agreement. If you trip one of the legal wires hidden in these documents, the "corporate shield" dissolves, and the lender can seize your personal bank accounts, your house, and your other investments.
The Two Tiers of Liability
Lenders categorize "bad acts" into two buckets. You need to know which is which.
Tier 1: "Loss Recourse" (You Pay for the Damage)
For these items, you are personally liable only for the amount of loss the lender suffers.
- Misappropriation of Funds: Using rent checks to pay your personal credit card instead of the mortgage.
- Security Deposits: Spending tenant security deposits instead of keeping them in a segregated account.
- Insurance Proceeds: Pocketing the check from a fire claim instead of repairing the building.
- Waste: Allowing the property to physically deteriorate to the point where its value collapses.
If you steal $50,000 of security deposits, the lender can sue you personally for $50,000. This is fair.
Tier 2: "Springing Recourse" (You Pay the Whole Loan)
For these items, the penalty is total. The entire loan balance becomes due immediately, and it becomes fully recourse to you.
- Voluntary Bankruptcy: Filing for bankruptcy protection to stop a foreclosure.
- Fraud: Lying on your T-12, Rent Roll, or Personal Financial Statement.
- Unauthorized Transfers: Selling the property or bringing in a new partner without lender consent.
- Blocking Foreclosure: Taking legal action to delay or hinder the lender's ability to foreclose.
The Environmental Indemnity Trap
The Environmental Indemnity Agreement is the scariest document in the closing package. It is separate from the loan. It is separate from the guaranty.
It never dies.
Most loan documents expire when you pay off the debt. The Environmental Indemnity often survives:
- Repayment of the loan
- Foreclosure
- Deed in lieu
If a tenant was dumping chemicals down the drain during your ownership, and the EPA finds it 15 years later (long after you sold the building), the lender can still drag you into court if they get named in a lawsuit.
The "Warm Body" Requirement
Borrowers often try to sign the Guaranty in the name of a Trust or an LLC to add another layer of protection.
Freddie Mac and Fannie Mae usually refuse. They require a "Warm Body Guarantor"—a living, breathing human being.
Why? Because a Trust can be emptied of assets overnight. A human being has a reputation, future earning potential, and a fear of bankruptcy. The lender wants moral hazard to work in their favor.
How to Protect Yourself
1. Negotiate the Definitions
"Waste" shouldn't mean "the boiler broke." It should mean "gross negligence." "Misappropriation" shouldn't mean a clerical error. Competent counsel can narrow these definitions in the Loan Agreement.
2. Understand "SPE" Covenants
Your borrowing entity must be a Single Purpose Entity (SPE). It cannot own other property. It cannot commingle funds. Violating SPE covenants is often a full recourse trigger.
3. The "Involuntary Bankruptcy" Clause
Watch out for clauses that trigger recourse if creditors force you into bankruptcy. You want to ensure you are only liable if you colluded with those creditors.
Summary
- Non-recourse isn't free: It is conditional on good behavior.
- Don't lie: Fraud is always a full recourse trigger.
- Don't steal: Misappropriating rents is personal theft.
- Don't block the exit: If the deal fails, hindering foreclosure triggers full liability.
- Read the "Bad Boy" Guaraty: It is the specific list of things that will ruin you.