Michigan Court of Appeals Upholds Non-Recourse Mortgage Loan Act

In what has been called a big victory for borrowers of commercial loans, the Michigan Court of Appeals has upheld the Michigan legislature’s recent passage of the Non-Recourse Mortgage Loan Act (NMLA). In the case of Wells Fargo Bank v Cherryland Mall Ltd Ptnsp, the Court addressed the issue of whether developer David Schostak is personally liable for a guarantee on an original $8.7 million non-recourse loan obtained for the purpose of renovations to the Cherryland Center Mall near Traverse City, Michigan. 

Generally, a “non-recourse loan” means a commercial loan secured by a mortgage on real property. In a non-recourse loan, the lender takes the risk of a borrower’s insolvency, inability to pay, or lack of adequate capital. In the event of default, the lender is limited to recovery of the loan by the sale of the asset. The asset used as collateral, as well as the money that flows from the asset, are isolated by covenants referred to as recourse triggers or carveouts, which are generally related to bad acts.

In the case of the Cherryland Center Mall, the foreclosure sale resulted in a $2.1 million deficiency. Wells Fargo Bank sued David Schostak who had signed a guarantee making him liable for any deficiency if a violation of the loan covenants was found. The Trial Court found that Schostak was liable “as guarantor” for the entire loan deficiency because insolvency was a violation of the loan covenants.

While the case was on appeal, the Michigan legislature passed the NMLA, which provides, in part, that a post-closing solvency covenant may not be used as a non-recourse carveout or as a basis for a claim against a borrower or guarantor on a non-recourse loan. The legislation was effective retroactively.  The Court made a review of the legislative hearings leading up to the passage of the NMLA. These discussions included the argument that allowing non-recourse loans to become recourse due to insolvency would “irreparably harm the current environment for investment in Michigan.” Furthermore, the failure to pass the proposed Act would “basically eliminate” non-recourse loans in Michigan leading to a collapse of non-recourse lending, a decrease in tax revenues, and a wave of foreclosures.

After considering the bank’s arguments that the retroactive modification of private contracts violated the Constitution of both the State of Michigan and the United States of America, and possible economic consequences of a failure to uphold the law, the Michigan Court of Appeals rejected the bank’s Constitutional challenge to the NMLA and held that it barred the bank’s claims against Schostak.

Robert J. Hahn is a partner in our Livonia office where he concentrates his practice on corporate and commercial litigation, securities and real estate. He can be reached at (734) 261-2400 or rhahn@cmda-law.com.