What are "Bad Boy" Carve-Outs?
Start Your Application and Unlock the Power of Choice$5.6M offered by a Bank$1.2M offered by a Bank$2M offered by an Agency$1.4M offered by a Credit UnionClick Here to Get Quotes!Bad Boy Carve-Outs
In multifamily lending, you’ll often hear the term “bad boy” carve-out when discussing non-recourse loans. So what is a bad boy carve-out? Well, typically, with a non-recourse loan, there are allowances that give the borrower the ability to not be personally held responsible in the event of a default on the terms of the loan —hence being non-recourse— but they also leave investors protected if the borrower has conducted themselves as, well, a “bad boy” by doing something not allowed in the loan terms, like raising subordinate financing without the primary lender's approval, and thereby over-leveraging the property as per the terms of the note.
Traditionally, all "non-recourse" loans carry some level of recourse in the event that if the borrower is a “bad boy,” then they are no longer protected by the non-recourse provisions in the loan, and assume full responsibility for the entirety of the note and all of its terms. So, in the event of default, that borrower is responsible for any losses that the bank incurs. Interestingly, there have been new trends where lenders are updating their carve-out provisions to include things like not sending financial reports on time, not paying real estate tax on time, or not having proper insurance on the property. It's imperative that borrowers read carve-out clauses very carefully because additions like these make a loan that appears to be non-recourse actually a full-recourse financial instrument.
Related Questions
What is a "Bad Boy" carve-out in commercial real estate financing?
A "Bad Boy" carve-out in commercial real estate financing is a provision in a non-recourse loan that gives the lender the ability to seek loan repayment or damages if the borrower engages in serious violations—like misrepresentations of the property, fraud, theft, or voluntary destruction of real estate—that impact the value of the property or loan. It also allows the lender to require payment for a real estate loan if the borrower files for voluntary bankruptcy or conspires with another party to have involuntary bankruptcy filed. Other common “bad boy” acts that could trigger a loan’s recourse provisions include failure to pay required property insurance premiums, failure to pay property taxes, wasting funds, environmental indemnifications, and borrower negligence. Source and Source and Source.
What are the risks associated with a "Bad Boy" carve-out?
The risks associated with a "Bad Boy" carve-out are that the borrower may no longer be protected by the non-recourse provisions in the loan, and become fully responsible for the entirety of the note and all of its terms. In the event of default, that borrower is responsible for any losses that the bank incurs. Additionally, lenders are extending their "bad boy" carve outs to include things like not sending financial reports on time, not paying real estate tax on time, or not having proper insurance on the property. It's important that borrowers read carve-out clauses very carefully, because additions like these make a loan that appears to be non-recourse actually a full-recourse financial instrument.
How does a "Bad Boy" carve-out affect the loan-to-value ratio?
A "Bad Boy" carve-out affects the loan-to-value ratio by allowing the lender to increase the amount of recourse they have in the event of a default. This means that if the borrower is found to have conducted themselves as a "bad boy" (e.g. raising subordinate financing without the primary lender's approval, or not sending financial reports on time, not paying real estate tax on time, or not having proper insurance on the property), then the lender can increase the amount of recourse they have in the event of a default. This can result in the loan-to-value ratio being increased, as the lender is now able to recoup more of their losses in the event of a default.
What are the benefits of a "Bad Boy" carve-out for a borrower?
The main benefit of a "Bad Boy" carve-out for a borrower is that it allows them to not be personally held responsible in the event of a default on the terms of the loan, thereby being non-recourse. This gives the borrower the ability to protect themselves while still leaving investors protected if the borrower has conducted themselves as a “bad boy” by doing something not allowed in the loan terms, like raising subordinate financing without the primary lender's approval, and thereby over-leveraging the property as per the terms of the note.
In addition, some lenders are updating their carve-out provisions to include things like not sending financial reports on time, not paying real estate tax on time, or not having proper insurance on the property. It's important for borrowers to read carve-out clauses very carefully because additions like these make a loan that appears to be non-recourse actually a full-recourse financial instrument.
Sources:
What are the most common types of "Bad Boy" carve-outs?
The most common types of "Bad Boy" carve-outs are raising subordinate financing without the primary lender's approval, fraudulently preparing financial statements or tax returns, failure to pay required property insurance premiums, failure to pay property taxes, wasting funds, environmental indemnifications, and borrower negligence. Source and Source.