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.