COVID-19 – Impact on Nonrecourse Loans and “Bad Boy” Carveouts

In this blog post, I cover how the COVID-19 pandemic may negatively influence your existing nonrecourse loans because of possible exposure under existing “bad boy” carveouts.

Real estate professionals have always preferred structuring the debt on their properties with nonrecourse loans. A nonrecourse loan allows the lender upon default to only go after the underlying collateral, as opposed to being able to go after the Borrower and any Guarantors for the full amount of the debt. However, most nonrecourse loans contain carveouts commonly known as “bad boy” carveouts or provisions. These “bad boy” carveouts are typically bad acts that if they occur, trigger liability for either the full amount of the loan or for the specific losses relating to such “bad boy” act(s).

Because of COVID-19, many Borrowers are facing difficulties with their loans and the performance of the underlying properties serving as collateral. If they structured their debt as a nonrecourse loan, they may falsely believe that their only exposure if possibly losing the property to the lender. However, all Borrowers and Guarantors with nonrecourse loans that contain “bad boy” carveouts should be aware of the following most common carveouts they may face exposure under:

Misapplication of Funds

In any property with tenants, the lender will require a “bad boy” carve out that covers misapplication of funds (such as rents, security deposits, insurance/condemnation proceeds, etc.). During the COVID-19 pandemic, Borrowers who are struggling financially and do not have tenants making timely rent payments need to be cautious that they are not misapplying the funds they do receive. All funds received need to be applied as set forth in the loan documents and the applicable lease(s).

Failure to Pay Taxes, Insurance, and/or Liens

Like the misapplication of funds, a “bad boy” carveout may cover lender for losses relating to failure pay taxes, insurance, and/or liens. If this is a requirement of Borrower and a “bad boy” carveout, then Borrower needs to be careful that all such expenses are being paid even if they are having rent or cash flow issues at the subject property.


It is a good bet that causing waste to the property will be a “bad boy” carveout, and thus every Borrower needs to be aware of how this could possibly affect their exposure. We always counsel our clients to negotiate this carveout to be limited to material, physical waste of the property and to carve out any waste that could have not been prevented because of insufficient cash flow from the operation of the property. Nevertheless, if any repair issues come up that are not fixed could possibly lead to exposure under this carveout even if these recommendations are incorporated into the loan documents. If they are not, Borrowers should be cognizant of how “waste” is defined in their loan documents and what it could constitute.  


A common “bad boy” carve out deals with losses caused by any fraud or intentional misrepresentation or failure to disclose a material fact by the Borrower. Many times, this specific carve out is tied into the representations, warranties, and covenants made by the Borrower under the loan documents. This can become an issue if any of those have been affected by the results from COVID-19; such as leases not having any defaults, financial stability of the property, or certain financial covenants. Tenants not paying rent can possibly lead to any number of these possible representations changing.

SPE Violations

Almost all commercial real estate loan documentation contains special purpose entity (“SPE”) requirements, and often a violation of same are a “bad boy” carveout. These need to be paid special attention to because Borrowers may not know that certain things can trigger an SPE violation. It is also especially important because many times SPE violation are “bad boy” carveouts that result in full recourse (we always negotiate against this for our clients unless the SPE violation actually results in a substantive consolidation). The most common things that may occur as a result difficulties from the COVID-19 pandemic that could lead to an unknown violation of SPE covenants are (i) maintenance of specific capital requirements (see insolvency discussion below), (ii) paying debts from outside the company’s own funds/assets, (iii) commingling of cash/funds, (iv) issuing/receiving affiliate loans, and (v) paying debts timely.


Another possible “bad boy” carveout is if the Borrower becomes unable to pay its debts as they become due. Basically, the Lender is trying to protect itself against the Borrower becoming insolvent. This could become a big issue as Borrowers negotiate with their lender any possible payment deferrals or other matters. Borrowers need to be careful not to freely admit the hardship and troubles they are having so lender does not construe same as a possible default under the loan documents and triggering exposure under a “bad boy” carveout. If needed, Borrowers can request for a pre-negotiation agreement to be entered into with lender so that they can feel free to negotiate with lender and not risk any discussions being viewed as an admission of insolvency.


These last two (2) carveouts are typically full recourse “bad boy” carveouts and thus risk the most exposure to the Borrower and Guarantor. If triggered, they could be liable for the full amount of the loan. With transfers, most Borrowers think this only means transferring the membership interests in the company, but this could be triggered by entering a lease amendment without lender’s consent. Accordingly, any lease negotiations and proposed amendments with tenants during COVID-19 must usually be approved by the lender. Failure to do so could trigger a default under the loan documents and possibly full recourse under a “bad boy” carveout. with lease negotiations and amendments becoming increasingly prevalent during the COVID-19 pandemic, this issue becomes unequivocally important for Borrowers to be aware of.


This last “bad boy” carveout always results in full recourse to the Borrower and Guarantor. Before deciding to move forward with any bankruptcy filing or assignment for the benefit of creditors, Borrowers need to realize they can be exposing themselves and the Guarantor to full recourse. These are matters that should always be discussed with counsel before any decision on bankruptcy is made.

The above is a basic introduction to the issues that may arise under “bad boy” carveouts Borrowers and Guarantors have on their existing nonrecourse loans because of the effects of CVOID-19. Based on all the above, real estate professionals with nonrecourse loans that contain “bad boy” carveouts would be wise to review their existing loan documentation to confirm whether they are at risk of exposure. They should also be mindful of such possible exposure prior to engaging in any workout discussions with their lender. Nevertheless, every situation is different and demands the proper attention and handling to navigate these uncertain times. If you are a borrower or related real estate professional and want to discuss any of the above or have a similar situation and would like to discuss with an attorney, please do not hesitate to contact me.

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