Real Estate Law

The Sixth Circuit, Relying upon Michigan’s Nonrecourse Mortgage Loan Act, Rejects the Enforceability of an Insolvency Covenant

Notwithstanding Michigan’s 2012 Nonrecourse Mortgage Loan Act (NMLA), which provides that solvency covenants in nonrecourse loans unenforceable, in Borman, LLC v. 18718 Borman, LLC, a third-party purchaser of a foreclosed property sought a deficiency judgment against the borrower and guarantor on the grounds that the solvency clause in the promissory note transformed the nonrecourse loan into a recourse loan when the borrower defaulted as a result of insolvency. On February 3, 2015, the U.S. Court of Appeals for the Sixth Circuit upheld summary judgment in favor of the borrower, holding that the NMLA applies retroactively, [enhanced version available to lexis.com subscribers].

In Borman, the borrower obtained an $8.7 million commercial mortgage-backed security loan in 2005 and defaulted on the loan in 2010. At the foreclosure sale in 2011, the servicer acquired the commercial property with a $2.1 million credit bid. Neither the lender nor the servicer sought a deficiency judgment against the borrower. A year later, the servicer sold the property at auction with a high bid of $756,000, advertising that the borrower “held the property subject to a nonrecourse loan before foreclosure.” The purchaser, contending that it stood in the shoes of the lender, then sought a deficiency judgment against the borrower and guarantor. The district court granted summary judgment in favor of the borrower and guarantor, [enhanced version available to lexis.com subscribers].

On appeal, the purchaser asserted that the loan failed to qualify as a “nonrecourse loan” under the NMLA because by the time the NMLA took effect, pursuant to the terms of the promissory note, the loan had transformed to a recourse loan as a result of the borrower’s insolvency. The purchaser also claimed that the loan did not constitute a “nonrecourse loan” under the NMLA because the loan was no longer secured by mortgage on real property following the foreclosure.

The Sixth Circuit rejected the purchaser’s arguments, holding that the NMLA applied to any loan containing a nonrecourse provision existing at the time the NMLA became effective, regardless of whether the nonrecourse provision remained enforceable at the time of NMLA’s effective date. And, following the same logic, the Sixth Circuit concluded that, although the NMLA defined nonrecourse loans as “secured by a mortgage on real property,” the loan need only have been secured by a mortgage on real property at any time, not merely beyond the effective date of the NMLA.

Accordingly, the Borman decision underscores that solvency covenants in promissory notes will be held unenforceable in Michigan.

- Alan S. Petlak, Ethan Chernin, and Edward Chang

Read more from this issue of the Mortgage Banking Update.


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