A year ago Standup Stanley bought Hotel 8 Properties. Stan’s banker Betty Maekit-hapen was able to get him the purchase money and an operating line of credit loan from DaytonaMac Bank. Hotel 8 was able to use its valuable Arizona real estate and cash flow as collateral without Stan’s personal liability so long as Hotel 8 did not incur any additional debt, or go into bankruptcy. Betty warned Stanley that if Hotel 8 defaulted, it had no right in their loan agreement to cure the problem.

Late last fall Hotel 8’s cash flow got tight. Being a Standup guy, Stanley made multiple personal loans to Hotel 8 which was a violation of the loan documents. Betty Maekit-hapen was aware of Stan’s personal loans because they were used to make DaytonaMac loan payments, and she was working with Stanley to keep his business afloat. Even though Hotel 8’s real estate was still worth more than the remaining DaytonaMac loan balance, this last quarter Hotel 8’s financial condition got even worse. Bankruptcy reorganization is Hotel 8’s only hope.  Alas, DaytonaMac also fell on hard times. Late last year DaytonaMac was closed and its loans were sold to Vapid Vulture Fund. Vapid is in the business of buying cheap loans in the hope of acquiring valuable property, like Hotel 8’s, at a deep discount. Vapid is forcing Hotel 8’s property to be sold at foreclosure, probably then to be purchased by Vapid. Vapid also advises Stanley that, if Hotel 8 files for bankruptcy, Stan will become personally liable for the remaining loan balance.

Tilting the Scales in Your Favor.

  • Keep your banker informed. No one, particularly your banker who is trying to keep her job, likes surprises. Give them plenty of warning if your company is experiencing problems – even if the problems are just compliance with financial loan covenants.
  • Take the loan covenants seriously. Before signing the loan documents, consult with your bookkeeper to assess whether you can consistently keep the financial loan covenants current. Do not assume that all problems can be worked out with the lender.
  • Before taking any action, pay particular attention to those loan covenants that may trigger personal liability if there is a violation of the company’s loan agreement, often referred to as a “springing recourse guaranty.”
  • Consult with legal counsel before contributing or loaning funds to the borrower entity, since this form of cash infusion may trigger a default under the loan covenants.
  • When considering a bankruptcy filing, make sure you understand the scope of any springing recourse guaranties that have been given by parents, affiliates, and, if the borrower is part of a joint venture relationship, your partners and/or their affiliates. If in a joint venture, pay particular attention to contribution or other back-stop provisions that would make your partner’s liability your own. Consider whether the bankruptcy will generate sufficient new value to outweigh the new recourse liability.
  • Delay tactics with the lender, which are intended to forestall foreclosure, can be risky if the borrower’s defenses to collection are not successful. In some instances, merely raising a defense can trigger springing liability into a personal guaranty.
  • If you are a guarantor who is not in control of the borrower, stay on top of the borrower’s business in order to avoid being surprised by springing liability created by the actions of others.
  • If your loan documents so require, follow the single purpose entity (SPE) provisions since any material deviation may create personal liability. Examples of SPE provisions include, but are not limited to: keeping separate accounts, maintaining required separate books and records, not commingling funds or other assets, conducting business in the borrower’s name, paying liabilities and expenses only with borrower’s own funds, respecting corporate formalities, maintaining arm’s-length relationships with affiliates, maintaining separate stationery, invoices, and checks, and maintaining adequate capital.

See LaSalleBankNA v. Mobile Hotel Properties, LLC, 367 F. Supp 2d 1022 (2004); Heller Financial, Inc. v. Lee, 2002 WL 1888591 (N.D. III. Aug 16, 2002); FDIC v. Prince George Corporation, 58 F.3d 1041 (1995); First Nationwide Bank v. Brookhaven Realty Associates, 223 A.D.2d 618 (1996)