Mich. appeals court rejects bank's challenge to state's new mortgage loan act

By Jessica M. Karmasek | Apr 10, 2013

LANSING, Mich. (Legal Newsline) -- The Michigan Court of Appeals on Tuesday rejected a constitutional challenge by Wells Fargo Bank to the state's recently passed Nonrecourse Mortgage Loan Act.

In its 14-page opinion, the court held that the NMLA bars the bank's claims in Wells Fargo Bank NA v. Cherryland Mall Limited Partnership and David Schostak.

The case was remanded to the appeals court from the state Supreme Court for reconsideration of its prior decision in light of the legislature's passage of the NMLA.

Cherryland secured an $8.7 million commercial mortgage-backed security, or CMBS, loan using a mall it owned as collateral. Schostak signed a guaranty.

Generally, CMBS financing involves the lender agreeing not to pursue recourse liability against the borrower or its owner; in return, the asset used as collateral, which is known as "a single purpose entity," as well as money that flows from that asset, is isolated pursuant to "separateness covenants" and narrow limitations on the lender's agreement not to pursue recourse liability.

These limitations are set forth in "limited recourse provisions," are referred to as "recourse triggers" or "carveouts," and are generally related to "bad acts."

In this case, Wells Fargo commenced foreclosure by advertisement when Cherryland failed to make a payment or payments.

The bank successfully bid $6 million, leaving a $2.1 million deficiency. It sued the defendants seeking to recover the deficiency.

Relative to the deficiency, the defendants appealed the trial court's finding that Schostak, "as guarantor, was liable for the entire loan deficiency on the basis of the trial court's conclusion that insolvency was a violation of Cherryland's [single purpose entity] status."

The appeals court affirmed, concluding that Cherryland's failure to remain solvent "breached the covenant to maintain its status as [a single purpose entity] and triggered the full recourse provision of the mortgage."

The court concluded, consistent with the trial court, that a section of the mortgage -- paragraph 9(f) -- was a single purpose entity requirement and that insolvency was a violation of single purpose entity status.

Further, the appeals court concluded, any failure to remain solvent, regardless of the reason, was a violation.

The court acknowledged the argument that its holding would "indicate economic disaster for the business community in Michigan," but concluded that its job "was not to save litigants from their bad bargains or their failure to read and understand the terms of a contract."

Moreover, in response to the argument that the contracts should not be enforced because they are against public policy, the appeals court noted that it was up to lawmakers to address matters of public policy.

Following its original decision, Cherryland and Schostak sought leave to appeal in the state's high court.

While the application was pending, the legislature passed the NMLA.

The act applies "to the enforcement and interpretation of all nonrecourse loan documents in existence on, or entered into on or after, the effective date of [the NMLA]," which was effective March 29, 2012.

Wells Fargo argued that the NMLA did not invalidate the guaranty because Schostak relinquished his right to future defenses and waives any statutory rights regarding the invalidity, illegality or unenforceability of the guaranty.

Further, the bank argued that the NMLA violates the contract clauses of the U.S. and Michigan constitutions, and the due process protections and separation of powers doctrine of the U.S. Constitution.

"We conclude that the guaranty provisions are invalid and unenforceable under the NMLA, and that the constitutional challenges to the Act must fail," the appeals court wrote in its per curiam opinion this week.

From Legal Newsline: Reach Jessica Karmasek by email at jessica@legalnewsline.com.

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