Borman, LLC v. 18718 Borman, LLC
| Decision Date | 03 February 2015 |
| Docket Number | No. 14–1419.,14–1419. |
| Citation | 777 F.3d 816 |
| Parties | BORMAN, LLC, Plaintiff–Appellant, v. 18718 BORMAN, LLC; Joseph Schwebel, Defendants–Appellees. |
| Court | U.S. Court of Appeals — Sixth Circuit |
OPINION TEXT STARTS HERE
ARGUED:Gregory D. Hanley, Kickham Hanley PLLC, Royal Oak, Michigan, for Appellant. Alan M. Greene, Dykema Gossett PLLC, Bloomfield Hills, Michigan, for Appellees. ON BRIEF:Gregory D. Hanley, Jamie Warrow, Kickham Hanley PLLC, Royal Oak, Michigan, for Appellant. Alan M. Greene, Jill M. Wheaton, Michael J. Blalock, Dykema Gossett PLLC, Bloomfield Hills, Michigan, for Appellees. Matthew K. Payok, Office of the Michigan Attorney General, Lansing, Michigan, Matthew W. Schlegel, Clark Hill PLC, Detroit, Michigan, for Amici Curiae.
Before: DAUGHTREY, CLAY, and COOK, Circuit Judges.
This appeal arises from Defendant–Appellee 18718 Borman, LLC's (“Borrower”) default on a nonrecourse loan secured by property located on Detroit's Borman Avenue, the street after which Borrower takes its name. The lender foreclosed, and Borman, LLC (“Purchaser”)—an unrelated entity also named after Borman Avenue—purchased the property at auction with a winning bid of $756,000. Then Purchaser, standing in the lender's shoes, sued Borrower and its guarantor to collect a roughly $6 million deficiency. The district court granted summary judgment in favor of Borrower, and we AFFIRM.
The issues on appeal require familiarity with the structure of Commercial Mortgage–Backed Securities (“CMBS”) loans and their recent history in Michigan. We review this background information before recounting the particular facts of this case.
In a nutshell, CMBS loans provide commercial real estate developers with project financing through capital markets. See Wells Fargo Bank, NA v. Cherryland Mall Ltd. P'ship ( Cherryland I ), 295 Mich.App. 99, 812 N.W.2d 799, 802 (2011) (per curiam) (citing Am. Br. of Commercial Mortg. Sec. Assoc. & Mortg. Bankers Assoc. at 4–14, In re Gen. Growth Props., Inc., 409 B.R. 43 (S.D.N.Y.2009)). Commercial real estate developers obtain CMBS loans to finance individual projects. The developer mortgages the property being developed as security for the CMBS loan. Lenders issue a number of CMBS loans and then pool the resulting mortgages into a trust. Finally, the trust issues securities backed by the cash flow from the developers' loan payments.
CMBS financing attracted new sources of capital to the commercial real estate market and “played a major role in leading the country out of the nationwide real estate depression caused by the savings and loan crisis of the late 1980s.” Id. (punctuation omitted). To attract these non-traditional investors, such as pension funds and individual bond investors, lenders structured CMBS loans to limit the risk that one developer's failed project might “drag the entire securitized mortgage pool into bankruptcy.” (R. 51, Summ. J. Order at 3.) And bankruptcy proceedings could hamper foreclosure by the trust and jeopardize timely payment to bondholders. CMBS loans contain two “bedrock elements” to limit the risks posed by bankruptcy. Cherryland I, 812 N.W.2d at 802 (citation omitted).
First, CMBS loans are nonrecourse. When a borrower defaults on a nonrecourse loan, the lender may foreclose on the asset and any other prearranged security, but the borrower and its guarantors do not become personally liable for any deficiency. In return for nonrecourse liability, the borrower promises to refrain from certain “bad boy” acts: financial behavior likely to increase the risk of default and bankruptcy. These covenants against “bad boy” acts constitute the second bedrock principle of CMBS loans. In general, the covenants require the borrower to maintain single-purpose-entity status. To achieve this, the developer “ring fences” the mortgaged property's operations from his other projects, usually by creating a separate legal entity concerned solely with managing the mortgaged property to act as the borrower. This way, a developer's personal financial difficulty resulting from his other, more risky projects will not affect the trust's ability to foreclose on the mortgaged property and—more importantly—its ability to make scheduled payments to bondholders.
Relevant to this case, the CMBS loan covenants commonly include a so-called solvency covenant, a promise that the borrower “shall not ... fail to remain solvent or pay its own liabilities (including, without limitation, salaries of its own employees) only from its own funds.” Cherryland I, 812 N.W.2d at 803 (citation omitted). Many in the CMBS loan industry intended solvency covenants to serve as a promise against filing for bankruptcy or colluding in an involuntary bankruptcy. ( See R. 40–14, Mins. Mich. Senate Econ. Dev. Comm. at 22–23.) For if “insolvent” meant simply the loss of cash flow resulting in default, then defaulting on a CMBS loan due to adverse market forces would expose a borrower—and its developer-principal—to personal liability, effectively obviating the first bedrock principle of nonrecourse liability.
In Cherryland I, the Michigan Court of Appeals considered how to interpret the solvency covenant quoted in the previous paragraph. In that case, the borrower failed to make its scheduled payments, and the trustee foreclosed on the collateral. Cherryland I, 812 N.W.2d at 804. The trustee then sued for a deficiency judgment against the borrower and its principal-guarantor, arguing that the default constituted insolvency, which destroyed the borrower's single-purpose-entity status and permitted recourse liability. Id. The borrower and its principal-guarantor countered that the promise of a nonrecourse loan would prove illusory if the court interpreted the solvency covenant to include simple default. Id. at 806, 814–15.
The court of appeals sided with the trustee, holding that the CMBS loan documents unambiguously required the borrower to remain solvent in order to maintain its single-purpose-entity status. The court rejected the borrower's interpretation because it relied on extrinsic evidence of industry practice, and the borrower failed to demonstrate any textual ambiguity with respect to the terms “single-purpose-entity status” or “solvent.” Id. at 809–10, 814–15. The court also rejected the stance that the trustee's interpretation created an illusory promise, demurring on the ground that the loan's allegedly illusory nature was a matter of Michigan legislative policy. Id. at 815–16. The court remarked in closing: “We recognize that our interpretation seems incongruent with the perceived nature of a nonrecourse debt and are cognizant of the amici curiae's arguments and calculations that, if accurate, indicate economic disaster for the business community in Michigan....” Id. at 815.
While the borrower's appeal of Cherryland I pended before the Michigan Supreme Court, the Michigan Legislature accepted the court of appeals's invitation to address the propriety of solvency covenants. See Wells Fargo Bank, NA v. Cherryland Mall Ltd. P'ship ( Cherryland II ), 300 Mich.App. 361, 835 N.W.2d 593, 597 (2012) (per curiam). In late March 2012, the legislature passed the Nonrecourse Mortgage Loan Act (“NMLA”) after conducting a senate hearing during which witnesses uniformly criticized Cherryland I and augured statewide economic disaster based on the number of CMBS loans in default—and therefore subject to a deficiency—after the 2008 recession. The NMLA applies retroactively to render solvency covenants in nonrecourse loans unenforceable, declaring them “inconsistent with ... the nature of a nonrecourse loan[ and] ... an unfair and deceptive business practice ... against public policy [that] should not be enforced.” 2012 Mich. Legis. Serv. P.A. 67, enacting § 1 (S.B.992); see alsoMich. Comp. Laws (“MCL”) §§ 445.1591–95.
In light of the NMLA, the Michigan Supreme Court declined to review the Cherryland I decision and remanded the case to the court of appeals for reconsideration. See Cherryland II, 835 N.W.2d at 596. The court of appeals held that the NMLA rendered the solvency covenant unenforceable and barred the trustee's deficiency action. Id. The court went on to reject the trustee's challenge to the statute's validity under the United States and Michigan Constitutions. Id. at 598–606. With this background, we turn to the facts of the case before us.
In June 2005, Borrower obtained an $8.7 million CMBS loan from Morgan Stanley Mortgage Capital, Inc., secured by the commercial property located at 18718 Borman Avenue in Detroit. Defendant–Appellee Joseph Schwebel, Borrower's principal, guaranteed all obligations on the loan for which Borrower might become personally liable. Borrower used the loan to purchase the property from and lease it back to a subsidiary of the Great Atlantic & Pacific Tea Company for use as a grocery distribution center. In December 2010, the grocery chain's subsidiary filed for bankruptcy. The bankruptcy court eventually permitted the subsidiary to terminate the lease and abandon the property. Borrower tried and failed to locate a replacement tenant or sell the property for its pre-recession value.
In October 2010, Morgan Stanley's loan servicer sent Borrower a formal notice of default, and Borrower turned the property over to a receiver. A year later, the servicer foreclosed on the property and purchased it with a $2.1 million credit bid. After the auction, either Morgan Stanley or its loan servicer took possession of approximately $1.76 million in escrow and a $500,000 letter of credit from Schwebel, both deposited as additional collateral under Borrower's loan. But neither Morgan Stanley nor the servicer sought a deficiency judgment.
In 2012, the loan servicer marketed the property onAuction.com, advertising that Borrower held...
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