BAD BOY CARVE-OUTS AND LATEST CALIFORNIA COURT INTERPRETATION

Guarantors’ liabiltiy for bad boy carve-outs in loan documents to be based upon the “intent” of the parties based upon a recent Calfiornia appellate case.

Facts in short are as follows: Loan documents were prepared to include a non-recourse carve-out if a lease was terminated without the lender’s consent. The tenant ceased to pay rent and abandoned the premises. California Civil Code Section 1951(a) provides “if a lessee of real property breachs the lease and abandons the property before the end of the term.. the lease terminates.” The trial court held this triggered the bad boy carve-out and triggered guarantor liability on the loan.

The court of appeal reversed looking to the issue of intent of the parties for the following reasons:

• The lease stated that the leases shall not be terminable for any reason by by the tenant. Thus, failure to pay rent and abandonment alone would not terminate the lease.
• California Civil Code Section 1951(a) is subject to California Civil Code Section 1951.4(b), which provides that, “ Even though a lessee of real property has breached the lease and abandoed the premises, the lease contineu in effect so long as the lessor does not terminate the lessee’s right of possession.”
• The borrower never gave notice of termination of the lease, and, in fact, gave written notice to the tenant that pursuant to California Civil Code Section 1951.4(a) that the lease would continue in effect.

This case promises to be part of a continuing series of cases that lenders and borrowers alike will be closely reviewing in the aftermath of the Cherryland case. See News on GLF website relating to our analysis of the Cherryland decision.

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