Springing Liability: Full Recourse Means Full Recourse

Oak Creek Plaza, LLC v. Thrivent Financial for Lutherans, 579 B.R. 460 (N.D. Ill. 2017) –

The key issue in this case turned on interpretation of the recourse provisions of a mortgage note. The bankruptcy court held that the debtor’s bankruptcy filing triggered full recourse, which led to a series of orders ending with dismissal of the bankruptcy case. The debtor appealed to the district court.

The debtor obtained a $6.3 million loan evidenced by a note and secured by a mortgage on property that it owned. After the debtor defaulted, the lender commenced a foreclosure action. Four days before the scheduled foreclosure sale the debtor filed bankruptcy.

The lender filed a proof of claim for ~9.7 million. It also sought relief from the automatic stay and dismissal of the bankruptcy case. The debtor objected to the claim and filed the first of several reorganization plans. The bankruptcy court agreed that the lender was entitled to relief from the stay.

While continuing to modify its plan of reorganization, the debtor moved to have the automatic stay reinstated. The court refused to reinstate the stay and also refused to confirm the debtor’s fourth (and final) plan because it did not provide for the lender’s deficiency claim.

The lender proceeded with its foreclosure. The property was sold at a Sheriff’s sale where the lender’s special purpose entity bought the property for $5.3 million. In the meantime, the debtor appealed the bankruptcy court‘s decisions refusing to reinstate the stay, overruling the debtor’s objection to the lender’s claim, and dismissing the case. All of the orders turned on the court’s interpretation of the mortgage note:

  • Section 1 was titled “Agreement to Pay” and provided that the debtor “hereby agrees and promises to pay” the principal amount of the loan together with interest.
  • Section 28 was titled “Limited Recourse to Borrower” and Section 28(a) provided that “subject to the provisions of Section 28(b) and Section 29” the debtor’s liability was limited to 25% of “All Amounts Owing To Lender” less credits.
  • Section 28(b) provided that the debtor had personal liability for certain items (such as rents collected after default) in addition to the amounts set forth in Section 28(a) and Section 29.
  • Section 29 titled “Full Recourse” provided that notwithstanding section 28 the debtor “shall remain personally liable for the prompt payment of all sums owing hereunder” upon the occurrence of specified events, including a voluntary bankruptcy filing by the debtor.

To recap: the debtor promised to pay the loan, but its liability was limited to 25% of amounts owing to the lender except (1) certain specified items and (2) it was liable for “all sums owing” under the note if it filed bankruptcy.

Most people would not be surprised to learn that the bankruptcy court had interpreted this to mean that the debtor was liable for the entire amount of the loan since it filed bankruptcy. However, the debtor argued that “all sums owing hereunder” meant “all sums computed in accordance with the terms of the Note” – meaning limited to 25% pursuant to Section 28(a).

The district court treated this issue as a simple question of contract interpretation. Under applicable state law the goal was to give effect to the intention of the parties. Based on a detailed review of the provisions of the note, the district court concluded that the bankruptcy court’s interpretation that the debtor was required to pay the full recourse amount was the only reasonable interpretation.

Thus, the district court affirmed the decision of the bankruptcy court.

Debtors will sometimes argue that springing full recourse liability triggered by a bankruptcy filing is a de facto prohibition on filing bankruptcy that is against public policy. However, that argument is generally fruitless. The moral of the story appears to be that full recourse liability as a penalty for filing is likely to be enforceable, although anybody can litigate anything.

Vicki R Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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