The California Court of Appeals recently held in, LSREF2 Clover Property 4, LLC v. Festival Retail Fund 1, LP, that California’s anti-deficiency statutes that prohibit lenders from obtaining deficiency judgments against borrowers following a non-judicial foreclosure do not extend to guarantors unless the guarantors are proven to be the principal borrowers.
In LSREF2, Festival Retail Fund 1, LP (Festival Fund) purchased commercial real property and formed a single purpose entity to hold title to the property (Festival 357). It also created a wholly owned LLC, FRF1, as the general partner of Festival 357. Festival 357 then borrowed $25 million from a bank and signed a written guaranty of $1.5 million of the loan. Four years later Festival 357 defaulted on the loan and the bank’s assignee non-judicially foreclosed on the property and purchased it for $17.5 million at the foreclosure sale. It then pursued a deficiency judgment against Festival Fund under the $1.5 million guaranty.
Festival Fund claimed it was the true principal obligor under the loan and thus, protected by California’s anti-deficiency judgment laws. The Court of Appeals noted that Festival Fund set up the structure, not the lender. Festival Fund argued FRF1 was its alter ego, had not maintained corporate formalities and, thus, were one and the same and, consequently, Festival Fund was not a third party guarantor. The Court rejected the argument. It held, in part,
“To allow a guarantor to avoid its obligations simply because the debtor’s general partner – which is owned entirely by the guarantor – avoided complying with corporate necessities would work an absurdity. Guarantors could choose to avoid liability by instructing their affiliated companies to disregard corporate formalities.”
There are significant limitations on the protections afforded borrowers under the California anti-deficiency judgment laws where a guarantor even has the appearance of being a separate entity from the primary obligor. Before you consummate a California real estate deal you should seek legal advice on the structure, especially if a person or entity will guaranty all or a portion of the loan. Guarantees are just that, and it appears the Courts will hold guarantors liable for deficiencies even if they have a close, inseparable relationship with the principal obligor.
The information presented is not intended to be, and does not constitute, “legal advice.” Because each situation varies, and only brief summary information is provided here, you should not use this information as a basis for action unless you have independently verified with your own counsel that it applies to your particular situation.
