As a matter of first impression, the Appellate Court of Illinois, First District, Second Division on December 28, 2012 held in Bank of America v. Freed that the guarantors of a non-recourse loan with "carve-out" provisions were liable for the full amount of the loan after one of the non-recourse carve-out provisions of the guaranty was triggered. The guarantors had challenged the carve-out provision, arguing that it was vague, ambiguous, overly broad and an unenforceable penalty.

The lender had entered into a construction loan agreement with Joseph Freed and Associates, LLC (JFA) with a maximum principal amount of $205 million. The loan was guaranteed by JFA's president, Laurance Freed, and JFA's parent company, DDL LLC. The guaranty placed an approximately $50 million cap on the guarantors' liability, subject to certain non-recourse carve-out provisions that, if triggered, would turn the non-recourse loan into a full recourse loan. The carve-out provision at issue in this case required full repayment if the borrowers or guarantors contested, delayed or otherwise hindered any action taken by the lender in connection with:

Following a failure to reach an agreement after the borrower defaulted on the loan, the lender filed a foreclosure complaint seeking to foreclose on the property and to obtain judgment on the guaranty for the capped guarantor liability amount. However, after the guarantors contested the foreclosure and the appointment of a receiver, the lender amended its complaint and sought the full amount of the loan from the guarantors when the carve-out provision was triggered.

The guarantors argued, in part, that the carve-out provision was an unenforceable penalty because there was no connection between the additional $94 million they now owed and the actual damages suffered by the lender as a result of the triggering of the carve-out provision. The Court disagreed, finding that the non-recourse carve-out clause was valid and enforceable because it permitted the lender to only recover its actual damages. The actual damages equalled the full amount of the loan and not, as the guarantors argued, the damages from the guarantors' breach of the carve-out provision.

The Court also disagreed with the guarantors that the carve-out provision was an unenforceable restraint on the guarantors' right to defend themselves and void as against public policy. The Court reasoned that the carve-out provision did not prevent them from contesting the appointment of a receiver or the foreclosure action. The guarantors could still take those actions but just forfeited their full repayment liability exemption by doing so. The carve-out provision only changed the personal liability of the guarantors if they chose to breach the provision.

This case presents another example of courts upholding non-recourse carve-out provisions. For more on non-recourse guaranties, see: