“Bad boy” carve-outs are conditions by which a lender can go after a borrower’s personal assets on a non-recourse loan.
A non-recourse loan normally protects the borrower’s personal assets in the event that he or she fails to pay the commercial loan payments. The lender can foreclose on and sell the property to replace lost loan funds but can’t go after personal assets.
At least, that’s how non-recourse loans typically work. But “bad boy” carve-outs are exceptions to the rule. If a borrower turns in fraudulent reporting, uses the property for crime, or lets the property fall into disrepair and low occupancy, that borrower is defined as a “bad boy” and the lender can go after his or her personal assets.
Another common carve-out is when the property owner gets additional financing when the loan terms don’t allow it, sell part of the property, or otherwise try to defraud the lender.
But not all lenders impose carve-outs equally. As a multifamily buyer, it’s your job to know the conditions of the loan. A supposed non-recourse loan might contain recourse conditions for fairly innocent acts, such as turning in financial statements late or obtaining insufficient insurance. Know what you’re getting into.
Most non-recourse loans like Freddie Mac Small Balance have reasonable bad boy carve-outs, though. They are usually nothing to be afraid of. Carve-outs are typically well worth accepting in light of the huge benefits of a non-recourse loan.