## Facts

- Royal Plaza, Ltd. and Maddlee, Inc. were formed to acquire a hotel in Orlando, Florida; Lee and VanWhy were principals of the acquisition entities.
- The acquisition was financed with a first mortgage loan (about $34.2 million) and a mezzanine loan from Heller Financial, Inc. (about $9.9 million).
- The mezzanine loan documents included an Equity Loan Agreement and a Promissory Note with a general nonrecourse provision limiting Heller to specified collateral.
- The Note contained an express carve-out making certain makers personally, jointly, and severally liable for repayment of the loan upon breach of covenants in the loan agreement, including a covenant barring additional encumbrances (liens) on the property and related interests.
- After closing, a third-party manager operated the hotel and tax and mechanics’ liens totaling about $820,000 were filed against the property.
- Heller treated the liens as a breach of the “additional encumbrances” covenant, declared a default, accelerated the mezzanine debt, and foreclosed on pledged equity interests.
- The collateral disposition and hotel sale proceeds were insufficient to satisfy the mezzanine debt, and Heller sued Lee and VanWhy to recover the resulting deficiency under the carve-out.
- Lee and VanWhy argued the liens could have been cured for $820,000 and that imposing personal liability for the entire $9.9 million debt functioned as an unenforceable penalty or disproportionate liquidated damages, particularly given their claimed lack of knowledge of the liens.

## Issues

1. Whether the loan documents’ nonrecourse carve-out unambiguously converted the mezzanine loan to full recourse against Lee and VanWhy upon the filing of any prohibited lien in violation of the “additional encumbrances” covenant.
2. Whether enforcing full personal liability for the entire debt/deficiency, triggered by liens totaling about $820,000, was unenforceable as a penalty or improper liquidated damages.
3. Whether the borrowers’ claimed lack of knowledge or direct fault for third-party-filed liens prevented enforcement of the carve-out.

## Decision

- The court denied defendants’ motion for summary judgment and granted Heller’s motion for partial summary judgment on personal liability.
- The court held that the plain language of the Note and Loan Agreement made Lee and VanWhy personally, jointly, and severally liable for repayment of the loan upon breach of the covenant against additional encumbrances.
- The court enforced the carve-out and rejected the argument that full recourse liability operated as an unenforceable penalty or liquidated damages clause.
- The occurrence of prohibited liens triggered the contractual recourse consequence despite arguments that liens arose from third-party management actions.

## Legal Principles

- Contract terms establishing nonrecourse status may validly include carve-outs that impose full personal liability upon specified covenant breaches, including unauthorized liens.
- Where a carve-out is drafted as a condition limiting recourse (rather than as a damages measure), courts may enforce full recourse liability upon the triggering breach without treating the provision as liquidated damages.
- A borrower may bear the contractual risk of prohibited liens even when liens arise through third-party conduct and without proof of the borrower’s intent to cause the breach.
- On summary judgment, unambiguous loan-document language allocating recourse consequences to defined covenant breaches may be enforced as written in a commercial financing transaction.

## Conclusion

The court enforced a nonrecourse carve-out provision in a mezzanine loan, holding that the filing of prohibited liens breached the “additional encumbrances” covenant and triggered full personal liability for the loan deficiency, and it rejected the borrowers’ contention that such recourse liability was an unenforceable penalty based on the disparity between the lien amount and the debt.


Heller Fin., Inc. v. Lee, No. 01 C 6798, 2002 WL 1888591 (N.D. Ill. Aug. 16, 2002)