GP indemnification and the limits of bad boy clauses
Typical GP indemnification has a carve out for "acts or omissions which involve intentional misconduct, gross negligence, or knowing violation of the law", which I'd generally understood to mean things like taking the company's funds and going to Vegas. It was suggested on the Trepp podcast a few weeks ago that something as minor (and unintentional) as forgetting to pay property taxes or allowing the property to change tax class because of the condition of the property could make the partner personally liable. Does anyone have any specific examples of when LPs or debt holders have pursued managers under this broad interpretation of the bad boy clause?
I don’t have any specific examples to point to but like most things it’s going to be highly situational. Probably really comes down to if 1. The degree of damages and 2. Lenders appetite to own the real estate. If they really want to own the real estate and aren’t married to the sponsor, then yeah they might follow things to a T. If they like the sponsor, damages are minimal and easily repairable, and they don’t want to be the landlord of the asset, the might be more lenient and give out a stern “don’t do that again”. Just my .02
This the answer - frankly forgetting to pay property taxes would be a very unlikely scenario that someone would try to invoke the bad boy clause (and I'm not sure who would win in that case), but allowing the property to change tax class I could for sure see somebody pushing for it if they wanted control as that's a different degree of negligence.
OP in short, the clause is mostly intended to cover ethical violations or outright illegal activity, but gross negligence could also be cause.
Yes, its definitely case specific and depends on a lot of factors. But I'm not talking about instances where the bank or partners might want the property back. I'm interested in how its handled when investment/debt terms are non-recourse, but because of the bad boy clause, the lenders or partners pursue personal recourse. In other words - if a GP hasn't maintained the property and the city is taxing it as blighted and it has a bunch of housing violations, when have partners pursued personal recourse against the sponsor? It seems like its something that will happen more frequently as all of these firms who went crazy on cheap debt start losing their properties but don't have the funds or staff to do basic upkeep. There must be a RealDeal article somewhere, but Google hasn't been helpful.
I strongly suspect that failure to pay property taxes would not be considered a bad boy act, unless that is specifically highlighted or called out. At the very least I imagine any judge would allow a GP or owner the right to cure in that case.
Bad boy acts in general are named that for a reason. It's an action or lack thereof that someone knowingly commits, and does so knowing that it is criminal. Stealing funds out of escrow or commingling funds are bad boy acts. Forgetting to pay a bill isn't and shouldn't be considered one
Agreed here. I also think the lender would have to prove intent. Typically there are mechanisms to remind the borrower about upcoming payments but most likely that the lender is escrowing a monthly payment to make payment on behalf of borrower or to reimburse them. If you intentionally misappropriated those funds to go to Vegas, then you'd trip recourse.
You're right, undoubtedly late payment of property taxes wouldn't qualify as gross negligence. But surely there are scenarios when inaction could be grossly negligent. Imagine - the GP is late with payroll, and the property manager quits. Broken windows aren't fixed, the trash isn't collected, tenant repair requests aren't addressed. City notices the GP repeatedly about the condition of the property, but they're too focused on a new raise or a workout to notice or maybe they just don't care since they're likely going to lose the asset. Then the city taxes the property at 10x the regular rate and issues multiple citations for housing code violations. Even when the GP turns over the keys, shouldn't they have personal recourse for the ghastly condition of the property and the costs incurred, due to their failure to perform basic upkeep? As has been pointed out, the answer here is dependent on a bunch of factors, not least of all the quality of the lawyers involved. I'm interested in reading articles or reviewing dockets of when this has occurred.
It is if it's happened before. Depending on jurisdictions, some judges won't look kindly upon multiple payment problems.
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