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NEW YORK: An Introduction


Adam H. Friedman

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Current Issues Facing Lenders and Real Estate Owners
In New York State

By Lori Marks-Esterman
Adam Friedman

During the COVID-19 pandemic, New York, like many other states, imposed foreclosure moratoriums that prohibited mortgage foreclosure proceedings. Now that these moratoriums have been lifted, owners of commercial real estate are confronting the reality of materially lower valuations caused by the lasting impacts of the pandemic. Real estate owners are thus facing a situation they never thought they would encounter: the possibility that their building is no longer worth the amount of pre-pandemic debt that encumbers it.

With this new reality as a backdrop, mortgage lenders are likewise in unchartered territory and may be considering foreclosure as a possible remedy in the event a workout is not attainable. With the possibility that underlying real estate may be sold at materially lower valuations, lenders and borrowers alike are reminded of New York’s “Single-Action Rule” and the remedies available to lenders. Relatedly, we also review a New York City law enacted during the pandemic to protect personal guarantors of lease obligations, leaving the burden to fall on building owners.

New York’s Single-Action Rule: Choose Your Path Wisely

New York Real Property Actions Law (“NY RPAPL”) § 1301(3) contains what courts refer to as the “Single-Action Rule.” That rule mandates that when there is a default on a debt secured by both real property and promissory note (and potentially also a guaranty), the lender may not simultaneously foreclose on the mortgage while also pursuing an action at law for money damages on the note or guaranty. Rather, once the lender elects one of those paths, it may not pursue the other in a separate proceeding, absent court approval.

In determining which path to pursue, a lender should consider that while it might be able to secure a money judgment based on the note or guaranty, the judgment will not mean much if the borrower or guarantor does not have the funds to satisfy the judgment; and the lender must exhaust its collection efforts on the judgment before it is permitted to foreclose on its mortgage.

Careful review of guarantees is also required. Many real estate loans feature non-recourse debt, where the lender agrees to limit enforcement of its loan to the collateral (ie, the property). However, some loans are structured as non-recourse loans, which require the sponsor to execute a “non-recourse carve-out” or “bad boy” personal guaranty. These carve-out guarantees are triggered upon delineated “bad boy” events, such as the filing of bankruptcy proceedings, fraud, waste, or other acts.

Borrowers and lenders alike should carefully review all triggering events and the scope of the guaranty when evaluating options. While it is sometimes clear whether a fact pattern will trigger “bad boy” liability, many are not, and some are prime for litigation, which can cause substantial further delay. Over the years, the list of non-recourse carve-outs has grown, including some that have not been tested in court. For example, some carve-out events include even raising a defense to a foreclosure lawsuit. Could it be that raising a COVID-19 defense triggers the guaranty?

A mortgage foreclosure carries its own hurdles. A sale of the property often yields less than the amount of the outstanding debt, requiring the lender to seek the difference in a deficiency judgment against the lender or guarantor. New York law requires lenders to seek a deficiency judgment in the same action in which they seek to foreclose on the mortgage. Thus, lenders must name the guarantor in the initial foreclosure action, and must file a motion for a deficiency judgment following the foreclosure sale. If no such motion for a deficiency judgment is made, the proceeds of the foreclosure sale are deemed to be in full satisfaction of the mortgage, with the lender then losing the right to bring a second proceeding to recover on the note or guaranty.

Finally, two interesting exceptions to Single Action Rule to note: (1) if the guarantor triggers recourse liability during the course of a mortgage foreclosure. New York courts have held that where this occurs, a lender may make a new election under the rule and can sue on the guaranty, notwithstanding that the lender first elected to pursue a mortgage foreclosure; and (2) a foreclosure of membership interests pursuant to UCC Article 9 does not implicate the Single-Action Rule, as an Article 9 foreclosure is not an action on a note, nor even a judicial proceeding.

NYC Guaranty Law: Is it Valid? 

In May 2020, during the height of closures relating to the COVID pandemic, the New York City legislature enacted the Guaranty Law (NYC Admin. Code § 22-1005) to protect individual guarantors of businesses subject to the governmental closures. The NYC legislature noted that the economic hardships imposed upon business by such closures could have devastating consequences on the individuals who personally guaranteed the financial obligations of these businesses. The NYC legislature stated:

If these individual owners [...] are forced to close their businesses permanently now or to suffer grave personal economic losses like the loss of a home, the economic and social damage caused to the city will be greatly exacerbated and will be significantly worse than if these businesses are able to temporarily close and return or, failing that, to close later, gradually, and not all at once.

Thus, the Guaranty Law prohibits landlords from enforcing personal guaranties of commercial leases for establishments that were ordered to close under certain of New York’s Executive Orders (ie, restaurants, barbershops, and bars) as well for non-essential retail establishments subject to “in-person” restrictions under the Executive Orders. The Guaranty Law originally covered defaults between March 7, 2020 and September 30, 2020, but was extended to include defaults through June 30, 2021.

Since the Guaranty Law’s enactment, New York state courts have applied its protections to a wide array of businesses, including retail locations such as apparel stores and stores selling baby items, restaurants and photo shops.

Of note, however, the constitutionality of the Guaranty Law is currently being challenged in the United States District Court for the Southern District of New York, in Melendez et al v City of New York et al. The plaintiffs argue that the Guaranty Law violates the Constitution’s Commerce Clause, which prohibits the state from impairing private contractual obligations. In November 2020 the District Court granted the defendants’ motion to dismiss the case, but on appeal the Second Circuit reversed and remanded the case to the District Court for further proceedings. On March 28, 2022, the plaintiffs filed a motion for summary judgment arguing that, in light of the Second Circuit’s decision, the court should declare the Guaranty law unconstitutional.

We await the court’s ruling as to whether this law, designed to protect personal guarantors, will be upheld.