Bankers and their counsel should note that during its December lame-duck session, the Ohio General Assembly passed the Ohio Legacy Trust Act (Am. Sub. H.B. 479), which will go into effect March 27, 2013.  The Act creates borrower-friendly provisions prohibiting the use of so-called “Cherryland” insolvency carve-outs in nonrecourse loan documents which will be of interest to all financial institutions engaged in commercial lending in Ohio.

“Cherryland” insolvency carve-outs are so named for the 2011 Michigan appellate case, Wells Fargo Bank, NA v. Cherryland Mall Limited Partnership, in which the court upheld a widely-used provision in non-recourse loan documents that caused the loan at issue to become fully recourse to the guarantor upon the insolvency of the borrower.

The Cherryland Mall decision prompted the Michigan legislature to pass the Nonrecourse Mortgage Loan Act, which became effective in Michigan in March of 2012. In order to legislatively overturn the Cherryland Mall decision, the Nonrecourse Mortgage Loan Act provides that a post-closing solvency covenant cannot be used as a nonrecourse carve-out or as the basis for any claim or action against a borrower or guarantor on a nonrecourse loan. It also provides that any provision purporting to create such a carveout is invalid and unenforceable.

"Post-closing solvency covenant" is defined in both Michigan’s Nonrecourse Mortgage Loan Act and the Ohio Legacy Trust Act to mean "any provision of the loan documents for a nonrecourse loan, whether expressed as a covenant, representation, warranty, or default, that relates solely to the solvency of the borrower, including, without limitation, a provision requiring that the borrower maintain adequate capital or have the ability to pay its debts, with respect to any period of time after the date the loan is initially funded." The definition does not include a covenant not to file a voluntary bankruptcy or other voluntary insolvency proceeding or not to collude in an involuntary proceeding, so provisions of this sort should continue to be included where appropriate in nonrecourse loan documents.

Ohio law had not explicitly addressed the issue raised in Cherryland until the passage of the Ohio Legacy Trust Act.  The Act contains language substantively identical to that of the Michigan Nonrecourse Mortgage Loan Act.  The Act will add Sections 1319.07, 1319.08, and 1319.09 to the Ohio Revised Code. When effective (which is itself a matter of some complexity as described below), these sections will prohibit the use of post-closing solvency covenants as nonrecourse carveouts in a nonrecourse loan and will make any provision purporting to create such a carveout invalid and unenforceable.  The Ohio General Assembly stated that the use of a post-closing solvency covenant as a carveout to a nonrecourse loan is inconsistent with the nature of a nonrecourse loan and is "an unfair and deceptive business practice and against public policy."

Lenders using nonrecourse loans should consult legal counsel about how this new statute will affect their loans. In addition to the Cherryland Mall provisions, the Act contains a number of unrelated provisions:  establishing “legacy trusts” in Ohio, increasing the personal residence exemption from execution, garnishment, attachment, or sale to satisfy a judgment from $20,200 to $125,000, effectively eliminating the rule against perpetuities in certain trusts, and changing various other trust-related provisions of Ohio law.