ALERT: Bad Boy Guarantees and the IRS
May 2, 2016
Most non-recourse loans contain a “Bad Boy” provision. Typical Bad Boy provisions may cover: the filing of a bankruptcy, the taking of funds, the nonpayment of insurance or taxes as well as other prohibited activities. If the General Partner does any of these acts, then the General Partner will be liable for the loan. The purpose of this provision is to create a penalty that will cause the General Partner not to participate in such activities. The benefit to the lender is that the collateral is better protected and the lender’s path to control of the asset in the event of a default is much easier.
The Internal Revenue Service in a recent memorandum had indicated that the “Bad Boy” provisions might cause a loan to be categorized as a recourse loan, thus depriving the limited partners of basis for utilizing losses in excess of their investment.
On April 15, 2016, the IRS changed its position on the matter and said in a new ruling that the common “Bad Boy” provisions fit within the guidelines of Reg. 1.752-2(b)(4) and as a result the inclusion of such provisions within loan documents will not cause a loan to be considered as a recourse loan. This will permit the limited partners to utilize losses in excess of their investment.