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Will Trump Organization Conviction Trigger ‘Bad Boy’ Clause With Lenders?

UPDATE, APRIL 3, 2023: This article was originally published after the Trump Organization was found guilty of tax fraud in New York in late 2022. Former President Donald Trump is expected to be indicted in federal court Tuesday, April 4, on dozens of charges related to business fraud. It is unclear if this indictment puts the properties his company owns at further risk of violating "bad boy" clauses in their loans.

The future of The Trump Organization is up in the air following its multiple tax fraud convictions earlier this week, but an aptly named clause present in most commercial property loans could force the company to pay out hundreds of millions in debt or risk immediate foreclosure of some of its portfolio.

“Bad boy” carve-outs became standard in the vast majority of loan documents following the Great Financial Crisis and are primarily intended to disincentivize unsavory activity.

They can be triggered via a crime like fraud, after which a lender could claim a loan’s borrower and guarantor may be immediately liable for its entire outstanding balance. In other cases, the parties may only be responsible for covering losses suffered by the lender as a result of the bad act.

Trump Tower in New York

Legal experts said it is unclear whether the Trump Organization’s property loans are subject to the carve-out, and opinions vary on whether criminal income tax fraud translates to lender damages.

But if Trump’s loan agreements include the common bad boy carve-out, the firm’s lenders may see criminal convictions as a compelling reason to exercise the remedy, said Eric Orenstein, an attorney at New York-based Rosenberg & Estis and leader of the firm’s transactional department.

“Lenders are averse to reputational risk,” he said. “If there is someone who risks their reputation, and they’re going to get dragged into the media for making these loans, they may try to figure out how to get out of the loans they have.” 

The Trump Organization could be subject to a maximum $1.6M fine following the conviction, and the company has said it plans to appeal. Former President Donald Trump was not a defendant in the case.

A lender invoking a bad boy carve-out would require the borrower — or in the case of many loans, the guarantor — to immediately pay out the deficiency on the loan. If the guarantor is unable or refuses to pay, the lender can seize the building.

In today’s market, Orenstein said, lenders must carefully weigh their options. If a property is equity-rich and can be refinanced and sold, then calling in the loan may be prudent. 

If the property is depreciating in value, invoking the carve-out may be more trouble than it’s worth. Trump’s commercial portfolio is made up of a handful of older office properties, including 40 Wall St., Trump Tower and minority stakes in 1290 Sixth Ave. and 555 California St. in San Francisco, all of which are decades old.

“If it’s an office building, in these times, you probably don’t want it back,” Orenstein said. 

In any scenario, invoking a bad boy carve-out will almost certainly lead to a lawsuit, Orenstein said, as guarantors are not likely to agree to an immediate payout of the property’s debt.

40 Wall Street

“People who have a penchant for being bad actors, more likely than not, aren’t afraid of litigation and aren’t just going to pay you to go away,” he said. “You’ll have some three- to five-year fight over a guaranty, and what does that get you?”

Some also believe that the Trump Organization’s crimes may not directly impact the loan on any given property, especially if mortgage payments are up to date. 

“In my experience, most of these loan documents don’t have a clause that says, ‘the guarantor is now liable for the entire loan if they get convicted of a crime,’” said Ross Yustein, a partner at Kleinberg Kaplan and chair of the firm’s real estate department. “That doesn’t mean they don’t exist out there, but that’s not the commercially standard document I’ve seen.” 

Where it gets tricky is if fraudulent documents were used to secure the loan.

Earlier this year, New York Attorney General Letitia James lodged a civil lawsuit against Donald Trump and his three eldest children for allegedly misvaluing assets in order to score better loans from banks and avoid paying taxes. 

But even if there is a reason to believe a client misrepresented their finances, the choice to invoke the bad boy clause will rely almost entirely on the performance of the loan, said Betsy Karmin, partner at Morris, Manning & Martin. 

“Most institutional lenders are not trigger-happy on calling a default if you’re otherwise current on loan payments and the property is otherwise performing,” she said. “Once they call a default, it puts it in a riskier category on the books of the lender that could also cause regulators to be concerned.”

How often the clause is triggered often comes down to clientele, Orenstein said. Some lenders are more comfortable than others with the risk of taking on clients who may breach a bad boy clause.

“In the real estate world, we know what we are getting involved in when we’re doing deals,” he said. “There are borrowers who are great borrowers and sponsors, and you have borrowers where you don’t know what you’re getting yourself into, and you price the deal accordingly.”

Some lenders may view invoking the bad boy carve-out as an opportunity to get out from under a loan on an underperforming asset, Karmin said. Trump Tower, for example, has struggled with high vacancies. Earlier this year, the Trump Organization secured a $100M mortgage to refinance the property.

“Maybe you’re not in monetary default and you’re still making payments every month, but it’s a poorly performing asset in the sense that it’s bad collateral for this loan,” Karmin said. “Then maybe you could use misrepresentation as a way to call a default … take the property back and sell it in foreclosure.”

1290 Sixth Ave. in Midtown Manhattan, New York

At first glance, it may appear that the Trump Organization’s crimes could trigger a wave of foreclosures, but that all depends on how much property the company actually owns.

Many of the buildings that bear the former president’s name are not actually owned by the organization. In some cases, the company licenses its name to a developer but has no actual ties to the property.

The buildings Trump does own may also be structured as a joint venture. And in those cases, Yustein said, it would not be uncommon for there to be a clause in the loan that automatically removes the bad actor from the agreement if the carve-out is breached. 

“If you are concerned or you morally have a problem being associated, or you feel political pressure, whatever it may be, you at least have the opportunity to invoke the removal clause,” he said. 

Legal experts who spoke to Bisnow agree it is highly unlikely the lenders who work with Trump will trigger a bad boy clause unless a property is in default or is in immediate danger of such. If distress does occur, whether a lender chooses to work with the borrower to rescue the property may hinge on their perception of the organization’s integrity.

“If a loan is in default, but it’s The Trump Organization, then maybe you’re less likely to do a workout with them at this point because of the level of trust,” Yustein said. “Are you getting accurate information? Do you want to be associated? Do they have the resources to back it up?”