Q. Well, I guess this is an important legal concept, but it sure doesn’t sound so technical…
A. For once, the lawyers are using plain language. Of course, normally the parties to a business deal are corporations, LLCs, other legal entities, and those entities are the ones who get sued if something goes wrong. The *owners* or *executives* of the legal entities are not themselves personally liable for a breach of the contract… but that’s what a “bad boy” clause changes– the individuals who own and run the entity become liable if the entity does something the contract prohibits.
Q. And these are fairly common in private transactions?
A. Not super common for routine breaches of contract, but more oriented to particular bad behavior, as the name implies. Things like waste, fraud, mis-appropriation. But they can also apply to financial acts, like taking on additional debt or filing for bankruptcy… you see a fair amount of commercial real estate deals, for example… where mortgage lenders will demand this of the building owner or developer.
Q. Seems kind of extreme.. how did these come about?
A. In RE downturn before last, a common problem was that, just when a lender was going to foreclose on a mortgage, the borrower would file bankruptcy and tie up the foreclosure for years. So they started imposing these “bad boy” provisions, saying that if the executives of the companies did that, they themselves would become personally liable. And that idea became very popular.
Q. So, despite the name, these happen not just with mom and pop type RE deals, but with really large commercial transactions?
A. Oh, yes, the largest. In fact, they actually have provided unexpected problems in the biggest deals because those require multiple lenders… who may not agree on how to deal with a troubled property– but, because of the big boy guarantee, the owners is not even going to think about filing bankruptcy, where everything can be worked out in court. Instead of speeding things along, bad boy guarantees actually created a big bottleneck in clearing a lot of distressed projects from the market. So, like everything else… be careful what you wish for!