A “bad boy” guarantee is triggered only upon the occurrence of certain events that would jeopardize the lender’s ability to be repaid from the partnership’s assets and that are within the control of the sponsoring or managing partner.“bad boy” events often include the partnership’s voluntary bankruptcy filing, the managing partner’s filing of an involuntary bankruptcy petition against the partnership, etc.In reaching its conclusion that the LLC’s financing did constitute a “qualified non-recourse financing” under the at-risk rules of Section 465 of the Code, the Chief Counsel stated: “When a member of an LLC treated as a partnership for federal tax purposes guarantees LLC qualified nonrecourse financing, the member becomes personally liable for that debt because the lender may seek to recover the amount of the debt from the personal assets of the guarantor . Investors could have ignored the Memorandum on the theory that it was illogical, contrary to standard practice in the real estate financing market and unlikely to be sustained by the courts.
Self liquidating loan example
For purposes of determining whether a partner bears the economic risk of loss with respect to a partnership liability under the tax basis rules of Section 752 of the Internal Revenue Code of 1986, as amended (the “Code”), and the Treasury Regulations thereunder, all statutory and contractual obligations relating to the liability are taken into account, including, for example, a partner guarantee of partnership debt. Further, if an “obligation would arise at a future time after the occurrence of an event that is not determinable with reasonable certainty, the obligation is ignored until the event occurs.” Treas.  Most real estate partnerships use a combination of equity and non-recourse financing to fund their real estate acquisition and/or development activities.
However, a guarantee obligation will be disregarded “if, taking into account all the facts and circumstances, the obligation is subject to .” Treas. In this context, non-recourse financing means the lender will look only to the assets of the partnership and not to the partners to repay the loan, except that the lender often requires the sponsoring or managing partner to give a so-called “bad boy” guarantee.
The meeting was held on March 8 at the IRS in Washington, and was attended by Mr. At the meeting, Joe Forte described the legal and practical evolution of the particular “bad boy” guarantee at issue in the Memorandum.
The participants explained to the IRS, among other matters, that the “bad boy” guarantee is a device to prevent the borrower from taking certain voluntary actions, such as a bankruptcy filing, and the guarantor is very unlikely to ever take any of the prohibited actions or have liability on the guarantee.
If this position had become established law, real estate investors would have had to recapture billions of dollars in losses from previous years and would not have been able to share in losses in excess of their equity capital going forward.