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CRE Finance World, Autumn 2012

Navigating the Structured Finance Waterfall: Smooth Sailing or a Barrel Ride over the Falls? foreclosure of its collateral (the borrower’s equity interest in the intercreditor agreement, proactive special servicing and decisions property-owning entity), would have the capacity to place the such as PCV and Star Pass now put what had been an effective property-owning entity into bankruptcy, thus blocking a foreclosure mezzanine lender strategy at risk. by the secured lender. Synchronized swimming is harder than it looks In Star Pass, the senior and mezzanine loans had been originated by Control waterfalls vest servicers with significant responsibility and the same bank. The mezz was economically underwater, creating can instill controlling certificateholder(s) with considerable authority. the appearance that the planned bankruptcy was an attempt to Borrowers, too, have levers they can pull. When the borrower, use legal and/or structural leverage, rather than a true economic controlling certificateholder and designated servicer involved in a equity position, to gain control of the underlying asset (or to be securitized financing tried a coordinated dive into the restructuring paid to get out of the way). water, the legal “splash” was considerable. Even more troubling for the senior lender was that if the mezz In a case involving The Atlantis, a $4 billion resort in The Bahamas, lender succeeded, it would foreclose on the mezz borrower and the controlling holder, in concert with the borrower, negotiated a take control of the mortgage borrower without assuming the debt-for-equity exchange which was to occur simultaneously with nonrecourse carveout guaranty. The typical CMBS 1.0 impediment a restructuring of the mortgage loan and other borrower obligations. to a mortgage borrower bankruptcy — springing guarantees which The borrower and controlling certificateholder wanted the servicer cause an otherwise nonrecourse loan to become recourse upon (appointed by the controlling certificateholder as was its right) to a bankruptcy filing — disappears when a mezz lender forecloses approve the restructuring. Other certificateholders sued, seeking since there is neither the requirement, nor the means to force, a a temporary restraining order on the grounds that the proposed mezz lender to assume the springing guaranty. transaction unfairly benefited the controlling certificateholder at the more senior certificateholders’ expense and, further, that the “Control waterfalls vest How did the court servicer had breached its fiduciary duty by failing to act in the best servicers with significant rule? In a decision interests of all certificateholders. responsibility and can instill similar to the New controlling certificate holder(s) York state court ruling In Trilogy Portfolio Company, LLC, et al. v. Brookfield Real Estate with considerable authority.” in the Peter Cooper Financial Partners, LLC et al; Court of Chancery of the State of Village/Stuyvesant Delaware; C.A. No. 7161-VCP (Atlantis), the court found the more Town case (Bank of senior certificateholders’ argument persuasive enough to grant a America, N.A. v. PSW, TRO. Subsequently, the controlling certificateholder abandoned NYC, LLC) (PCV), the Federal District Court in Arizona issued the proposed transaction, restructuring the loan and control of the an injunction against the mezz’s UCC foreclosure. As in PCV, the borrower on terms that received enough certificateholder support Star Pass court focused on a rock beneath the control waterfall to close. — the widely used form of senior/mezz intercreditor agreement (used here) requires the mezz lender to cure defaults under the Some key takeaways (and unanswered questions) from this case senior loan before exercising its UCC foreclosure rights. Had the highlight the complications associated with control waterfalls mezz lender foreclosed without doing so (and without assuming and the relationships among stakeholders than can evolve in the springing guaranty) and subsequently placed the mortgage structured transactions. borrower in a Chapter 11, the senior loan’s special servicer and the CMBS trust would have found themselves in exactly the position •The plaintiffs alleged that due to prior negotiations between the they had bargained to avoid in the loan and intercreditor agree- controlling certificateholder and the borrower (before the new ment, while fighting a debtor with little to lose and much to gain. servicer was designated) the controlling certificateholder had become an affiliate of the borrower and was therefore prohibited In Star Pass and PCV, each court — aware of the mezz lender’s from acting as the directing certificateholder. Regardless of the intention to chapter the borrower unbridled by the springing argument’s merit (the court did not rule on that issue), holders of guaranty — may have determined that the ends (an economically junior interests should be cautious with respect to the degree of fair result) justified the means (nuanced decisions narrowly interaction they can or should independently have with the borrower. interpreting the intercreditor bargain). Depending on the A publication of Autumn issue 2012 sponsored by CRE Finance World Autumn 2012 37


CRE Finance World, Autumn 2012
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