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CRE Finance World, Autumn 2012

Navigating the Structured Finance Waterfall: Smooth Sailing or a Barrel Ride over the Falls? •This case also poses questions regarding the range of workout interests in the Participation A note as well as control rights over options a servicer should explore and negotiate with the borrower other mortgages owned by the trust, since their ownership would (the suit alleged, and the servicer contested, that little independent be terminated (purchased) before completion of the appraisal and exploration or negotiation was done by the new servicer which control shifting to them. allegedly was brought in to effectively rubber stamp the previously negotiated deal), and how the best interests of all certificateholders The trust agreement in Pipe Break Hypothetical required (as is is actually determined. Is the typical maximize NPV concept common) that at least 25% of each affected class of certificates enough and to what alternatives, if any, should the proposed deal make a written request of the trustee in order to institute a legal be compared? As NPVs are often calculated using a loan’s proceeding in connection with the trust. The Participation C holder non-default interest rate as the discount rate (absent PSA provisions argued that the proposed sale of Participation A and B at a substantial to the contrary), this question might be even more germane in loss would affect all certificate classes, and the plaintiffs (holders of today’s interest rate environment. some, but not all, of the classes) failed to meet the 25% threshold. •More generally,Atlantis shines a bright light on the ambiguity that Pipe Break Hypothetical raises several issues. exists regarding a servicer’s fiduciary duty in light of the inevitable •Timetable mismatches occur more frequently than one might conflicts between senior and junior certificateholders. Can the imagine, sometimes affecting servicer tasks such as preparing, kind of debt-for-equity swap attempted here (a trade often seen submitting and gaining controlling certificateholder consent for in corporate restructurings) ever work given the control waterfall workout plans and/or foreclosure actions. and competing interests present in a securitized financing? •Trustees and special servicers are contractually bound to observe Elements of two cases (one in litigation and another which settled) the letter of the underlying documents — including timetables. have been merged to provide an example (Pipe Break Hypothetical) What is a trustee or servicer’s duty when presented with a proposed of what is both right and wrong with control waterfall timetables, the transaction that would not be supported at the conclusion of rights of controlling holders, and the obligations of special servicers. another, misaligned timetable? Had the control appraisal pipe been shorter than the FMV option pipe, would shifting control In Pipe Break Hypothetical, the controlling holder, owner of the to senior Participation A classes before the option closed really non-securitized Participation C note in an A/B/C structure, be a more equitable result? One could argue that the documents wanted to exercise its fair market value (FMV) purchase option of are what they are, warts and all; if you didn’t like what they say, the securitized Participation A and B interests, and sought to do so perhaps you shouldn’t have invested in the first place. according to the timetable specified in the co-lender agreement. So far, so good. The price the Participation C holder proposed to pay •What does “affected classes” really mean? Are affected classes for Participation A and B was less than par. While not the economic only those negatively affected, or do they also include those result the Participation A and B certificateholders anticipated when that are positively affected? Assuming, for argument’s sake, it’s the loan was originated, the plumbing nevertheless still appeared the former, are affected classes only those which will suffer to be working as designed. So why the lawsuit? a realized loss (as defined in the trust documents) or do they also include those who will suffer an economic loss as a result While the Participation C holder was pursuing its FMV option via of lowered market value and/or subordination levels? one pipe, a control appraisal event was moving through another. The control appraisal event, which would transfer control to certain Contractually, trustees, servicers and administrative agents are senior Participation A classes was proceeding — but had not yet service providers. Do they have the legal standing and authority been completed — according to a separate timetable. It’s not hard to make these kinds nuanced judgment calls in the absence to guess whose pipe was shorter…the Participation C holder’s. of litigation? In addition to questioning whether the trustee and special servicer Finally, from the special servicer’s perspective (one influenced acted appropriately (and in accordance with the trust’s controlling in part by the fact many servicer affiliates own junior interests documents), the plaintiffs alleged that allowing the Participation C like Participation C), to what extent is an FMV option a valuable holder’s transaction to close would wrongly deprive them of their CRE Finance World Autumn 2012 38


CRE Finance World, Autumn 2012
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