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32

Issues in Commercial Real Estate Finance: The Litigator’s Point of View

Janice Mac Avoy

Justin J. Santolli

Fried, Frank, Harris, Shriver & Jacobson LLP

If you find this article helpful, you can learn more about the subject by going to www.pli.edu to view the on demand program or segment for which it was written.

 

 

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I. You Have to Say What You Mean

A. Basics of Contract Interpretation

1.

Number of Agreements

(a)

It is important to consider whether there are multiple agreements relevant to a dispute and whether those documents will be construed together.

(b)

Contracts entered into at the same time for the same purpose are typically read together. However, “[t]he mere fact that a contract refers to another contract does not mean that it has ‘incorporated’ the other contract.” MBIA Ins. Corp. v. Patriarch Partners VIII, LLC, 842 F. Supp. 2d 682, 706 (S.D.N.Y. 2012) (citation omitted).

B. Clear Contracts Are Enforced According To Their Terms

1.

New York courts place the utmost importance on the intent of the parties, which is best evinced by the terms of the written agreement. This is particularly true where the parties are sophisticated business entities and are presumed to use precise drafting. Camperlino v. Bargabos, 96 A.D.3d 1582, 1583 (4th Dep’t 2012) (citations omitted) (“Particularly ‘in the context of real property transactions, where commercial certainty is a paramount concern, and where … the instrument was negotiated between sophisticated, counseled business people negotiating at arm’s length … courts should be extremely reluctant to interpret an agreement as impliedly stating something which the parties have neglected to specifically include.’”) (citation omitted).

2.

Courts will not save parties – particularly well counseled parties – from the clear terms of an agreement because they are ultimately disadvantageous. John Doris, Inc. v. Solomon R. Guggenheim Found., 209 A.D.2d 380, 381 (2d Dep’t 1994) (“The language of the contract is clear and unambiguous, and the courts may not rewrite the agreement to relieve a sophisticated contracting party from terms that it later deems disadvantageous.”) (citations omitted).

C. Ambiguous Language

1.

As courts will not allow extrinsic evidence of a contract’s meaning unless the contract is ambiguous, the key inquiry is whether the

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contract is reasonably susceptible to more than one interpretation. Greenfield v. Philles Records, 98 N.Y.2d 562, 571-72 (2002).

2.

Clear language – even if it is clearly wrong and contrary to the parties’ intent – will, absent unique circumstances, be enforced as written. Disagreement between the parties will not cause a court to find contractual language ambiguous. Rather, language is “capable of more than one meaning when viewed objectively by a reasonably intelligent person who has examined the context of the entire integrated agreement and who is cognizant of the customs, practices, usages, and terminology as generally understood in the particular trade or business.” Revson v. Cinque & Cinque, P.C., 221 F.3d 59, 66 (2d Cir. 2000) (citation omitted).

3.

Evidence of custom and usage can be relevant to determining whether an ambiguity exists. See Last Time Beverage Corp. v. F& V Distrib. Co., LLC, 98 A.D.3d 947, 951 (2d Dep’t 2012).

D. Contract Interpretation Guidelines

1.

Courts will interpret contracts in light of the surrounding circumstances. In re Korosh v. Korosh, 99 A.D.3d 909, 911 (2d Dep’t 2012) (citation omitted) (explaining that “[i]n making [the determination of whether an agreement is ambiguous] the court also should examine the entire contract and consider the relation of the parties and the circumstances under which the contract was executed”) (citation omitted).

2.

An interpretation should be commercially reasonable, see ERC 16W Ltd. P’ship v. Xanadu Mezz Holdings LLC, 95 A.D.3d 498, 503 (1st Dep’t 2012), and courts will not enforce language that will produce a commercially absurd result. SPCP Group, LLC v. Eagle Rock Field Servs., LP, 2013 WL 359650 (S.D.N.Y. Jan. 30, 2013).

3.

Courts will interpret agreements in an effort to give every provision meaning. That is to say: (1) terms are considered in the context of the larger agreement and (2) terms are not construed in a way that renders them, or other terms, meaningless or unnecessary.

4.

Courts will attempt to reconcile conflicting terms. Village of Hamburg v. American Ref-Fuel Co., 284 A.D.2d 85, 89 (4th Dep’t 2001) (“[R]easonable effort must be made to harmonize all of its terms.”).

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5.

General words, followed by specifics, will be interpreted as limited to items of a similar type as those listed (“Ejusdem generis”).

6.

Expressing one thing implies the exclusion of another (“Expresio unius est exclusio alterus”).

7.

Specific language controls over general language.

8.

Words have a consistent meaning throughout.

II. Common Issues in Loan Documents

A. Who is Going to Decide the Case: The Things Litigators Care About

1.

Where Will the Case Be Litigated – Forum Selection Clauses

(a)

A failure to pay attention to the forum selection clause could mean the case is litigated in an unexpected jurisdiction or one where the law is unknown or unfavorable to your arguments.

(b)

If the loan agreement fails to specify a forum selection clause, the plaintiff can determine where to file their case.

2.

Federal Courts

(i)

Federal courts have limited jurisdiction, and so a plaintiff can elect this forum in only certain circumstances.

(ii)

Federal Question Jurisdiction

(1)

“The district courts shall have original jurisdiction of all civil actions arising under the Constitution, laws or treatises of the United States.” 28 U.S.C. § 1331.

(iii)

It is unlikely that a case arising from a real estate dispute would trigger federal question jurisdiction.

(b)

Diversity Jurisdiction

(i)

The federal district courts have original jurisdiction of all civil matters where the matter in controversy exceeds the value of $75,000, so long as the dispute is between:

(1)

Citizens of different states;

(2)

Citizens of a state and citizens or subjects of a foreign state;

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(3)

Citizens of different states and in which citizens or subjects of a foreign state are additional parties; and

(4)

A foreign state as the plaintiff and citizens of a state or a different sate. 28 U.S.C. § 1332(a).

(ii)

Limited liability companies are frequently borrower entities in commercial real estate financing. The citizenship of a limited liability company is determined by looking at citizenship of each member. Mack v. Harrah’s Casino, No. 08 Civ. 5690, 2010 U.S. Dist. LEXIS 12260, at *5 (S.D.N.Y. 2010).

(iii)

Trustee/special servicers can present complicated jurisdictional issues. A court will determine the identity of the real party in interest by deciding who has a stake in the outcome of the litigation, and whether that party is bringing suit in its own right or as an agent. U.S. Bank National Ass’n v. Nesbitt Bellevue Prop LLC, 859 F. Supp. 2d 602, 606-07 (S.D.N.Y. 2012).

(iv)

The Supreme Court recently addressed the proper test to apply in determining the citizenship of a REIT for purposes of diversity jurisdiction. See Americold Realty Trust v. Conagra Foods, Inc., 136 S. Ct. 1012 (2016). The Supreme Court determined that, for purposes of diversity jurisdiction, a REIT “possesses the citizenship of all its members.” Id. at 1016. Thus, a REIT can only invoke a federal court’s diversity jurisdiction if no stockholder of the REIT is the citizen of the same state as a party that is adverse to the REIT in the litigation.

(1)

There is a split of authority among district court regarding the reach of the Supreme Court’s Americold decision. Some district court have applied the Supreme Court’s decision in Americold to find that they lack diversity jurisdiction in cases involving CMBS trusts. See, e.g., Guillen v. Countrywide Home Loans, Inc., No. 15-cv-849, 2016 WL 7103908, at * 5-8 (S.D. Texas Dec. 6, 2016) (finding that the court did not possess diversity jurisdiction to adjudicate the litigation based on the Supreme Court’s Americold decision); Wells Fargo Bank, N.A. v. Transcontinental Realty Investors,

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Inc., No. 14-cv-3565, 2016 WL 3570648, at *4 (N.D. Tex. July 1, 2016) (finding that the court lacked diversity jurisdiction because J.P. Morgan Chase Commercial Mortgage Securities Corp., Commercial Mortgage Pass-Through Certificates Series 2001-C1 was the “real party in interest, and, as an unincorporated entity, the Trust is a citizen of the states in which its members are located”).

3.

State Courts

(a)

New York state trial courts (confusingly called New York Supreme Court) have broader jurisdiction than their federal counterparts.

(b)

Unlike federal courts, New York law allows parties to assign jurisdiction to the New York courts, so long as certain conditions are met.

(i)

N.Y. Gen. Oblig. Law § 5-1402 – parties can designate by contract New York as the forum for dispute resolution so long as (i) the contract is in excess of $1,000,000, and (ii) the parties agree to submit to the state’s jurisdiction.

(ii)

The submission to jurisdiction must be to the “exclusive jurisdiction” of the New York courts. Otherwise, your counterparty can sue in another state first and you may have a fight transferring the litigation to New York.

(c)

The forum selection provision will be presumed valid.

(i)

“A contractual forum selection clause is prima facie valid and enforceable under unless it is shown by the challenging party to be unreasonable, unjust, in contravention of public policy, invalid due to fraud, or overreaching, or it is shown that a trial in the selected forum would be so gravely difficult that the challenging party would, for all practical purposes, be deprived of its day in court.” Bernstein v. Wysoki, 77 A.D.3d 241, 248-49 (2d Dep’t 2010).

(d)

A defendant can typically seek to remove a case filed in state court to federal court, so long as there is an independent basis of federal jurisdiction. See 28 U.S.C. § 1441(a).

(i)

See Motiva Enters. LLLC v. SR Int’l Bus. Ins. Co. PLC, C.A. No. 12-1097, 2013 WL 3571538, at *2 (D. Del.

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July 12, 2013) (“It is also well established that parties may contractually waive their right to remove. However, the Court applies a strict standard, as there can be no waiver of a right to remove . . . in the absence of clear and unambiguous language required such a waiver.”). (internal citations and quotations omitted).

B. Whose Law Governs – Choice of Law Provisions

1.

As with the forum selection clause, the parties have an opportunity to pick the governing law in the contract. If they don’t, that decision will be ultimately left to the court to resolve.

(a)

New York law permits parties to designate New York’s law in contracts in excess of $250,000 as controlling with respect to the interpretation and enforcement of the agreement. N.Y. Gen. Oblig. Law 5-1401.

2.

In many cases, there is unlikely to be any significant difference between the laws of New York and Delaware, which are frequently used in connection with commercial loan transactions. Both New York and Delaware courts pride themselves on issuing decisions that protect certainty in commercial transactions. Delaware courts tend to decide matters faster, but the New York commercial division is faster than other New York courts and the judges tend to be more predictable.

3.

There are, however, certain gaps in the law that have developed and that the drafters of the agreements should keep in mind. One prominent example is:

(a)

Statute of Limitations: How long a party has to bring a claim.

(i)

New York: statute of limitations for a breach of contract claim is six years. CPLR § 213.

(ii)

Delaware: statute of limitations for a breach of contract claim is 20 years. 10 Del. C. § 8106(c).

(1)

In 2014, Delaware amended its statute of limitations for breach of contracts from 14 years to 20 years. The amendment was applied retroactively, meaning that contracts signed before August 2014 have 20 year statutes of limitations, absent a showing of manifest injustice.

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(2)

The parties can nevertheless contract to a shorter period. This could be a specific period (such as 15 years from execution), or from the occurrence of some triggering event.

(b)

Sandbagging: Whether a party can bring a claim even though it knew of the default prior to consummating the transaction.

(i)

The Second Circuit has held under New York law that if a buyer learned of a breach through the seller’s affirmative disclosure, the buyer cannot later bring a claim.

(1)

“Where a buyer closes on a contract in the full knowledge and acceptance of facts disclosed by the seller which would constitute a breach of warranty under the terms of the contract, the buyer should be foreclosed from later asserting the breach.” Galli v. Metz, 973 F.2d 145, 151 (2d Cir. 1992).

(ii)

Delaware: absent an express provision, pre-closing knowledge of a breach generally is not a bar to recovery under Delaware law.

(1)

Cobalt Operating, LLC v. James Crystal Enters., LLC, No. Civ. A. 714-VCS, Del. Ch. LEXIS 108, at *90-91 (Del. Ch. July 20, 2007) (a buyer’s claim for breach of representation and warranties was not barred by the fact that they discovered the breach prior to the closing because the seller contractually promised that the buyer could rely on that representation and thus could not claim that the buyer was “unreasonable in relying on [the seller’s] own binding words”).

(iii)

Jury trial waivers will be enforced, but if the loan documents are silent, either party is entitled to a jury trial. Jury trials take longer to schedule, last longer and, since the judge will not be the trier of fact, results are less predictable.

C. Material Adverse Changes

1.

In response to the Great Recession, lenders began to include in loan documents some type of protection against material adverse

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changes in the condition of the borrower, the guarantor, or the property.

(a)

These “MAC” clauses became a new type of loan default and granted the lender a right to call a default based on any such material change.

(b)

Borrowers have of course resisted such provisions, arguing that they give lenders the flexibility to call a default based purely on an economic downturn.

(i)

One potential compromise is to carve out from the definition of a MAC clause the effect of particular types of events, such as loss in value due to an economic downturn.

2.

One contested issue has been how to interpret “Material.”

(a)

Lenders want “material” to cover all unknown and unforeseen events. Borrowers, naturally, want a more limited definition.

(b)

Materiality is ultimately a fact-based determination and highly dependent on the circumstances of each case.

(c)

To date, there is no black line rule regarding what percentage or threshold amount that makes something “material,” absent specific language in the loan documents.

(d)

There is thus some utility to including in the loan documents a specific, objective threshold about whether a particular event is “material”: it would provide both the borrower and lender with certainty about when a MAC clause could be invoked.

(e)

Absent such a provision, “materiality” will be left to the determination of the court.

(i)

In the context of corporate transactions, the Delaware Court of Chancery has long held that a MAC clause can be triggered only if the matter at issue is “significant,” “long term,” “durational,” and that it “must be expected to persist significantly into the future” or “substantially threaten the overall earnings potential.” See, e.g., Hexion Specialty Chems., Inc. v. Huntsman Corp, 965 A.2d 715 (Del. Ch. 2008) and IBP, Inc. v. Tyson Foods, Inc., 789 A.2d 14 (Del. Ch. 2001).

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(1)

In Hexion Specialty Chemicals v. Huntsman Corp., the Delaware Chancery Court refused to find that a MAC clause was triggered, noting that “a buyer faces a heavy burden” to invoke such a clause to avoid its obligations. Hexion tried to premise the MAC on Huntsman’s failure to achieve its earning forecast, increases in Huntsman’s net debt, and underperformance of certain of Huntsman’s operating divisions. 965 A.2d at 738.

(2)

In IBP, Inc. v. Tyson Foods, Inc., the Delaware Chancery Court rejected Tyson’s claim that IBP’s decline in performance and $60.4 million impairment charge from improper accounting constituted a MAC. The Court stated that “a buyer ought to have to make a strong showing to invoke a material adverse effect exception to its obligation to close.” 789 A.2d at 68.

(ii)

Delaware courts have been hesitant to find a material adverse effect that would permit a party to terminate a merger agreement or avoid the party’s contractual obligations. In Hexion, the Chancery Court noted that as of 2008 a Delaware court had never found a material adverse effect to have occurred in the context of a merger agreement.

(iii)

The various states’ laws on this point have developed in different ways. A cautionary tale involving lender overreaching in the context of a MAC clause in the real estate context is a decision from a California trial court in 1601 McCarthy Blvd., LLC v. GMAC Commercial Mortgage Corporation, Case No. CGC-03-425848. In that case, a lender asserted that the MAC clause was triggered after a borrower refused to renegotiate the terms of a loan so that certain funds that the borrower had placed into a reserve account would be used to pay down the loan balance. The lender claimed that there had been a change in the borrower’s financial condition, triggering the MAC clause. A jury rejected the lender’s assertion, and found instead that the lender had breached its contractual obligations and acted with malice and fraud.

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(f)

BT Triple Crown Merger Co., Inc. v. Citigroup Global Mkts. Inc., 19 Misc.3d 1129(A) (N.Y. Sup. Ct., N.Y. Co. 2008), arose out of the proposed leveraged buyout of Clear Channel Communications. The plaintiff claimed that the lenders for the potential transaction breached their obligation under the commitment letter to fund the transaction by inserting terms in the loan documents that were inconsistent with the commitment letter, all as a pretext to evade their obligation to fund in light of the credit crisis in 2008. Although noting that specific performance is not typically awarded on a contract to lend money, the court held that given evidence of the unavailability of alternate financing, a trial would have to be held on the issue of specific performance.

D. Default Interest Rates and Late Fees

1.

Lenders and borrowers typically agree in advance to a default interest rate, as well as late fees for the borrower in the loan documents.

(a)

A word of caution: courts have held that where the acceleration of the loan is a condition precedent to imposing default interest, a lender is not entitled to collect default interest unless an acceleration has occurred.

(i)

For example, in JCC Development Corp. v. Levy, 208 Cal. App. 4th 1522, 1534 (Cal. Ct. App. 2012), the California court of appeals found that that default interest rate could not be charged because acceleration was a precondition to collecting default interest and “once the promissory note matured and the lump-sum payment of principal and interest became due, the acceleration could not be triggered because there was nothing to accelerate.” The court noted that the “drafter of the agreement could have included language stating that the default interest rate applied not only after circumstances of acceleration, but also after the loan matured and no payment was made, but he did not include such additional language.”

(b)

With respect to late fees, courts have distinguished between late fees charged for failing to make an installment payment and late fees charge for failing to pay the note at maturity.

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(i)

Poseidon Development Inc. v. Woodland Lane Estates, LLC, 152 Cal. App. 4th 1106, 1113-16 (Cal. Ct. App. 2007) (rejecting lender’s attempt to charge late fee for failure to pay at maturity because the provision permitting lender to charge a late fee related only to borrower’s failure to pay an installment).

(ii)

A number of courts have also found that late fees charged for a borrower’s failure to pay at maturity is an unreasonable penalty. Id.; North Water, LLC v. North Water St. Tarragon, LLC, 2009 Conn. Super LEXIS 2696, at *56-60 (Conn. Super. Oct. 13, 2009).

(iii)

New York courts typically will enforce late fees if the agreement is clear on its face. See 1300 Ave. P. Realty Corp. v. Stratigakis, 720 N.Y.S.2d 725 (App. Term, 2d Dep’t 2000) (a late charge due on “any payment” applied to both installment payments and full amount of the loan after maturity).

E. Cautionary Tales, and How to Avoid Them

1.

Planning for Worst Case Scenarios

(a)

To begin, a thorough understanding of when a default could be triggered is key. These terms will be heavily negotiated, but some are boilerplate.

(b)

Borrower’s counsel frequently will request provisions for notice and cure periods, along with the right to cure any non-compliance.

(c)

Lenders may seek to limit the number of times a borrower can exercise its cure rights in a given year.

(d)

It is also critical to understand the difference between a default and an Event of Default.

(i)

A default is an event or occurrence that with the passage of time can ripen into an event of default; its mere occurrence will not necessarily trigger Events of Default.

(ii)

An Event of Default is a defined set of circumstances after notice and cure periods have expired or that cannot be cured.

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(iii)

Borrowers may seek a chance to cure issues before a lender exercises the available remedies under the loan documents.

(e)

Exercising remedies may have costs, such as requiring a lender to pay a transfer tax, make protective advances, or potentially pay off a senior loan at face value.

(i)

For instance in connection with Stuyvesant Town here in New York City, a plan to foreclose on the owners of Stuyvesant Town and Peter Cooper Village precipitated a lawsuit by a debt holder because it believed “that a foreclosure could cost as much as $200 million in transfer taxes.” Charles V. Bagli, Hedge Fund Moves on Stuyvesant Town and Peter Cooper Village, New York Times (Feb. 24, 2010), available at http://www.nytimes.com/2010/02/25/nyregion/25stuytown.html; see also Bank of America NA v. PCV St. Owner LP, 1:10-cv-01178, Dkt No. 89 (April 30, 2010 S.D.N.Y. ) (denying Appaloosa’s motion to intervene).

F. SPE Covenants

1.

General Growth Properties (“GGP”) was a property owner that eventually went bankrupt. At the time of its bankruptcy filing, GGP operated approximately 200 malls and shopping centers and was the parent of over 700 affiliates. In Re General Growth Properties, Inc., Case No. 09-11977 (ALG), Memorandum Opinion at 4 (Bankr. S.D.N.Y. Aug. 11, 2009). In connection with each project, GGP created a special purpose entity (“SPE”) to own each specific project and isolate assets, liabilities, and operations from affiliated entities. Id. at 6-9. The GGP parent entity filed for bankruptcy and the majority of GGP’s project specific SPEs also filed for bankruptcy, although many of them were solvent at the time of the bankruptcy filing. Id. Prior to the GGP bankruptcy, most of the provisions designed to mitigate a bankruptcy filing were constructed around the idea that a financially solvent upstream entity would force the financial distressed borrower into bankruptcy. Id. at 17. The GGP bankruptcy reversed that assumption.

2.

One argument advanced in favor of the bankruptcy filings for General Growth’s subsidiaries was that a bankruptcy of the parent would result in the subsidiaries being unable to timely pay their

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debts because cross-default provisions in the loan documents of the subsidiaries would result in an event of default under those loan documents. Id. at 27-30. In light of this argument, lenders have included provisions that provide that a guarantor’s bankruptcy will lead to a default only at the option of the lender.

3.

The lenders in the GGP bankruptcy also argued that the single purpose entity debtors acted in bad faith by replacing their independent directors with directors who were more likely to support a bankruptcy filing on the eve of filing. Id. at 38-42.

(a)

The bankruptcy court rejected this argument because there was no provision that prohibited the replacement from occurring and the replacement directors were adequately qualified to serve. Id. at 40.

(b)

Lenders can seek to protect themselves against such actions by requiring advance written notice of the replacement, setting forth minimum qualifications to serve as an independent director, and requiring lender approval of any agreements with the independent directors.

4.

The GGP cash management system provided for all funds held at the property level to be swept up to the parent entity on a periodic basis. This structure permitted an argument that debtor-in-possession lenders should be granted a first priority lien on the property level cash flow, priming the liens of mortgage lenders.

(a)

In light of the issues posed by GGP’s cash management system, segregation of property-level cash flow through the use of lender controlled accounts, with only excess cash flowing to the commingled operating account, has tended to become a more common feature.

G. Mezzanine Loan Issues

1.

Mortgage loan documents must be drafted to permit a mezzanine lender to exercise any rights it has under the mezzanine loan. If the mezzanine lender forecloses, it owns the property owner, subject to the mortgage and other obligations of the property owner.

2.

The Mezzanine lender should ensure that the mortgage clearly provide that the pledge of equity interest in connection with the mezzanine loan and any foreclosure of the mezzanine loan is neither a default nor a recourse event under the mortgage loan.

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Absent a provision carving these provisions out of typical mortgage loan documents, a foreclosure of a mezzanine loan could trigger a default and a full recourse event.

H. Intercreditor Agreements

1.

An intercreditor agreement protects a senior lender by imposing conditions on a mezzanine lender’s right to foreclosure on its equity collateral, limitations of a mezzanine lender’s rights to modify mezzanine loan documents and priority to payment rights from senior collateral and with respect to property owner (senior borrower) in a property owner bankruptcy.

2.

An intercreditor agreement protects a mezzanine lender by acknowledging mezzanine lender’s separate collateral rights, limiting senior lender’s rights to modify senior loan documents, requiring senior lender to accept mezzanine lender as owner of property owner on mezzanine UCC foreclosure, and providing mezzanine lender rights to protect itself against mortgage loan defaults or foreclosure by the curing the default or purchasing senior loan at face value.

I. Cross-Defaults

1.

Typically, a default under the mezzanine loan should not be included as an event of default under the mortgage loan documents.

(a)

If a default under the mezzanine loan was treated as a default under the mortgage loan, a mortgage lender could pursue remedies against the property irrespective of whether the mortgage loan is performing.

2.

The opposite is true, though, with respect to the mortgage loan: the mezzanine lender will insist on the event of default under the mortgage loan triggering an immediate event of default under the mezzanine loan.

(a)

Foreclosing under the loan documents would extinguish the value of the mezzanine loan and thus the cross default provision allows a mezzanine lender to protect its investment.

J. Deed in Lieu Issues

1.

Historically, many intercreditor agreements were silent about a deed in lieu of foreclosure. This led borrowers to execute a deed

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in lieu in favor of the mortgage lender without providing any notice or cure rights to the mezzanine lender.

2.

Mezzanine lenders have sought to address this issue by requiring notice of a deed in lieu transaction from the mortgage lender and the ability to purchase the property from the mortgage lender.

K. UCC Foreclosure on Mezzanine Collateral

1.

Intercreditor Agreements

(a)

One issue of particular importance to mezzanine lenders is their ability to conduct a UCC foreclosure on the mezzanine collateral when the senior loan is in default. New York courts have been presented with this issue on several occasions. The case law demonstrates the importance of careful drafting and attention to the language of intercreditor agreements. See Karmely v. Wertheimer, 737 F.3d 197, 198-99 (2d Cir. 2013) (concluding that documents relevant to mezzanine loan, including intercreditor agreement, were ambiguous as to whether mezzanine borrower’s failure to pay a promissory note at maturity triggered mezzanine lender’s right to foreclose on mezzanine collateral).

2.

Mezzanine lenders need to exercise any special rights under the intercreditor agreement prior to any event that terminates the intercreditor agreement, such as a senior loan foreclosure sale.

(a)

Some intercreditor agreements seek to restrict a mezzanine lender’s ability to foreclose on the equity collateral by requiring certain defaults to be cured prior to foreclosure by the mezzanine lender.

(b)

If the mortgage lender has accelerated its loan, a requirement that the mezzanine lender cure defaults may result in the mezzanine lender needing to pay the mortgage loan in full before it may foreclose.

(c)

Priority disputes among lenders: U.S. Bank Nat’l Assoc. v. Lightstone Holdings LLC, 103 A.D.3d 458 (1st Dep’t 2013):

(i)

Here, the parties – senior lenders and mezzanine lenders – disputed who had priority to payments personally guaranteed by defendant-guarantor. The dispute arose out of the bankruptcy of the debtors to a series of

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loans totaling $7.4 billion dollars, each of which was personally guaranteed by guarantor.

(ii)

Following the debtors’ bankruptcy, the collateral securing the senior loans (more than 600 hotel properties) was sold and the senior lenders were paid $3.9 of the $4.1 billion owed. The mezzanine lenders, however, received none of the money they were owed, and subsequently filed suit to enforce the guaranty agreements. In relevant part, the mezzanine loan guarantee agreements provided mezzanine lenders with the right to collect a capped amount ($100 million) in the event of bankruptcy. In an effort to prevent the mezzanine lenders from recovering under the guaranty agreements while the balance of the senior loan remained unpaid, the senior lenders filed suit.

(iii)

The First Department reversed, in part, the trial court’s decision in the mezzanine lenders’ favor. The court concluded that the intercreditor agreement – the sole document governing the relationship between the lenders – was ambiguous as to the lenders’ respective rights to collect on the guarantee claims.

(iv)

The court reasoned that the provisions of the various agreements “that [were] not fully consistent with each other,” were open to more than one reasonable interpretation. Id. at 458-60. In other words, the Senior Lenders’ and Mezzanine Lenders’ competing interpretations were “equally plausible.” Id. at 459-60.

(d)

Bank of Am., N.A. v. PSW NYC LLC, 2010 N.Y. Misc. LEXIS 5200 (N.Y. County Sept. 16, 2010).

(i)

The dispute related to the foreclosure of Stuyvesant Town and Peter Cooper Village, the largest rent-regulated residential housing development in New York. The property was financed through a $3 billion dollar senior loan, secured by the property, and an additional $1.4 billion in mezzanine loans. The mezzanine loans were divided into 11 tiers. The junior loans were secured by a pledge granting each junior lender an equity interest in the corresponding borrower. The relationship between the senior and

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junior lenders was governed by an intercreditor agreement. Id. at *2-5.

(ii)

In 2010, the senior borrowers defaulted under the loan and, shortly thereafter, the senior lender issued a notice of default, which was also delivered to the junior lenders. The servicer to the loan notified the senior and junior borrowers that the senior loan was being accelerated, making all amounts immediately due. The junior lenders were notified of their right to cure the default pursuant to the intercreditor agreement. None took that opportunity. Id. at *8-9.

(iii)

In February of 2010, the senior lenders filed suit in the Southern District of New York, seeking to foreclose on the property. A judgment of foreclosure was entered several months later. Id. at *9-10.

(iv)

Prior to foreclosure, the senior lenders were notified that the interests in certain mezzanine loans had been transferred to PSW and that PSW intended to conduct a UCC foreclosure on the equity collateral without paying off the senior mortgage. Id. at *10-11.

(v)

The mortgage lender sued PSW to prevent PSW’s proposed UCC foreclosure while the senior loan default remained uncured – arguing that the mezzanine lenders could not foreclose until they first paid off the $3.1 billion mortgage. Id. at *9.

(vi)

The trial court, agreeing with the senior lenders, reasoned that the intercreditor agreement unambiguously obligated PSW to cure all senior loan defaults if PSW acquires the equity collateral. Id. at *9-10.

(vii)

In relevant part, the intercreditor agreement provided that:

Where a transferee “acquires the equity collateral pledged to a Junior Lender . . . [t]ransferee shall acquire the [equity collateral] subject to (i) the Senior Loan and the terms, conditions and provisions of the Senior Loan Documents[.]”

(viii)

As a condition to transferee’s acquisition of the equity collateral, transferee was required to (1) affirm

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that it was bound by senior loan documents and (2) cure “all defaults under (1) the Senior Loan and (2) the applicable Senior Junior Loans, in each case which remain uncured or unwaived as of the date of such acquisition[.]” Id. at *16 (emphasis in original).

(ix)

Although the intercreditor agreement permitted “defaults that can only be cured by the Junior Lender following its acquisition of the Equity Collateral” to “be cured by the Junior Lender prior to the expiration of the applicable Extended Non-Monetary Cure Period,” the court reasoned that the default under the senior loan is not one that can “only be cured” following PSW’s acquisition. Accordingly, PSW was required to cure the senior loan default “as of the date of [its] acquisition.” Id. at *16-17.

(e)

The PSW decision was followed in CSMSC 2007-C2 Broadway Portfolio II, LLC v. OREP/Oxford HY Venture Funding 4, L.P., No. 652809/2011, Order (Sup. Ct. N.Y. County Dec. 12, 2011) (ECF. No. 12) (granting preliminary injunction to senior lender preventing mezzanine lender from conducting UCC foreclosure on the equity collateral where the senior loan was in default and had not been cured).

(i)

The court, relying on Bank of America, N.A. v. PSW NYC LLC, 918 N.Y.S.2d 396 (N.Y. Sup. Ct. 2010), concluded that the senior lender demonstrated a strong likelihood of success where the mezzanine lender had not complied with the two following provisions of the intercreditor agreement: “(i) the Mezzanine Lender . . . shall have agreed in writing . . . thereafter to perform . . . all conditions and provisions of the Senior Loan Documents on Borrower’s part to be performed and (ii) all defaults under the Senior Loan Documents which remain uncured as of the date of . . . acquisition [of the mezzanine collateral] have been cured . . .” Id. at 5-6 (emphasis added). Id.

(ii)

The court was not swayed by the potential effect of a preliminary injunction on the mezzanine lender – namely, that it would be left “bankrupt or nearly so” – concluding that the balance of equities did not weigh in its favor given the strong likelihood of success. Id. at 7.

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(f)

However, PSW sued when CW Capital entered into an agreement 6 years later to sell Stuyvesant Town to Blackstone for $5.6 billion. Ultimately, PSW and CW Capital, the mortgage loan servicer, entered into a settlement and a CW Capital affiliate repurchased the mezzanine loan from PSW for $45 million. PSW NYC LLC v. Bank of Am., N.A., No. 650390/2016 (Sup. Ct. N.Y. County Oct. 31, 2016) (granting defendants’ motion to dismiss complaint for claims arising from the sale of rights under mezzanine loan).

(i)

With the CW Capital affiliate now owning the mezzanine loans, CW Capital conducted a strict foreclosure on the mezzanine collateral, “without paying off the [senior loan],” which CW Capital argued PSW was prevented from doing by the intercreditor agreement.

(ii)

In dismissing PSW’s claims, the court reasoned that, although PSW could still sue defendants for a breach of the sale agreement, there was no support for PSW’s contention that defendants agreed to abide by the terms of the intercreditor agreement. Although defendants warranted that the sale of the mezzanine loans to CW Capital would not violate any “judgment, order, injunction, decree or award of any court” (e.g., the 2010 injunction), the injunction was no longer in existence for defendants to violate when they conducted the strict foreclosure. Accordingly, “even if defendants’ subsequent assumption of control over the mezzanine collateral would have violated the injunction had it not been dissolved . . . such assumption could not have violated [the 2010] preliminary injunction” and no violation of the agreement would be found. Id. at 11.

(iii)

As a result of the court’s determination that none of the relevant warrants had been breached, PSW’s claims were dismissed.

(g)

U.S. Bank Nat’l Assoc. v. RFC CDO 2006-1, Ltd., No. 11-cv-664, 2011 WL 9530795 (D. Ariz. Dec. 6, 2011) (granting injunction preventing mezzanine lender from conducting UCC foreclosure, reasoning that intercreditor agreement applying New York law required mezzanine lender to cure senior loan default before foreclosure).

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(i)

As part of the development of a resort, Borrower obtained a $145 million dollar loan (the “Senior Loan”) secured by “a deed of trust lien and security interests in the assets of the Borrower.” Id. at *1. To obtain additional funding, the sole member of Borrower (the “Mezzanine Borrower”) obtained a $20 million dollar mezzanine loan, secured by a pledge of Mezzanine Borrower’s 100% ownership interest in Borrower. The senior and mezzanine lenders’ relationship was governed by an intercreditor agreement. The intercreditor agreement was governed by New York law.

(ii)

Ultimately, both the Borrower and Mezzanine Borrower defaulted. Following the defaults, senior lender noticed its intent to initiate foreclosure proceedings. The Mezzanine lender, similarly, noticed its intent to conduct a UCC sale on the mezzanine collateral. Id.

(iii)

Senior lender filed suit seeking to enjoin the proposed UCC sale.

(iv)

The court, similar to the 2010 PSW court, concluded that senior lender was entitled to a preliminary injunction enjoining the proposed UCC sale where the senior loan remained uncured. The court began by looking to the language of the intercreditor agreement – which contained provisions almost identical to those in PSW. Among the requirements relevant to the court’s decision, the intercreditor agreement provided that any transferee that acquired the mezzanine collateral “shall have caused two things to happen—one being that ‘as of the date of the acquisition’ the Qualified Transferee shall have cured all defaults under the Senior Loan. The Qualified Transferee must have cured the defaults as of the date of the acquisition.” Id. at *3 (emphasis in original).

(h)

However, the Stuyvesant Town decision was rejected in U.S. Bank National Association v. LH Hospitality LLC, No. 653351/ 2012 (Sup. Ct. N.Y. County Oct. 16, 2012) (concluding that mezzanine lender subject to identical language in the PSW intercreditor agreement at issue in Stuyvesant Town could conduct UCC foreclosure prior to curing default on senior loan).

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(i)

U.S. Bank sought to enjoin LH Hospitality from conducting a UCC sale of the equity collateral – a 100% ownership interest in the borrower of the senior loan – securing a $35 million dollar mezzanine loan.

(ii)

The agreement at issue, identical to the PSW inter-creditor, required a transferee to (1) reaffirm that they are bound by the obligations applicable to the transferor and (2) cure all defaults.

(iii)

The court, however, declined to follow the logic of the 2010 decision in PSW and agreed with defendant that the relevant provisions of the intercreditor agreement were not conditions precedent to the transferee taking possession of the mezzanine collateral. Defendant contended, and the court agreed, that the relevant provisions were aimed at preventing the acceleration of the loan. The court agreed that under plaintiff’s interpretation “[t]here would be no point” in requiring a transferee to cure the senior loan if the loan was already accelerated.

3.

All assets of a UCC foreclose sale must be “Commercially Reasonable”

(a)

AC I LEDGEWOOD MEZZ LLC vs. DMR CRE OPPORTUNITY FUND I LP, No. 153809/2014, Order (Sup. Ct. N.Y. County Feb. 3, 2015) (ECF No. 100) (rejecting claim that UCC foreclosure sale was commercially unreasonable).

(i)

This dispute arose out of the mezzanine loan between plaintiff-borrower and BCM, under which plaintiff pledged BCM a security interest in all of plaintiff’s membership interests in Ledgewood. Following plaintiff’s default, BCM noticed a public sale of the mezzanine collateral. Ultimately, the sale was commenced with the mezzanine collateral being sold to defendant – an affiliate of BCM. Id. at *1.

(ii)

Plaintiff sought to vacate the sale of its membership interests and halt the sale of Ledgewood’s sole asset, arguing that BCM acted in a commercially unreasonable manner that permitted its affiliate to obtain its membership interests in Ledgewood and the sole asset of Ledgewood for far below market value. Id.

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(iii)

The court rejected plaintiff’s claims finding them barred by collateral estoppel; plaintiff had previously unsuccessfully attempted to enjoin the foreclosure. Id. at 14. In the prior decision the court held that the UCC foreclosure sale was conducted and noticed in accordance with UCC law, and therefore permitted the foreclosure sale to go forward.

4.

Sutton 58 Owner, LLC v. Sutton 58 Associates LLC, Index No. 650832/16, Transcript (Sup. Ct. N.Y. County Feb. 23, 2016) (ECF No. 33) (denying plaintiffs’ request for a preliminary injunction, finding that there was no showing that the proposed UCC foreclosure was commercially unreasonable where plaintiffs were unable to explain how delaying the proposed disposition would have any effect).

(a)

Plaintiffs, led by Joe Beninati, sought a preliminary injunction to prevent a UCC foreclosure on the equity collateral – a 100% ownership interest in the owner – pledged as security on a mezzanine loan in connection with a development site at EGM and Sutton Place. Plaintiffs claimed that the proposed foreclosure was not being conducted in a commercially reasonable manner and that the UCC foreclosure would clog the owner’s equity right of redemption.

(b)

The court denied plaintiffs’ motion, explaining that plaintiffs failed to demonstrate a likelihood of success, irreparable harm, or even a balance of equities in their favor. There was no indication that the sale was not properly noticed or otherwise conducted in accordance with NY UCC. The court drew particular attention to the plaintiffs’ inability to answer when asked “what makes you think anything is going to be different from what your client has been after [i.e., financing] for the last year [assuming the preliminary injunction is granted]?” Id. at 37.

5.

Clogging Equity of Redemption

(a)

One concern arising in the dual loan context, where a single lender issues both a mortgage loan and a mezzanine loan to a borrower in connection with a transaction, is whether a borrower’s pledge to grant the lender a 100% ownership interest in the borrower as security for the loan “clogs” the borrower’s right of redemption under the mortgage loan.

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New York law is clear that a borrower cannot waive its right of redemption under the mortgage loan. The concern, where equity is pledged in relation to a mortgage raised primarily by law professors and not judges, is whether foreclosure on the pledge would “clog” or prevent the borrower from exercising that right. Commentators have suggested one potential way to mitigate risk to address concerns regarding the clogging of the equity of redemption is to require the delivery of an affidavit from the mortgagor providing that it is his or her understanding that the transaction will not clog the equity of the redemption. See John C. Murray, Clogging Revisited, 33 Real Prop. & Tr. J. 279 (1998-1999).

(b)

The purpose of granting an equity interest to the lender is to allow the lender to have the ability to either (i) foreclose on the mortgage or (ii) foreclose on the pledge of equity. This dual loan structure provides the lender added protection in the event they are unable to foreclose on the mortgage by granting them another avenue to recover money due (namely, through a UCC foreclosure on the equity pledge).

(c)

Despite frequent challenges to UCC foreclosures, there is relatively little case law addressing whether such a foreclosure clogs the borrower’s right of redemption. Clogging claims in the dual loan context are likely to encounter some judicial resistance as these loan structures usually involve sophisticated parties on both sides of the table and the UCC foreclosure process requires a commercially reasonable sales process. See John C. Murray, Clogging Revisited, 33 Real Prop. & Tr. J. 279 (1998-1999) (noting the paucity of case law regarding clogging claims in mezzanine finance transactions and that “courts ought not to take an overly restrictive view of the clogging doctrine as applied to mezzanine financing transactions”). Moreover, New York cases that have addressed the equity of redemption more generally have typically involved situations where borrower was effectively denied the right to repay the debt and repay the property. See Mooney v. Byrne, 163 N.Y. 86 (1900) (finding that plaintiff’s equity of redemption where the property was worth substantially more than the debt and did not have an avenue to repay the debt); Basile v. Erhal Holding Corp., 538 N.Y.S.2d 831 (2d Dep’t 1989) (where mortgagor gave mortgagee a mortgage

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that would not be recorded unless the mortgagor defaulted, the court granted mortgagor a right of redemption).

(d)

In Larson v. Hinds, 394 P.2d 129 (Colo. 1964), the Colorado Supreme Court concluded that a transaction under which a deed was placed in escrow and was to be “immediately deliver[ed]” in the event of a default “deprived the defendants of any redemption rights which the public policy of this state guarantees and amounted to a forefeiture which the policy of this state abhors. The evidence in this case compels the conclusion that under the circumstances here present the arrangement was a security transaction as a matter of law and the court erred in holding the same to be an absolute sale.” Id. at 132-33.

(e)

See Sutton 58 Owner, LLC v. Sutton 58 Associates LLC, Transcript at 20 (rejecting plaintiffs’ claim that the structure of the transaction – under which the lender issued a mortgage loan and a separate mezzanine loan secured by an equity pledge – was designed to allow lender to effectively defeat its equity right of redemption, reasoning that “[t]hese are highly sophisticated . . . real estate professionals, who are well counseled”).

(f)

In YL Sheffield LLC v. Wells Fargo Bank, 2009 WL 6408598 (N.Y. Sup. Ct. July 29, 2009), the borrower failed to pay maturity a mortgage loan and a mezzanine loan. The governing documents provided that upon default ownership of the mezzanine entity would transfer to the lender. Following the transfer to the lender, the lender commenced a UCC foreclosure sale. The court found that “[d]efendants’ legitimate exercise . . . of their remedies upon default – in this case, [UCC] foreclosure – cannot constitute irreparable harm to Plaintiffs. . . . In this case, there is no dispute that the Current First Mezzanine Loan is valid, in default, and subject to foreclosure. That foreclosure then cannot, as a matter of law, cause irreparable harm to Plaintiffs.”

6.

Deed in the Box

(a)

New York law is clear that at the outset of a loan, the lender may not require that the borrower place the deed to the property in escrow in the event of a default. The giving of a deed as security merely creates a mortgage, and the lender

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must nonetheless go through the mortgage foreclosure process. See N.Y. Real Prop. Law § 320. However, practitioners have generally believed that, if the deed in escrow is given after an Event of Default and in consideration for a forbearance agreement or a loan modification, the “deed in the box” arrangement for a future default was permissible. See Verity v. Metropolis Land Co., 248 AD 748 (N.Y. App. Div. 1936); Ringling Joint Venture II v. Huntington Nat. Bank, 595 So. 2d 180 (Fla. Dist. Ct. App. 1992) (deed delivered from escrow to defendant after default in commercial transaction was enforceable and did not clog borrower’s right of redemption). A recent First Department case has created significant uncertainty in this area.

(b)

Patmos Fifth Real Estate Inc. v. Mazl Bldg., LLC, 140 A.D.3d 527 (1st Dep’t 2016) (concluding that deed given to defendant to secure agreement for an additional loan and extension of time following default on a consolidated mortgage created a mortgage requiring defendant to commence foreclosure proceedings prior to filing the deed).

(i)

In Patmos, the plaintiffs defaulted on a consolidated mortgage relating to property plaintiffs purchased and financed through defendants. The defendants, however, agreed to give plaintiffs additional time and credit. This agreement was secured by plaintiffs executing a deed to the property to be held in escrow and not to be released unless and until plaintiffs defaulted. Id. at 527.

(ii)

Plaintiffs defaulted under the agreement. Defendants subsequently “filed and recorded the deed and became the record owner of the property.” Id. at 527.

(iii)

Plaintiffs – who had paid taxes and renovated the property – contended that defendants improperly filed the deed without first commencing foreclosure proceedings in accordance with New York law. Id. The court agreed, explaining that “the courts are steadfast in holding that a conveyance, whatever its form, if in fact given to secure a debt, is neither an absolute nor a conditional sale, but a mortgage, and that the grantor and grantee have merely the rights and are subject only to the obligations of mortgagor and mortgagee. Significantly, the statute does not require a conclusive showing that the

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transfer was intended as security; it is sufficient that the conveyance appears to be intended only as a security in the nature of a mortgage.” Id. at 528 (internal citations and quotation omitted).

L. Statute of Limitations

1.

ACE Securities Corp. v. DB Structured Products, Inc., 25 N.Y.3d 581 (2015).

(a)

This case underscores that if the parties intend for the contractual remedies to be independent contractual obligations giving rise to a separate statute of limitations, the contract must be clearly drafted to reflect that intention.

(b)

This dispute related to the representations and warranties included in a transaction involving residential mortgage backed securities, which ultimately underperformed, causing losses of $330 million. Defendant DBSP purchased thousands of mortgage loans, which were sold to an affiliate pursuant to a mortgage loan purchase agreement (“MLPA”). The affiliate subsequently transferred its rights under the MLPA to a Trust pursuant to a pooling and servicing agreement (“PSA”) to which – for the purposes of this case – DBSP was not a party or signatory. Id. at 589-90.

(c)

DBSP made numerous representations and warranties in the MLPA concerning the quality of the loans “as of the Closing date,” but the Trust’s sole remedy if DBSP “‘breach[ed] … any of the representations and warranties contained in’ the MLPA was for DBSP to cure or repurchase a non-conforming loan.” Id. Under the PSA, the trustee of the Trust could enforce DBSP’s repurchase obligation by: (1) “promptly notify[ing]” DBSP and requesting that DBSP cure the defect within 60 days and (2) if DBSP failed to cure the defect, enforce DBSP’s obligations under the MLPA within 90 days of being notified of the breach. Id. at 591.

(d)

Several years after the parties executed the two agreements, the Trust experienced substantial losses. Two certificate holders in the Trust investigated and ultimately determined that nearly all of the loans failed to comply with at least one of the representations and warranties of the MLPA. The certificate holders gave notice to the trustee of the alleged

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breach and demanded that the loans be repurchased, and sought a tolling agreement to avoid the potential expiration of the statute of limitations on their claims. Id.

(e)

When the trustee failed to act, the certificate holders filed suit against DBSP. The certificate holders sought specific performance and damages to recover their losses. The trustee subsequently sought to be substituted for the certificate holders and filed a complaint on the Trust’s behalf alleging a breach of the MLPA representations. DBSP moved to dismiss the action, alleging that the statute of limitations had expired as trustee’s claims accrued, if at all, on the closing date over six years before the filing of the complaint. Id. at 591-92.

(f)

The trial court denied the motion, reasoning that a breach could only have occurred until DBSP “‘fail[ed] to timely cure or repurchase a loan’ following discovery or receipt of notice of a breach of a representation or warranty.” Id. at 592. The First Department reversed, concluding that “the claims accrued on the closing date of the MLPA . . . when any breach of the representations and warranties contained therein occurred.” Id. at 593.

(g)

The Court of Appeals affirmed the First Department’s decision. The Court of Appeals began by noting that “New York does not apply the ‘discovery’ rule to statutes of limitations in contract actions. Rather, the ‘statutory period of limitations begins to run from the time when liability for wrong has arisen even though the injured party may be ignorant of the existence of the wrong or injury.’” Id. at 594. The court rejected plaintiff’s view of “the repurchase obligation as a distinct and continuing obligation that DBSP breached each time it refused to cure or repurchase a non-conforming loan.” Id. “Although parties may contractually agree to undertake a separate obligation, the breach of which does not arise until some future date, the repurchase obligation undertaken by DBSP d[id] not fit this description.” Id. The court, looking to the terms of the agreements, reasoned that DBSP never guaranteed the loan’s future performance. Indeed the agreement expressly provided that the representations “did not survive the closing date.” Id. at 595. Rather, the cure obligation gave the Trust an alternative remedy to

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suing DBSP in the event of a breach. In other words, “the cure or repurchase obligation was not an independently enforceable right, nor did it continue for the life of the investment.” Id. at 599.

M. Consequential Damages

(a)

ERC 16W Ltd. P’ship v. Xanadu Mezz Holdings LLC et al., 133 A.D.3d 444 (1st Dep’t 2015) (affirming Supreme Court’s order granting defendants’ motion to dismiss plaintiff’s claim for consequential damages).

(i)

Lehman Brothers was a member of a consortium of lenders in connection with the Xanadu mall in New Jersey, (renamed the American Dream mall after Governor Chris Christie called it the ugliest building in America). After Lehman’s bankruptcy, it failed to fund its share of construction loan advances. Lehman’s failure to fund essentially settled the project for several years. Plaintiff alleged both direct damages stemming from a breach of contract in the amount Lehman was supposed to fund plaintiff but did not ($23M), as well as consequential damages stemming from an alleged loss of equity investment in the Xanadu project ($1.3 Billion). Id. at 444.

(ii)

The First Department, affirming the trial court and relying on Kenford Co. v. County of Erie, 67 N.Y.2d 257 (1986), held that the provisions of the loan agreement relating to remedies for a default “do not suggest or provide for such a heavy responsibility on the part of” defendants, and that evidence was lacking showing that these damages were “foreseeable and contemplated” by the parties at or before the time of contract. Id.

(iii)

The court looked to the remedies listed in the loan agreement to see what the parties had bargained for and/or contemplated, and determined that plaintiff’s loss of its entire equity investment in the project upon defendant’s default was not foreseeable at the time the loan was entered into. Id.

(iv)

The court concluded by comparing the asserted direct damages amount ($23M) and asserted consequential damages amount ($1.3B), and determined plaintiff’s consequential

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damages claim was “out of proportion to any liability contemplated by the contract.” Id.

(b)

Cornell Holdings, LLC v. Woodland Creek Assocs., LLC, 64 A.D.3d 1020 (3d Dep’t 2009) (reversing Supreme Court’s order awarding Woodland Creek’s damages for lost profits).

(i)

Defendants held title to a large tract of property which was under contract to a third party, but then entered into a “deposit receipt and sales agreement” with another buyer (Woodland Creek Associates); property was sold to the third party and Woodland Creek sued for fraud/breach of contract, alleging as damages its lost profits from the proposed development. Id. at 1021.

(ii)

The court found that “Woodland Creek bore the burden of demonstrating that its claimed damages were attributable to breach of the subject real estate contract, were capable of measurement with a reasonable degree of certainty and were reasonably within the contemplation of the parties when the contract was made.” Id. at 1022.

(iii)

The court held that while Woodland Creek clearly established that it was purchasing the tract for development and resale purposes and expected to generate a profit from such development and resale, this was “not adequate to demonstrate that the parties contemplated liability for lost future profits in the event of a breach…” Id. at 1023.

(iv)

“To hold otherwise would read such special damages into every like real estate contract, a result which would be inimical to the very limitations imposed by the Court of Appeals in [Kenford] and its progeny…” Id.

(c)

Siegel v. People’s United Bank, No. 505372/2013, 2014 N.Y. Slip Op. 51358(4) (Sup. Ct. Kings County Sept. 4, 2014) (denying defendant’s motion to dismiss complaint, permitting plaintiffs’ lost profits claim to proceed)

(i)

Plaintiffs partnered to develop properties in Brooklyn. In order to begin construction, plaintiffs obtained a $4.3 million hard money loan, secured by a mortgage on the property. Plaintiffs then sought to obtain a $10 million first mortgage construction loan “for the purpose of satisfying the hard money loan and to complete the construction of the project

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at the properties.” Plaintiffs entered into a Commercial Mortgage Commitment to obtain the construction loan. As a result of entering into this agreement, plaintiffs “did not seek commitments from other lenders for the construction loan.” Although plaintiffs allegedly met all the requirements of the Commercial Mortgage Commitment, and were repeatedly assured that the loan would be funded, the bank ultimately notified plaintiffs it would not fund the loan. Plaintiffs sued for lost profits as a result of the lender’s failure to fund the loan pursuant to the Commercial Mortgage Commitment.

(ii)

Defendant moved to dismiss, arguing that plaintiffs failed to satisfy certain preconditions in the Commitment and that the Commitment “is merely a preliminary agreement to agree, and is not a final binding contract that is enforceable.”

(iii)

The court disagreed, finding that the Commitment was an enforceable agreement offered by the lender and accepted by the borrower. The Court held that the terms of the agreement were ambiguous and therefore factual issues remained as to whether the precondition was satisfied. Thus it was premature to make a determination regarding plaintiffs’ claim at the motion to dismiss stage. The motion to dismiss was denied.

N. Lender Liability Issues – Recent Developments

1.

In re BH Sutton Mezz LLC, 2016 Bankr. LEXIS 4113 (Bankr. S.D.N.Y Dec. 1, 2016)

(a)

This adversary proceeding brought by Plaintiffs BH Sutton Mezz LLC (“Sutton Mezz”), Sutton 58 Owner LLC (DE) (“Sutton DE”) and Sutton 58 Owner LLC (NY) (“Sutton NY”) (collectively, the “Debtors”), arises out of the failed development of a nearly 1,000 foot luxury residential tower in Midtown, Manhattan. The project was led by three principals, who indirectly own 100% of the membership interests in Sutton Mezz. Sutton Mezz, in turn, owns 100% of the membership interests in Sutton DE and Sutton NY. The project was financed by defendants, the lenders, through two complex financing transactions – both involving multiple loans, including mezzanine loans, secured by a mortgage on the Property and development rights, and a pledge of 100% equity of the fee owner respectively. Plaintiffs alleged improper

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conduct by defendants and sought to subordinate and reduce the amount they owed defendants on these loans as a result. The improper conduct, plaintiffs contended, was designed to allow defendant lenders to effectively take over the project.

(b)

In order to finance the project, plaintiffs initially entered into negotiations with Inbursa. While these negotiations were ongoing, however, plaintiffs considered pitching the project to defendant Gamma – which happened to be run by the second cousin of plaintiffs’ attorney. Id. at *12. After executing a term sheet with Inbursa, “Inbursa advised that the value of the anticipated collateral would not be sufficient to satisfy their 45% LTV requirement.” Id. at *14. The defendant lenders offered plaintiffs bridge financing sufficient to close on the Property and acquire certain development rights (the “Gamma 1 transaction”).

(c)

After the Gamma 1 transaction, plaintiffs had numerous communications and meetings with the defendant lenders. During these meetings “it’s safe to say that [Defendants] offered [Plaintiffs] advice related to the design of the Project.” Id. at *21. During this time the defendants also directly communicated with others regarding various aspects of the project – e.g., the acquisition of certain air rights – without involving plaintiffs. Id. at *23-25.

(d)

Plaintiffs subsequently considered a number of alternatives to raise additional financing. Ultimately, defendants proposed providing additional funding to Plaintiffs (the “Gamma 2 transaction”) in excess of $145 million, with an exit fee of 20%. Id. at *27-30. Although plaintiffs recognized that “Gamma 2 . . . involved a ‘very big’ ‘vig’ – [Plaintiffs] also believed that its advantages justified its expense.” Id. at *31.

(e)

After Gamma 2, the project began experiencing difficulties that ultimately resulted in its failure. Notably, the disputes between the parties related to “reserve requests and the draw requisition process.” These disputes included, among other things, “Lenders’ refusal to make disbursements,” its alleged failure to make timely payments, and “delay in releasing funds.” Id. at *34.

(f)

During the course of Plaintiffs’ relationship with defendant lenders, two pre-negotiation agreements were executed, both

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of which “acknowledge and agree that Lender has no fiduciary, confidential or special relationship with any of the Borrower Parties and no such relation-ship is created by the execution of this Agreement[.]” Id. at *25-26, 35.

(g)

Plaintiffs asserted numerous claims against defendants. The alleged improper conduct was categorized as follows: Plaintiffs’ claims for unconscionability, lender liability, breach of contract, breach of implied covenant, equitable subordination, fraudulent transfer, and criminal usury.

(h)

The court rejected nearly all of Plaintiffs’ claims.

(i)

The court rejected plaintiffs’ procedural and substantive unconscionability claims noting that the principals were “sophisticated and experienced” in real estate development, and “[t]he mere fact that the Plaintiffs were new to the New York City real estate market does not change his level of sophistication.” Id. at *39.

(ii)

As to plaintiffs’ lender liability claims – premised on the theory that Defendants had a fiduciary duty to Plaintiffs – the court was not persuaded that Defendant lenders effectively exercised control over Plaintiffs. Although “Defendants were more involved in this project than a traditional lender . . . this approach appears normal for . . . a lender who is used when more risk adverse traditional lenders won’t finance a project because of the high level of risk.” Id. at *56-57. What’s more, the parties specifically disclaimed the existence of a fiduciary relationship on multiple occasions through the pre-negotiation agreements. Id. at *57-59. “The existence of these waivers on multiple occasions by a party as sophisticated as the Plaintiffs gravely undercuts their fiduciary duty claim.” Id. at *59. The court similarly rejected plaintiffs’ numerous other theories giving rise to a fiduciary relationship.

(iii)

The court rejected plaintiffs’ breach of contract claims, noting that plaintiffs’ theories all failed. For instance, plaintiffs claimed that improper payments were made by the defendant lenders to their attorneys from certain reserve funds. The court, however, concluded that plaintiffs failed to show how the alleged “nefarious

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dealing” caused any harm – particularly in light of Defendants’ explanation that the particular invoices were paid incorrectly, but subsequently corrected once the error was discovered. Id. at *86.

(iv)

The court quickly dispensed of plaintiffs’ breach of implied covenant claims, noting that “[a]s with some of Plaintiffs’ breach of contract claims, the Debtors have not made clear the basis for this claim.” Id. at *98.

(v)

The court rejected plaintiffs’ equitable subordination claims, once again noting the lack of evidence suggesting Defendant lenders “breach[ed] the parties’ written agreements, breach[ed] a fiduciary duty to the Debtors, or bec[a]me enriched through unconscionable, unjust, unfair, close or double dealing or foul conduct.” Id. at *108.

(vi)

Lastly, the court rejected plaintiffs’ fraudulent conveyance claims, explaining that plaintiffs failed to establish the debtor insolvency requirement, “but instead have merely provided scattered and anecdotal information.” Id. at *112.

(i)

Although the court largely rejected plaintiffs’ claims, it ruled in their favor with respect to the criminal usury claim.

(i)

The court first concluded that the rate charged by defendants exceeded the maximum allowable interest rate. The principal amount of one of the loans involved in the Gamma 2 Transaction (the “Building Loan”) was $1.4 million with a stated interest rate of 6% per year. Id. at *118. However, there was an “additional interest” of $280,000 due at maturity or upon prepayment. As a result, the loan had an effective interest rate of 38% (dividing the “additional interest” over the seven month term of the loan) – well in excess of New York’s statutory maximum rate of 25%. Id.

(1)

The court rejected defendants’ argument that this ought to be viewed as part of the larger Gamma 2 transaction totaling $145.5 million – thereby exempting it from the criminal usury statute because it exceeded the $2.5 million statutory threshold. Although New York law allows for the aggregation

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of loans pursuant to “a written agreement” under the criminal usury statute, the court explained that the Building Loan was a separate “written agreement” from the other loans involved. In other words, the Building Loan could not be aggregated with the other loan agreements. Id. at *119-21.

(ii)

The court secondly found that the lenders met the requisite intent under the criminal usury statue, “particularly given the level of sophistication of the Defendants.” Id. at *123.

(iii)

Although the Building Loan was criminally usurious, the court declined to void the agreement. “Instead, considering the sophistication of the parties here and all the facts and circumstances of this case, the Court finds the appropriate remedy is to revise the interest obligation on the Building Loan to an appropriate non-usurious rate.” Id. at *126.

(1)

Defendants ultimately waived their entitlement to interest on the Building Loan, resolving the usury issue. Id. at *127.