The right to replace the special servicer in CMBS transactions is perhaps the most important and powerful tool available to the Controlling Party. However, the replacement right is usually subject to the satisfaction of certain conditions, which vary from transaction to transaction, but often include a confirmation from the applicable rating agencies that the replacement will not lead to a downgrade or withdrawal of the ratings of the applicable CMBS notes. What happens if the rating agencies refuse to give that confirmation?
As described in “CMBS – who is really in control?” it is typical in a CMBS transaction for a so-called “Controlling Party” to be appointed with respect to each loan in the CMBS transaction, with the status as “Controlling Party” typically being with the party in the applicable debt stack that is exposed to the first loss position in relation to that loan – i.e. either an applicable B-piece lender or the lowest ranking class of noteholders in the CMBS (often labelled the “controlling class”). The Controlling Party has certain rights to make decisions with respect to that loan based on the theory that it is strongly motivated to ensure that the maximum recovery from the loan is achieved by the special servicer.
There have been some interesting developments in the marketplace over the last year or so relating to the ability of the Controlling Party in certain existing CMBS structures to replace the special servicer. In December 2012, Fitch Ratings announced that it will no longer issue ratings confirmations in connection with the replacement of special servicers on EMEA CMBS transactions. Fitch has taken this position based on its concerns about certain conflicts of interest that it views as inherent in such situations. In Fitch’s view, a lack of insight into the reasons for a requested change in special servicing and the nature of the Controlling Party’s commercial relations with other interested parties make the task of prejudging the consequences for ratings unreliable.
Since the replacement of the special servicer is often conditioned on the receipt of a no-downgrade letter from each of the applicable rating agencies, Fitch’s announcement that it will not issue such no-downgrade letters – even on deals that Fitch initially rated – has introduced a significant obstacle for investors seeking to exercise their contractual right to replace the special servicer.
For example, throughout 2013 and into 2014, there were several attempts to replace Hatfield Philips as special servicer for the loans in the Windemere XIV CMBS transaction. There – amid a very contentious effort to remove the special servicer (in which Lone Star twice attempted to replace Hatfield Philips with Hudson Advisors only to be thwarted by obtaining slightly less than the required 75% bondholder vote) the Note Trustee received the required rating agency confirmations from S&P and Moody’s and ultimately exercised its discretion under the applicable transaction documents to waive the requirement of a Fitch no-downgrade letter.
More recently, the controlling class of Noteholders in the Titan 2007-1 (NHP) care home CMBS transaction have attempted to replace Capita with Mount Street as special servicer of the only loan in that securitisation. As in the Windemere XIV CMBS transaction, the transaction documents require the delivery of no-downgrade confirmations from the applicable rating agencies as a condition to the replacement of the special servicer. In this instance, the Note Trustee, faced with transaction documents that do not offer a clear path to waiving the Fitch no-downgrade requirement, has essentially thrown up its hands in frustration and applied to an English court for direction on the correct interpretation of the transaction documents with respect to the applicability and satisfaction of the conditions to the special servicer replacement. Although there are other contractual interpretation issues at play in the case, the court may ultimately set an important precedent in this area. At press-time for this article, the court had not yet issued its directions and it remains unclear whether the outcome of the case will further frustrate the special servicer replacement process or finally provide a suggested pathway around the problem created by Fitch’s refusal to issue no-downgrade letters.