In re Innkeepers USA Trust, et al., -- B.R. --, 2011 WL 1206173 (Bankr. S.D.N.Y. 2011)

In a decision entered April 1, 2011, the Bankruptcy Court for the Southern District of New York denied standing to the holder of a certificate of beneficial interest in a real estate mortgage investment conduit (“REMIC”).1 Appaloosa Investment L.P. I, Palomino Fund Ltd., Thoroughbred Fund L.P. and Thoroughbred Master Ltd. (collectively, “Appaloosa”) filed objections to the motion of the debtor, Innkeepers USA Trust, and certain of its debtor affiliates, seeking approval of, among other things, bidding procedures and a stalking horse bid for the sale of certain real estate assets. Appaloosa argued that it was a party in interest with standing to be heard in the bankruptcy proceedings by virtue of the fact that (1) it was a holder of 100 preferred shares of the debtor; (2) it held a $10 million interest in one of the debtors’ debtor in possession loans; and (3) it held certificated interests in a fixed rate loan evidenced by two notes, one of which was owned by a REMIC known as the C-6 Trust and the other was owned by a REMIC known as the C-7 Trust. The C-6 Trust was comprised of a total of 181 loans with principal outstanding totaling approximately $2.95 billion. The C-7 Trust was comprised of a total of 97 loans with principal outstanding totaling approximately $3.15 billion. Appaloosa’s interests in each of the C-6 and C-7 Trusts was $412 million, representing approximately 13% and 14% respectively. Based on the revised form of proposed stalking horse bid at issue, the Court determined that Appaloosa’s objection would be deemed made on account of its certificated holdings.

Each of the REMICs was governed by its own pooling and servicing agreement (each a “Servicing Agreement”),2 the purpose of which is to protect the tax treatment of the REMICs and to ensure fair treatment of all parties, whose interests sometimes conflict. The C-6 Trust Servicing Agreement3 includes a clause prohibiting individual certificateholder action unless a certificateholder has delivered a notice of default to the servicer and certificateholders holding at least 25% of the voting rights of the C-6 Trust have made a written request to the servicer and the servicer has failed to take such requested action for at least 60 days. Neither of those had occurred prior to Appaloosa’s raising its objection.

In determining that Appaloosa did not have standing in its certificateholder role,4 the Court also considered existing Second Circuit case law, which provides that a party in interest under § 1109(b) of the Bankruptcy Code is one who has a direct pecuniary interest that will be affected by the outcome of the case and who has legal rights against the debtor. The Court attempted to draw a distinction between the relationship between certificateholders and mortgage trusts and the relationship between bondholders and indenture trustees – stating that bondholders have a direct right to payment from the obligor, whereas holders of certificates in a pool of mortgage loans do not have a direct right to payment from the obligors on the underlying loans and may only look to the cash generated from the pooled assets in the trust for payment. The Court further relied on the express language in the C-6 Trust Servicing Agreement providing that direct rights to enforce the underlying loans is limited to situations in which the trustee has been instructed to take action and has failed to do so for 60 days.

However, in so doing, the Court failed to address almost identical language limiting the exercise of rights and remedies by individual bondholders in most bond indentures. Indenture provisions customarily provide that a bondholder cannot take action its name unless the holder provides notice to the trustee of a default, at least 25% of the holders request that the trustee take a specified action and offer indemnity reasonably acceptable to the trustee for taking the requested action, and the trustee fails to take such requested action for 60 days.

Appaloosa had also argued that the special servicer of the secured loan (the “Fixed Rate Loan”), the two notes for which comprise the C-6 Trust and the C-7 Trust, respectively, Midland Loan Services (“Midland”), was conflicted and not acting in the best interests of all certificateholders. In its role as special servicer of the Fixed Rate Loan, Midland sought to provide “stapled financing” to any qualified bid for the Debtors’ enterprise. The Court’s decision was unaffected by Appaloosa’s contentions about the servicer. The Court held that the servicer is contractually bound by the servicing standard – to consider the interests of all certificateholders as a collective whole – and that if Appaloosa believes that the servicer is breaching that standard, it has the option of pursuing its contractual remedies in another forum.

This case adds yet another wrinkle to the already murky area of minority holders’ rights.