A New York federal district court recently granted summary judgment to a special servicer of a trust on the grounds that the plaintiff investors failed to comply with the no action clause of the Pooling and Services Agreement (“PSA”). The special servicer, CRIIMI MAE Services Limited Partnership (“CMSLP”), asserted that plaintiffs had failed to satisfy the no action clause as they were not authorized by more than 25% of the holders of Class A-1 certificates to bring suit. While the plaintiff argued that it did not need the authorization of the Class A-1 holders as that class was not adversely affected by the transaction complained of, the court disagreed, finding that plaintiff had failed to carry its burden of establishing that the Class A-1 certificate holders were unaffected. Teachers Insurance and Annuity Association of America v. CRIIMI MAE Services Limited Partnership, No. 06 Civ. 0392, 2011 WL 403428 (S.D.N.Y. 2011).
In October 1995, plaintiffs allegedly invested in a trust comprised of nine fixed-rate mortgage loans with an aggregate principal balance of $967 million created pursuant to the PSA. The trust issued several classes of certificates with different interests in the trust. The PSA established a distribution priority on the borrowers’ principal payments whereby the senior class with an outstanding principal balance was to be paid in full prior to the next class receiving principal payments. As the time of the relevant events, Class A-1 was the most senior class with an outstanding balance. Plaintiffs owned more than 25% of the interest-receiving Class A-CS2 certificates, a class lower than Class A-1.
The Hardage Loan
One of the nine loans in the trust was a fixed-rate mortgage loan owed by Hardage Hotels I, Inc. (“Hardage”). At the time it was transferred to the trust, that loan’s balance was $91 million with a fixed interest rate of 9.54 percent and a maturity date of July 11, 2017. In late 2002, Hardage ran into financial difficulties. In July 2003, CMSLP sold that loan’s $80.7 million principal balance for $74.4 million. As Class A-1 was the most senior class with an outstanding principal balance, it received all of the proceeds of that sale. Class A-1 had an original principal balance of $652.7 million on which the certificate holders were paid an interest rate of 7.1 percent. The Hardage loan proceeds reduced this principal balance and, accordingly, reduced the future interest payments to the Class A-1 certificate holders.
In December 2005, the Class A-CS2 holder plaintiffs brought suit contending that the special servicer breached the PSA by modifying and selling the Hardage loan. Plaintiffs contended that the special servicer did so to advance its own personal interests as the special servicer’s parent owned lower-priority principal-receiving certificates. The plaintiff asserted that such sale harmed them financially.
In its defense, the special servicer relied on a “no action clause” in the PSA which provided that a certificate holder could bring suit only if at least 25% of the certificate holders of each affected class first made a demand on the trustee. It provided, in relevant part:
No Certificateholder shall have any right to institute any suit, action or proceeding in equity or at law upon or under or with respect to this Agreement, unless . . . the Holders of Certificates representing Percentage Interests Action Against Servicer Dismissed continued from page 19of at least 25% of each affected Class of Certificates shall have made written request upon the Trustee to institute such action, suit or proceeding in its own name as Trustee hereunder and shall have offered to the Trustee such reasonable indemnity as it may require against the costs, expenses and liabilities to be incurred therein or thereby, and the Trustee, for 30 days after its receipt of such notice, request and offer of indemnity, shall have neglected or refused to institute any such action, suit or proceeding.
The court explained that, in its earlier decision Teachers Ins. & Annuity Ass’n of Am. v. CRIIMI MAE Svcs. Ltd. P’ship, 681 F. Supp. 2d 501 (S.D.N.Y. 2010), it concluded that “this language means that plaintiffs may sue only if they represent 25 percent in interest of every class of certificates that was affected adversely by the sale of the Hardage loan.” Accordingly, “[a]s plaintiffs represent only Class A-CS2, the question is whether any other class was affected adversely” in December 2005 when plaintiffs initiated this action. The court noted that “[t]he focus of this motion is whether plaintiffs complied that a ‘no action clause’ contained in the PSA in bringing this action.”
In moving for summary judgment, the special servicer argued that the sale of the Hardage loan adversely affected the holders of all Class A-1 Certificates. While that motion was originally denied, following additional factual development the special servicer sought and was granted leave to renew their motion for summary judgment.
To defeat the special servicer’s motion, the plaintiffs were required to “adduc[e] admissible evidence that, if believed, would create a genuine issue of fact as to whether Class A-1 was affected adversely by the sale of the Hardage loan.” Both parties submitted evidence to support their views of the effect of the Hardage loan sale on Class A-1. The plaintiffs argued that the sale benefited Class A-1 and submitted a spreadsheet showing that when a discount rate of 7.1 or greater was used Class A-1 benefited from the sale. For its part, the special servicer pointed to an expert declaration that expressed the view that the sale harmed Class A-1 because Class A-1 would have earned an interest rate of between 2 and 3.5 percent on the Hardage loan sale proceeds—assuming the proceeds were invested in a vehicle that was comparable in rating and maturity to the Class A-1 certificates—which is substantially less than the 7.1 percent interest Class A-1 was earning on the principal balance.
Before reaching the issue of whether Class A-1 was adversely affected, the court concluded that the effects of the sale of the Hardage loan were (i) Class A-1 received an accelerated principal disbursement and (ii) as a result of the accelerated disbursement, Class A-1’s principal balance was decreased which reduced the amount of interest disbursed to Class A-1. Therefore, to determine the sale’s “net effect,” the benefits of the accelerated principal disbursement need to be compared to the costs to Class A-1 of reduction in interest. As the costs and benefits were realized at different times—the benefit being received upon the principal paydown in July 2003, and the interest reduction being felt over time through the maturity date of the certificates in 2017—a discount rate needed to be applied to reflect the “time value of money and the risks associated with any investment.” The court concluded that, whether Class A-1 benefited from the sale of the Hardage loan or were adversely affected by that sale, turned on the discount rate used to measure the effects of the sale.
The court explained that “[d]etermining a discount rate is an issue of fact on which the parties may adduce evidence.” The special servicer contended—based upon comparables investments—that the appropriate discount rate is between 2 and 3.5 percent. Although plaintiffs challenged the appropriateness of the comparable investments used by the special servicer, the court observed that, under plaintiff’s approach, the comparable investments of the sale did not harm Class A-1 only if a discount rate of 7.1 or higher was applied. Although the court conceded and provided examples of when, theoretically plaintiffs’ assertion is possible, the court explained that plaintiffs cannot carry their burden “with a theoretical illustration that the sale might not have harmed Class A-1.” Instead, to survive summary judgment plaintiffs were required to put forth “admissible evidence that, if believed, would support the use of a discount rate of 7.1 percent or greater in these circumstances.” The court concluded that plaintiffs had failed to put forth that evidence. Instead, the evidence plaintiffs pointed to with respect to the determination of a “discount rate” was the 2003 ten-year Treasury notes, that were paying between 4 and 4.5 percent after the loan was sold, the court noted, was “far short of the 7.1 percent that plaintiffs need to prove.”
No action clauses in trust agreements can impose substantial bars to an investor’s standing to bring a suit. As this case amply demonstrates, courts enforce such clauses as written, and hold plaintiff holders to their burden of proving compliance with restrictions in no action clause.