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In a securitisation case on the interpretation of a servicing agreement in a commercial mortgage-backed securities (CMBS) transaction, the court was asked which party would have the right to require termination of the appointment of the special servicer and the appointment of a successor. The court looked at the interpretation of the contractual documentation rather than the terms of the offering circular.
The Chancery Division was asked in US Bank Trustees Ltd v Titan Europe 2007-1 (NHP) Ltd, a securitisation transaction case, to look at the interpretation of contractual terms which conflicted with terms in the Offering Circular for floating rate notes issued as part of a CMBS transaction. The dispute arose about which party within the structure had the right, on a particular event which related to the valuation of the underlying property portfolio, to appoint a successor servicer to replace the special servicer under the servicing agreement.
After much debate about the interpretation of particular definitions and clauses in three particular transaction documents (the servicing agreement, the intercreditor agreement and the Offering Circular for the CMBS floating rate notes), the court held that Titan Europe 2007-1 (NHP) Limited (the issuer), rather than the representative of a subordinated class of notes, was the party with the right to remove the special servicer and appoint a replacement.
The issuer was a special purpose company set up in Ireland for a CMBS structure as the issuer of floating rate notes. The underlying assets for the securitisation were hundreds of healthcare properties (the property portfolio) in the UK. £638m of floating rate CMBS notes due in 2017 were issued by the issuer in May 2007 in different classes and seniority ranging from Class A Notes to Class E Notes (the Notes). The senior Class A Notes were issued with a face value of £435m. The other classes were in tranches of between £42m and £60m. US Bank Trustees Limited, the claimant, is the note trustee.
The Notes formed part of financing relating to a total loan of £1,172m (the whole loan) made to Libra No 3 Limited (the borrower). The whole loan had seven tranches. The senior tranche was for £638m (the libra loan) and the other tranches were all subordinated in descending order of priority. The original lender had been a company in the Credit Suisse Group, however, the lender had transferred its interest and, in turn, it had been transferred again and now sat with the issuer which had acquired the interest in the loan using the proceeds of the Notes. So, the issuer was in the position of lender under the whole loan to the borrower.
The value of the property portfolio at 31 January 2007 was £1,338m. By November 2008 the valuation in a report instructed by the servicer had fallen to £926m. By 31 December 2013 the property portfolio was valued at £529m. The effect of the decline in the valuation of the property portfolio meant that the loan to value covenant in the whole loan documentation was triggered and a special servicer, Capita Asset Services (UK) Limited (Capita) was appointed on 25 November 2008. There were also substantial obligations outstanding under a forward interest rate swap in the original structure which would rank ahead of the Class A Notes.
It became clear that there would not be sufficient funds in the securitisation structure to meet the liabilities under all the classes of notes. Capita took action to start arranging an exit strategy which would involve a sale of the property portfolio. At this point the second defendant (Anchorage), as holder of Class E Notes, which would not be repaid, objected to the premature sale saying that recent capital investments had not had time to feed through into the business and affect the value of the property portfolio. The proposed sale would only pay out the Class A Notes, and possibly the Class B Notes, but none of the other classes of Notes, including the Class E Notes. Anchorage claimed it was the 'controlling party' in the transaction which had the right to require the note trustee to terminate the appointment of Capita as special servicer and appoint a successor. The issuer, note trustee and Class A noteholders did not agree and claimed that the issuer was in fact the controlling party with those rights and not Anchorage.
The court looked at three documents in particular, the servicing agreement, the A/B intercreditor agreement (the intercreditor) and the Offering Circular for the Notes. It looked at the chronology of when these were created to see if this would aid interpretation to help determine who would qualify as the controlling party. The intercreditor set out the terms on which servicing should be done and what the servicing agreement should say. Where there was a conflict between the terms of the agreements, the terms of the intercreditor would prevail. Both the intercreditor and the servicing agreement were contractual documents entered into by parties to the transaction.
The Offering Circular is not a contractual document between the contracting parties, but is addressed to investors who are potential noteholders. Its influence on interpretation of contractual provisions, the court said, is minimal. Indeed, there is a proviso that the obligations of the parties to the CMBS transaction set out in the Offering Circular are governed by the transaction documents described in the Offering Circular and all information and statements are qualified by those transaction documents. Therefore, the parties and the court should look at the contractual documentation to determine the rights and obligations of the parties to interpret who the controlling party would be.
The court heard arguments that the parties had made mistakes in drafting as the commercial position could surely not have been to appoint a special purpose company as the party having a right to remove and replace the special servicer. It had not heard any commercial logic as to why a subordinated noteholder which would not be repaid, should be the controlling party, when only senior Class A Notes would be paid out. The court stated that it would look to the contractual documents. The court said that if the issuer was considered the controlling party, it would have the interests of all noteholders in mind. It held that it was not conclusive that there had been mistake. If there were inconsistencies in the terms of the Offering Circular and the underlying transaction documents, the noteholders could have claims in respect of the Offering Circular, but it would not mean the court would use the Offering Circular to aid interpretation of the contractual documentation.
The court concluded that the issuer, rather than Anchorage, the holder of Class E Notes, was the controlling party. The remaining questions raised about the method of notice of removal and involvement of the rating agencies were consequently of no practical consequence as these were the acts of Anchorage and not the issuer. However, the judge did express a view on these, as described below.
In the servicing agreement, it was a condition for the termination of the appointment of the special servicer and appointment of a successor special servicer that the rating agencies, (in this case, Standard & Poors (referred to as S&P in the judgment), Fitch and Moody's) had confirmed that the appointment would not cause an 'adverse rating event'. S&P rated all of the Notes, Moody's the Class A Notes and Fitch the Class B-E Notes. An adverse rating event meant that a downgrade, qualification or withdrawal of the rating was confirmed in writing by S&P or Fitch. Moody's was not included as it was a policy of Moody's not to issue such confirmation in writing on transactions, although it may give confirmation otherwise (but not in writing).
Counsel for the third defendant argued that the condition could not be satisfied as confirmation could not be obtained in writing. Counsel for the second defendant argued, by reference to a proviso in the servicing agreement, that if the rating agency declined to produce a confirmation, or indeed as a matter of policy decided it would no longer do so, the parties could proceed as if the written confirmation had not been required, as long as their acts were consistent with the servicing standards within the transaction documentation. The judge agreed with the latter approach, saying that the parties plainly intended the successor special servicer should not be prevented from acting merely because a rating agency stopped issuing confirmation notices.
Rating agency confirmation is significant, as the role of the servicer, special servicer or successor servicer is important in a CMBS transaction. The servicer is the party servicing the mortgages of the commercial properties and putting the proceeds into the financial structure. A statement by a rating agency that the appointment of a new party to the role would not downgrade the notes is of major importance to the operation of the securitisation financing structure and to the status of the Notes themselves.
The judge considered whether only the experience in 'servicing mortgages of commercial property' was the only matter the note trustee, (US Bank Trustee) should consider or, whether in exercising its discretion, it could consider wider issues (eg its views on the commercial interests of the noteholders or certain classes of noteholders) when deciding whether to approve a successor special servicer. The judge confirmed that in this situation there were two elements to consider--the experience, and the approval of the issuer and the note truustee (not to be unreasonably withheld). Given the importance of the role of special servicer there should be proper checks on the suitability of the party and experience is only one aspect.
A similar issue was raised as to whether the replacement of the advance provider was a condition to the termination of the appointment of the special servicer. The advance provider would provide short-term loans to the issuer if there was shortfall to satisfy obligations to the noteholders. The special servicer could demand the loans be made and advise if they would be repayable. A backup advance provider would step in if the advance provider failed to provide funding. In this case, the backup advance provider had had to fund up to £14m of loans which meant it was entitled to terminate the appointment of the advance provider. The judge stated that it was a condition to the termination of the appointment of the special servicer if, at the same time, the advance provider was replaced by a suitable alternative. The advance provider though was not a party to the case, so the judge did not go further.
Finance lawyers can draw a few lessons from this case which looked extensively at the wording of particular clauses in an offering circular and two transaction documents in a CMBS transaction:
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