How will CMBS transactions affect professional negligence claims?

In what circumstances will an issuer have a right to bring a claim in commercial mortgage-backed securities (CMBS) transactions? James Walton, partner at Rosling King, comments on a case which he says will impact upon other professional negligence claims being brought by issuers of CMBS.

Original news

Titan Europe 2006–3 plc v Colliers International UK plc (in liquidation) [2014] EWHC 3106, [2014] All ER (D) 07 (Oct)

The defendant valued a commercial property for the claimant which was security for a loan. The tenant of the property became insolvent and the property was in the process of being sold for a price far below the valuation. The claimant brought a claim for professional negligence against the defendant company which went into liquidation in 2012. It sought judgment for €58,400,000, being the difference between the valuation of the property at €135m and what the claimant contended was the true market value at €76.6m. The Commercial Court concluded the true value of the property as at December 2005 was €103m and that the defendant had therefore 'negligently' overvalued the property by €32m.

In a CMBS transaction, is it usual to rely on the original valuation from when security is taken over the property rather than looking for a new valuation at the time the loans and collateral for the loans are transferred into a special purpose vehicle for the CMBS?

In a CMBS transaction, this is absolutely the usual position. A transaction like the Titan Europe 2006-3 transaction (and many others at around that time) was made up of a multitude of different loans (in some cases with a number of properties securing each loan).

It takes time to originate these loans, pool them all together and then to go out and find investors who would be prepared to invest in the notes that would subsequently be issued. It would be entirely impractical either for:

  • the investors themselves to go out and obtain current valuations, which were correct as of the date of the CMBS issuance, or
  • the investment bank, which was putting together the securitisation, to obtain further valuations at the date of the CMBS issuance

In Titan, the investors (and the issuer) were relying upon the original lender having obtained a valuation report from an independent valuer and the original lender gave a warranty to the issuer to say that such a report had been obtained. The offering circular attached a copy of the valuation report obtained from Colliers.

Was there a contractual link between the valuation and its addressee and the issuer?

Yes—it was made clear at the time of the instruction to Colliers that the loan would be securitised. The original lender (Credit Suisse) was keen to ensure there was appropriate ‘reliance’ language both in the terms of the retainer between the lender and the valuer and in the valuation report itself. The wording was—as was often the case in valuation reports of this nature—extremely wide and sought to ensure that a whole range of parties involved in the securitisation structure (including the issuer and the investors) could rely upon the valuation report. As it happens, though, this case was brought by Titan in tort and not in contract.

The court stated that Titan, as issuer, was relying on the valuation figure, even though the directors said they had not read the valuation report itself which contained explanations of how the valuers had reached the valuation figure. Do you think this is still correct to create a contractual and causal link between the issuer and the valuer?

Yes, in this case the important thing for Titan was not necessarily what it said in the valuation report itself, but what the valuation figure was. Mr Justice Blair quoted the case of Hunt and others v Optima (Cambridge) Ltd and others [2014] EWCA Civ 714, [2014] All ER (D) 70 (Aug) and in particular the comment that ‘a person can, in appropriate circumstances, be said to rely on a report that is in existence, and of whose contents he is aware, but which he has not seen and which is to be provided to him later’.

I agree with the judge that the fact that the directors of Titan did not read the valuation report itself does not alter the fact that they placed reliance upon the valuation figure (of which they were aware) and that a loss was caused as a result.

The second issue the court dealt with was who had suffered a loss and therefore had a right of action. In a CMBS transaction, would the note trustee or the issuer usually act on behalf of the noteholders?

Neither. In a CMBS transaction, while it is correct that certain security interests are conferred upon the note trustee (which are ultimately for the benefit of the noteholders), and while the issuer does of course owe certain duties to the noteholders, it would be incorrect to say that the issuer acts on behalf of the noteholders.

In this case, it was accepted by both parties that the note trustee did not hold any right of action to pursue a claim against Colliers. However, Titan was not acting on behalf of the noteholders. Titan was bringing this claim on its own behalf for its own loss.

Surely, with a lot of noteholders, an individual noteholder would not have a right of action alone? Is that the case here?

Yes, that is correct. This was a key focus of Colliers’ defence. Colliers argued:

  • the securitisation was structured so as to confer upon the noteholders a right of action against Colliers
  • it was the noteholders who had sustained a loss and it is the noteholders who could bring a claim against Colliers
  • the non-recourse nature of the notes meant that Titan was ‘loss-proof’ and could never suffer a loss

Mr Justice Blair disagreed. He refused to detach any right of action that a noteholder may have to pursue Colliers from the rights attached to the notes themselves. He dismissed Colliers proposition that a noteholder transferring a note retained a cause of action it may have had in respect of Colliers’ negligent valuation. Instead, he commented that ‘a negligence claim against valuers who appraised the security for the notes is essentially an aspect of recovery on non-repayment of the loan in question, and in my view it goes with the notes’.

He agreed with Titan that it had suffered a loss at the moment it acquired the loan from Credit Suisse because it acquired a chose in action worth less than the price it paid for it—the amount of the loss would become crystallised at a later stage once the insufficiency of the security was known. He also agreed with Titan that the fact that the notes were issued on a non-recourse basis was irrelevant and fell within the principle of res inter alios acta (a thing done between others).

The court held that the issuer had had a right of action because it had a contractual obligation to distribute funds to noteholders. Could you explain what this means in practice and whether this is a standard provision in a CMBS transaction?

The judge placed great emphasis on the fact that once Titan was in receipt of any damages that Colliers was ordered to pay to it, Titan was contractually obliged to pass these damages through the contractual ‘waterfall’ to the various noteholders. In other words, the damages would be paid out to all the noteholders in the structure in accordance with the usual priority of payments (meaning those noteholders who would stand to benefit from the recovery would vary depending upon a number of factors, including when the money was paid out, which notes had been written off at that point and the amount of the recovery).

Many CMBS transactions from around the time in question would not have expressly stated what would happen in the event that the issuer made a recovery from a negligent third party. Therefore, whether or not there would be a contractual obligation upon the issuer to pass the proceeds through the payment waterfall is a question of contractual interpretation. However, given the structure of a CMBS transaction, it would be difficult to argue that the issuer could do anything with the proceeds of a recovery other than to filter it through the waterfall provisions.

Do you think the findings in this case will affect practice or the terms of CMBS transactions from now on?

This case will certainly impact upon other professional negligence claims currently being brought, and which may in the future be brought, by issuers of CMBS.

However, I think we will also now see much clearer provisions being placed in future CMBS transaction documentation emphasising the:

  • issuer’s right to bring a claim
  • special servicer’s obligations to investigate and pursue claims, and
  • obligations of the issuer to distribute the proceeds of any claims through the payment waterfall

Interviewed by Nicola Laver.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

First published on LexisPSL Banking & Finance. Click here for a free trial.

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