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 New York court provides broad interpretation of ''default cure'' in structured f

Buyer Beware

MORTGAGES; STRUCTURED FINANCE; MEZZANINE LOANS; New York court provides broad interpretation of "default cure" in structured finance intercreditor agreement. Mezzanine lender takes loss. 

Bank of America v. PSN, Index No. 651293/10, (N.Y. Sup. Ct. 9/15/10)

 New York State Supreme Court Justice Lowe (a trial judge in the New York system) ruled that investors who had acquired a piece of a a mezzanine lender could not foreclose on its mezzanine lien and take Stuyvesant Town/Peter Cooper Village (Stuyvesant Town) from its current owner and a foreclosing mortgage lender without paying the accelerated senior loan on the property of $3+ billion. The ruling, if upheld and followed, will add considerably to the power of senior commercial real estate (CRE) mortgage lenders versus subordinate "mezzanine" lenders where assets have decreased massively in value.

 When the deal was formed in 2007, a consortium of investors bought Stuyvesant Town, a, 11,200-unit Manhattan residential development, for $5.4 billion. This "top of the market" price was the highest price ever paid for contiguous U.S. realty. Buyers financed the purchase with a $3 billion securitized first-mortgage loan and a $1.4 billion mezzanine loan secured by the ownership interest in the owner. The project is now said to be worth less than $2 billion. The owner defaulted on the senior mortgage and mortgagee accelerated the loan later that month.

 Investors ("Pershing") unexpectedly responded to the acceleration and scheduled foreclosure by buying the top $300 million slice of the mezzanine loan for just $45 million. They then scheduled their own Uniform Commercial Code (UCC) foreclosure sale of the equity collateral. Pershing intended to buy at the UCC foreclosure sale and informed the press that they planned to put Stuyvesant Town into bankruptcy prior to the scheduled mortgage foreclosure auction.

Prior to the UCC sale, the servicer for the first mortgagee sued to stop the Pershing auction. There was an inter-creditor agreement binding the mezzanine lender which stated, in what has been described as "industry-standard" language, that the mezzanine lender must cure all defaults before acquiring the property. ,Senior lender argued that this meant that the mezzanine lender must cure the $3.7 billion accelerated claim on the senior debt. Pershing argued that the clause applied only to amounts owed before senior loan acceleration,

The trial court agreed with CW the senior lender, concluding that the intercreditor agreement language was "unambiguous" and that "its plain language" required Pershing to pay the $3.7 billion due on the accelerated loan before it acquires the ownership of the equity collateral. Pershing and Winthrop have already appealed the decision.

 Comment: In the past, parties involved in arguments over these intercreditor agreements rarely thought it appropriate to bring them to court. The huge differences in value at stake and the leverage enjoyed by the party controlling a bankruptcy may lead to further litigation of this and other issue. But this case certainly will be a powerful bargaining chip in favor of senior lenders, assuming that it is upheld if appealed.

 There always has been some question on Wall Street about the legal position of the mezzanine lender. Nonetheless, significant mezzanine loans exist in many deals and often have been successfully resold, as was the case here (eight tranches). The heat's now up in the kitchen. Let's see how the mezzanine lenders can really protect their position. It's unlikely that they'll have to step up to these massive senior loans. But they may have to bargain for a discounted purchase of such loans. Whether these purchases will include claims against any guarantors will also be interesting.

Patrick A. Randolph

Elmer F. Pierson Professorship and Professor of Law; B.A. (Yale University); J.D. (University of California, Berkeley)



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