First English law decision deals with replacing special servicers, reports Jane Roberts
The procedure for replacing a special servicer in a European CMBS deal has been clarified for the first time in a high court judgement relating to the distressed £1.17bn Nursing Home Properties and Southern Cross Libra loan. The judgement, delivered in April, deals with several issues, not least the problem of how to replace a special servicer when rating agency confirmations (RACs) are required, although rating agency Fitch has stopped giving RACs; this conundrum has caused widespread uncertainty in the securitisation market for at least 18 months.
The judgement also gives guidance on the role of the note trustee in making the decision, which had been unclear before. Several of the court’s directions are in line with recommendations for best practice in new CMBS issuance made by CREFC Europe in its CMBS 2.0 principles, published in 2012. Additionally, deputy judge Richard Snowden confirmed that where there are discrepancies in the CMBS documentation, as there was in this case between the servicing agreement and the original Titan Europe 2007-1 (NHP) offering circular, it is the contractual document – the servicing agreement here – that carries more weight than the offering circular.
DEFINING THE PARAMETERS
Michelle Duncan, a partner at law firm Paul Hastings, who advised the class A noteholders, said the judgement “will most likely define the parameters for the termination of appointment of special servicers and other securitisation parties”. The case was brought by the note trustee, US Bank Trustees, after Anchorage Capital, the owner of the £60m of most subordinated, class E, notes in the CMBS, took action last December to terminate the mandate of the loan’s special servicer, Capita Asset Services. Anchorage’s grounds for this were that the class E was the presumed controlling class in the deal.
Anchorage made its move shortly after Capita announced the sale of either the borrower, HC-One (see panel) or the underlying properties – a strategy that a group of class A noteholders supported. At the same time, Capita announced a series of valuations by JLL, varying from £427m for just the property to £529m for the company and the assets, which meant the properties’ value had plunged to less than 40% of their 2007 valuation and the class E noteholder were ‘out of the money’.
The class A noteholders opposed replacing Capita, believing that Anchorage was trying to delay or stop the sale of either the properties or the borrower company. Faced with this conflict, US Bank Trustees sought the court’s guidance as to how it should exercise any discretion in dealing with the controlling class’s instruction, while one class A noteholder joined the proceedings to get clarification on whether Anchorage was in fact the controlling party.
A QUESTION OF CONTROL
The class A noteholder argued that both the servicing agreement and intercreditor agreement said the issuer was the control-ling party, while Anchorage’s counsel said the interpretation of the offering circular was that its client was the controlling party and any other interpretation was “commercially absurd”. Deputy Judge Snowden found against Anchorage and said that the issuer was the controlling party, highlighting that although the offering circular “is undoubtedly an important part of the relevant matrix against which the servicing agreement must be construed”, it is not a contractual document, and that it was not commercially absurd to have the issuer as the controlling party.
Duncan’s view is that the judge “confirmed what was pretty well-known. All along our view was that the binding document is the contractual, servicing document.” The judge also said Anchorage hadn’t presented any argument for its interpretation that once the value had broken in the securitised Libra loan, the controlling party should remain the most junior, class E notes, rather than the most junior notes still “in the money”. Duncan points out that the CREFC Europe CMBS 2.0 principles, recommended for use in future deals, also backs the controlling party as being the notes where the value breaks.
While the commercial effect of the judge’s ruling on this point was to put the class As back in the driving seat and for Capita’s sale strategy to continue, he gave clear guidance on other points that would have arisen had he found for Anchorage. In relation to Fitch, and the requirement to get rating agency confirmations that the bonds would not be downgraded if the special servicer was replaced, he relied on the servicing agreement. This said that if a rating agency would not issue a RAC, the provision should be construed as being not required.
This approach is also recommended in the CREFC CMBS 2.0 principles and has been included in several of the new securitisation deals carried out since 2011, but was rare before that. Titan-Europe 2007-1 was originally rated by Moody’s and Standard & Poor’s as well as Fitch, and Moody’s had declined to provide a written RAC, though it did agree to give a verbal confirmation. The judge said that having not explicitly declined to provide a RAC, Moody’s must provide one, but it could be either verbal or in writing.
In terms of clarifying the note trustee’s role in terminating the special servicer, the judge said the note trustee was not obliged to serve a conditional termination notice upon receiving written notice from the controlling party, but must take the steps required to confirm that the preconditions for termination have been met. Then the issuer and note trustee must exercise their discretion about whether to approve the successor special servicer, taking into account the replacement servicer’s experience.
“These points were of a lot of interest to the market because it was the first time the courts had considered them,” Duncan says. “It will give the market a lot of certainty as to how to deal with Fitch in future; if there’s a similar clause in the documents, you can go ahead without them.
IMPORTANT DECISION ON MOODY’S
“The decision about Moody’s was very important: even though Moody’s didn’t have to provide a confirmation in writing, it did have to provide one. And it is clear that the trustee does have some discretion to exercise.” One example of the problem with Fitch’s no-RACs policy surfaced last summer, when Hatfield Philips contested its replacement as special servicer of two Windermere XIV loans.
Lone Star, the B noteholder and controlling party, served notice to replace the special servicer, but Hatfield argued that without Fitch’s RAC, the pre-conditions had not been met, before resigning on the last day of the notice period.
Ian Llewellyn of Capita Asset Services says the sale of the HC-One/NHP Group is at due diligence stage, prior to inviting final bids. Four Seasons, Patron Capital, Duke Street and Formation Healthcare are among those said to be preparing to bid.
UNHEALTHY OUTCOME FOR LIBRA LOAN
The Libra loan backing the Titan-Europe 2007-1 CMBS was the senior, securitised tranche of a whole loan that also included subordinated B debt. The loan matured in January 2009 without any prospects for repayment and for two and a half years the loan was in standstill.
In June 2011 the largest tenant, Southern Cross Healthcare Group, was unable to pay its rent and was forced to transfer its operations to other operators before being wound up. The borrower, Nursing Home Properties, supported by special servicer Capita, formed a new company, HC-One, to take control of 239 NHP care homes under new management.
In November 2013, Capita announced a sales process for the borrower group, run by Deutsche Bank. The outstanding balance is £1.17bn, which included the £610m senior, securitised debt plus the multi-tranched, £560m, subordinated B loan. There are also more than £190m of swap breakage and arrears costs, which rank ahead of the class A notes.