iIn the decade since the 2008 financial crisis, the U.S. commercial mortgage backed securities (CMBS) market has come back. According to Commercial Mortgage Alert, the value of CMBS issued in 2019 was $98 billion, an increase of more than $20 billion over the $77 billion of CMBS issued in 2018.[1] In the aftermath of the financial crisis, CMBS was moribund; but it has been steadily rebuilt to occupy an important place in the overall commercial real estate finance market. This renewed CMBS market has come to be referred to as CMBS 2.0, to call attention to the changes to the loan origination and securitization process that have been implemented since the financial crisis. The CMBS 2.0 changes have included enhanced cash management protections, higher loan-to-value ratios and debt-service coverage ratios, and simpler deal structures with greater oversight provisions.[2]
In reviving the CMBS market, however, industry participants have not devoted much attention to the repurchase remedy, which is the exclusive remedy available to seek redress in a situation where loan sellers make false representations about loans that they are selling into a securitization. Case law in the intervening period has largely filled the void. While the repurchase remedy remained largely untested before the 2008 financial crisis, in the ensuing decade, courts have been required to interpret many facets of the remedy, and there is now a stable body of case law that industry players can rely upon in understanding the repurchase remedy. This article summarizes the most salient features of the repurchase remedy based on clear trends in the applicable case law.[3]
Material Adverse Effect.
To prevail on a repurchase claim, a CMBS trust, acting through its special servicer, must prove that the loan seller breached a representation about the loan, and that the breach had a material and adverse effect on the loan or the interests of the CMBS trust or its certificate holders in the loan. Breach is straightforward enough: it requires a showing that a specific representation about the loan set forth in the mortgage loan purchase agreement was untrue. The action in the case law has centered on the second prong of the claim: material and adverse effect. The key question when it comes to material and adverse effect is whether it is necessary for the trust to suffer an actual loss with respect to the loan at issue, as a prerequisite for establishing material and adverse effect.
After a period of some flux and uncertainty, the settled answer now seems to be that an actual loss is not required to prove material and adverse effect. Instead, what is required is an increased risk of loss with regard to the loan, even if an actual loss has not been suffered.[4] As one New York appellate court observed: A loan “need not be in default to trigger the obligation to repurchase it.”[5] Thus, a CMBS trust has a viable repurchase claim when a breach increases the risk of loss, even if that risk never actualizes.[6]
Liquidated Loans.
The repurchase remedy is an example of specific performance of a contract. Rather than an award of monetary damages, the remedy’s key feature is that it allows the CMBS trust to return the loan to the loan seller in exchange for a refund, calculated as the Purchase Price or Repurchase Price (a defined term in all CMBS contracts that includes all outstanding principal and interest payments due on the loan, all servicing advances, attorneys’ fees, and other categories of expenses necessary to make the trust whole with regard to the flawed loan).
The problem is that often the pace of repurchase litigation is slow relative to the pace of working through a potentially troubled loan that may be in foreclosure. Because the foreclosure timeline may overtake the effort to have the loan repurchased, sometimes the loan will be liquidated before the repurchase litigation reaches its resolution. In such circumstances, at least in the residential mortgage backed securities context, courts have been willing to improvise a common sense remedy, even though that remedy is not specified in the governing documents.
There is now a fairly wide body of law in New York state and federal courts holding that a remedy akin to repurchase is available for liquidated loans.[7] Where a loan has been liquidated, courts have been willing to fashion a remedy that awards the prevailing CMBS trust the equivalent of the contractually specified “Repurchase Price” less any value realized by the trust upon liquidation of the loan. This has been a particularly important development because it allows CMBS trusts the flexibility necessary to maximize value to the trust. Under this trend in the caselaw, CMBS trusts may proceed with liquidation of loans when that course of action is in the best interest of the trust, without having to worry that, in the process of liquidating the loan, the trust will be forfeiting a potentially valuable repurchase remedy.
Timing Is Everything.
There are two different, and interrelated, timing considerations with regard to claims for loan repurchase: notice and statute of limitations. Before seeking repurchase, the governing agreements typically require that the loan seller be provided with notice of the CMBS trust’s intent to seek repurchase and a 90-day opportunity to cure the breach. This 90-day period may be further extended upon a certification by the loan seller that it is engaged in a good faith effort to cure the breach. Courts have dismissed cases where this notice period was not satisfied before the CMBS trust commenced suit.
A repurchase claim is a contract claim, which under New York law has a six-year statute of limitations. Though the applicability of a six-year statute of limitations has never been in doubt, there was much uncertainty about when the clock begins to tick on that six-year period. Specifically, CMBS trusts, as plaintiffs in repurchase actions, argued for later statute-of-limitation accrual dates based on language in the governing contracts, including the date that the breach was discovered or the date when a loan-seller defendant failed to cure the breach. That uncertainty has largely now been resolved by New York’s Court of Appeals, which definitively rejected these efforts to extend the statute of limitations period, holding that the statute of limitations accrues on the date that the loan was first sold into the securitization.[8]
The 90-day notice requirement and statute of limitations considerations are interrelated. Those responsible for acting on behalf of CMBS trusts need to be aware of when the six-year statute of limitations expires, measured from the date of loan sale. To the extent that the CMBS trust has viable repurchase claims, the trust must then ensure that it provides notice of the intent to repurchase sufficiently in advance of the expiration of the statute of limitation to clear all hurdles to suit in time to file suit before expiration of the statute of limitations.
Conclusion.
It is important for CMBS market participants to understand the substantial body of case law elaborating and clarifying how the repurchase remedy works. Before the 2008 financial crisis, the repurchase remedy was largely untested; but many of the unknowns about this potent remedy have now been addressed by the courts. One of the many lessons of the 2008 financial crisis is that it is important to have a solid grasp of what redress is available when a securitization goes wrong before it becomes urgent to know that information.
[1] See CMBS Issuance in 2019, CM Alert (Feb. 29, 2020).
[2] See Adam Piore, CMBS 2.0, The Real Deal (Feb. 29, 2020).
[3] Because CMBS documents invariably contain New York choice-of-law provisions, this article focuses exclusively on developments under New York law.
[4] Wilmington Tr. v. MC-Five Mile Commercial Mortg. Fin. LLC, 99 N.Y.S.3d 11 (N.Y. App. Div. 2019) (the authors served as counsel to the plaintiff-trust in this action).
[5] MBIA Ins. Corp. v. Countrywide Home Loans, Inc., 963 N.Y.S.2d 21 (N.Y. App. Div. 2013).
[6] See, e.g., Wells Fargo Bank, N.A. v. JPMorgan Chase Bank, N.A., No. 12 Civ. 6168 (MGC), 2014 WL 1259630, at *4 (S.D.N.Y. Mar. 27, 2014).
[7] See, e.g., Nomura Home Equity Loan, Inc. v. Nomura Credit & Capital, Inc., 19 N.Y.S.3d 1, 6 (N.Y. App. Div. 2015), cert. granted on other grounds and affirmed as modified on other grounds, 92 N.E.3d 743 (N.Y. 2017); see also Nomura Asset Acceptance Corp. Alt. Loan Tr. v Nomura Credit & Capital, Inc., No. 653390/2012, 2014 N.Y. Slip Op. 31671(U), 2014 WL 2890341 (N.Y. Sup. Ct. N.Y. Cnty. June 26, 2014); MASTR Adjustable Rate Mortgs. Tr. 2006-OA2 v. UBS Real Estate Secs. Inc., No. 12-cv-7322 (PKC), 2015 WL 764665, at *12 (S.D.N.Y. 2015); U.S. Bank, Nat’l Ass’n v. UBS Real Estate Secs. Inc., 205 F. Supp. 3d 386, 414-415 (S.D.N.Y. 2016); Wells Fargo Bank, N.A. v. Bank of Am., N.A., No. 10 Civ. 9584 (JPO), 2013 WL 1285289, at *11 (S.D.N.Y. 2013), vacated and remanded on other grounds, 627 F. App’x 27 (2d Cir. 2015).
8] Deutsche Bank Nat’l Tr. Co. v. Flagstar Capital Mkts. Corp., 112 N.E.3d 1219 (N.Y. 2018).
