Justice Sherwood ruled in favor of the proponents of the Empire State Building IPO a few hours ago. I discussed the case on Fox Business earlier today. The clip is here:
Author Archives: David Reiss
The Servicing Field Is Wide Open
The CFPB has proposed an additional comment to Regulation X to emphasize that that regulation does not preempt state regulation of mortgage servicing:
Proposed comment 5(c)(1)-1 would state further that nothing in RESPA or Regulation X, including the provisions in subpart C with respect to mortgage servicers or mortgage servicing, should be construed to preempt the entire field of regulation of the covered practices. The Bureau believes that this proposed addition to the commentary would clarify that RESPA and Regulation X do not effectuate field preemption of States’ regulation of mortgage servicers or mortgage servicing. The comment also makes clear that RESPA and Regulation X do not preempt State laws that give greater protection to consumers than they do. (12)
This proposed comment is pretty belts-and-suspenders given that preamble to the 2013 RESPA Servicing Final Rule said as much. But it is still worth noting how different this approach is from the Bush years when large swaths of state consumer protection regimes were preempted by federal regulators. As the mortgage industry takes its post-Bust shape, states may begin to flex their muscles to address servicing practices that concern their residents. It will be interesting to see how this all plays out in the long game.
Empire State of IPO
Bloomberg interviewed me and others about the litigation over the proposed IPO for the Empire State Realty Trust Inc. (which would include the Empire State Building and a few other properties):
A 15-month effort to take New York’s Empire State Building public is approaching a crucial ruling in a legal challenge by investors who oppose the deal put together by the family that controls the iconic skyscraper.
On April 29, New York State Supreme Court Justice O. Peter Sherwood may decide whether unit-holders who object to the transaction can be bought out for $100 a share, as proposed in the plan. He previously said he could throw out the votes the Malkin family has already received approving the plan if he determines the provision is illegal. Sherwood is also set to hold a hearing on a $55 million class-action settlement that is opposed by some of the tower’s more than 2,800-plus investors.
“This represents a kind of watershed moment for the case,” David Reiss, a professor of real estate finance law at Brooklyn Law School, said in an interview.
The rest of the story is here.
S&P Myth #1: No One Could Have Known
S&P filed its Memorandum in Support of Defendants’ Motion To Dismiss the DoJ lawsuit filed back in February. The memorandum states that S&P’s inability, along with other market participants, “to predict the extent of the most catastrophic meltdown since the Great Depression reveals” only “a lack of prescience” and “not fraud.” (1) This short phrase requires some serious unpacking.
First, it ignores the fact that many of the analysts who engaged in fact-based investigations of the rated securities were sounding warnings but were overruled by higher ups who demanded that market share be maintained. So if S&P and “other market participants” is defined to exclude all of those analysts, risk officers, underwriters and due diligence providers that worked for all of those market participants, then S&P is certainly right. But if plaintiffs can demonstrate that facts were ignored to the extent that short term profits would be hurt by them, then S&P’s characterization is less compelling.
A second related point is that S&P’s argument that “its views were consistent with those of virtually every other market participant” is not compelling if plaintiffs can demonstrate that it ignored the facts before it and the findings of its own models.
Finally, its characterization of the Subprime Bust as “the most catastrophic meltdown since the Great Depression” fails to acknowledge that an S&P AAA rating offers quite the stamp of approval: “An issuer or obligation rated ‘AAA’ should be able to withstand an extreme level of stress and still meet its financial obligations. A historical example of such a scenario is the Great Depression in the U.S.” (The quote is from S&P’s website and can be accessed here on page 58.) But mortgage-backed securities with that S&P triple A did not quite live up to their promise.
This is not to say that S&P has not raised serious legal issues with Justice’s complaint in its motion to dismiss, but just that its rationalizations of its own behavior (which echo those of Dick Fuld and many others at the helm of various “market participants”) don’t stand up against the record.
No Scarlet Letter for Robo-Signing
An “admitted robo-signer” and her bank were let off the hook in Grullon v. Bank of America et al. (Mar. 28, 2013, No. 10-5427 (KSH) (PS)) (D.N.J.). (19) Grullon, a homeowner, alleged that he, and others similarly situated, was entitled to relief under New Jersey’s Consumer Fraud Act because of BoA’s “bad practices, including: robo-signing, foreclosure documents, concealing the true owner of loans from the borrowers, and initiating foreclosure proceedings before it had the right too, resulted in unreliable and unfair foreclosure proceedings and ascertainable losses.” (1)
Grullon alleged a variety of fraudulent robo-signing practices, including for affidavits and assignments. The Court found that in “light of the lack of- or de minimis nature of- the errors found on the documents said to have been “robo-signed,” and Grullon’s lack of standing to challenge the Assignment, the Court is not satisfied that Grullon has proffered sufficient evidence to support his NJCFA claim on this basis.” (21) The Court was also not satisfied that Grullon “has adequately shown that he suffered any ascertainable loss as a result of the 2009 NOI [Notice of Intention to Foreclosure] or the ‘robo-signed’ documents.” (24) The Court also appears to find that the “robo-signing” of assignments presents no problem as the signer is not attesting to the truth of such a document. (20-21)
Bottom line: one needs to demonstrate that there was a wrong and that harm resulted from it. Scatter shot allegations of robo-signing don’t work.
Cherryland, Very Strange
I looked at the Cherryland decision yesterday. Law360 ran a story (behind a paywall) about it today, quoting me and others. To recap, the original Cherryland case appeared to unexpectedly open up many commercial borrowers in Michigan to personal liability. The most recent Cherryland opinion reversed this result as a result of Michigan’s newly passed Nonrecourse Mortgage Loan Act.
The story reads in part:
Cherryland and Schostak reaped the benefits of the NMLA. But many CMBS loan documents are similarly written, and other borrowers and guarantors “may not have the saving grace of a politically connected developer getting a law passed very rapidly,” said Brooklyn Law School professor David Reiss.
“If I was an existing borrower [or borrower’s counsel], I would look at this very carefully,” Reiss told Law360. “And new borrowers should try to negotiate new language that protects for this, saying that becoming insolvent is not something that is going to trigger the bad boy guarantee.”
After the initial decision was handed down last year, attorneys say they and their colleagues all took a hard look at the language in their clients’ nonrecourse loan documents to be sure that if they found themselves in a similar situation they would be protected without the cover of a law like Michigan’s NMLA or Ohio’s Legacy Trust Act, which followed shortly thereafter.
In fact, experts say they don’t believe many other states will likely follow suit with their own guarantor-protecting statutes. So even though Wells Fargo lost out in the Cherryland row, lenders will likely keep the case in mind when considering deals.
Although “most people believe that the [pre-NMLA] decision in Cherryland was not what was intended by virtue of the documents,” said Schulte Roth & Zabel LLP real estate partner Jeff Lenobel, the solvency covenant was drafted in a way that allowed it to be read as a bad boy trigger.
This has led many who represent borrowers and guarantors to seek more due diligence and spend more time making sure loan language is just right.
More than $1 trillion in CMBS loans are coming due over the next several years, and Lenobel said he wouldn’t be surprised to see the issue come up again in a different court.
While the Cherryland case is all but over, another similar suit — Gratiot Avenue Holdings LLC v. Chesterfield Development Co. LLC — is making its way through Michigan’s federal courts. And attorneys aren’t ruling out the possibility of an appeal to the U.S. Supreme Court to ultimately determine the responsibilities of a guarantor in a nonrecourse loan.
“It may be a very smart move by the lending industry to appeal to the Supreme Court,” Reiss said.
Cherry Bombs in Michigan
An ongoing Michigan state case, Wells Fargo Bank, N.A. v. Cherryland Mall L.P. et al., has been generating a lot of heat over an obscure but important issue for commercial mortgage borrowers, the scope of carveouts from standard nonrecourse provisions in loan documents. And now the most recent opinion issued in the case raises important constitutional issues as well.
This case (as well as the similar Chesterfield case (a federal court case also in Michigan)) took many in the real estate industry by surprise by reading language in the loan documents at issue in those cases so as to gut their nonrecourse provisions. Michigan (as well as neighboring Ohio) quickly passed legislation to return the nonrecourse language to how it was commonly understood.
The Michigan courts’ interpretations of the language in the loan documents was inconsistent with how such provisions were typically understood in the industry. While the new statutes returned things to how they were commonly understood to be before the cases were decided, they did so in a way that raises more fundamental issues. Most importantly, such statutes potentially violate the Contracts Clause of the United States Constitution which bars the “impairing” of “the Obligation of Contracts.”
The most recent Cherryland opinion upheld the constitutionality of the new Michigan statute and rightly notes that the Contracts Clause is not read literally. This has been true at least since the Depression era U.S. Supreme Court case of Home Building & Loan Association v. Blaisdell did not invalidate Minnesota’s mortgage moratorium. The U.S. Supreme Court had thereby given states some leeway pursuant to their police power to remedy social and economic problems, notwithstanding the text of the Contracts Clause. The situation in the Cherryland case is less sympathetic than that in Depression-era Blaisdell, where many, many homeowners were being foreclosed upon. The Cherryland borrower, in contrast, is a politically-connected real estate developer. But the point remains that the Contracts Clause is not an absolute bar to legislative revision of privately negotiated contracts. How politically connected, you might ask. The court indicates that
defendant [David] Schostak is co-chief executive officer of defendant Schostak Brothers & Company, Inc., and that Robert Schostak is co-chairman and co-chief executive officer. . . . Robert Schostak is “a high ranking Republican Party leader in Michigan, with many years of involvement in assisting the party’s candidates to gain election in the legislature.” We note that Robert Schostak has been chairman of the Michigan Republican Party since January 2011, was finance chairman through the 2010 election cycle, and had served on campaign fundraising teams for prominent Republicans. (8, note 3)
The borrowers here are as well positioned to get helpful legislation passed as anyone. There is much to chew over here, not the least of which is the Court’s finding that the statute was not “intended to benefit special interests.” (8)
There are also important practical aspects to the case. For instance, it is quite possible that courts in other jurisdictions will read the typical CMBS nonrecourse language similarly to how the Michigan courts read it. Lenders will want to take a look at their loan documents to determine whether they mean what they say and say what they mean. And borrowers should read the language in their loan documents carefully before signing on the dotted line. They have been warned.
