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LNR Partners, LLC v. C-III Asset Management LLC

Court of Chancery of Delaware

March 31, 2014

LNR PARTNERS, LLC, solely in its Capacity as Special Servicer, Plaintiff,

Date Submitted: September 3, 2013

Supplemental Submission: February 7, 2014

James L. Holzman, Esq., J. Clayton Athey, Esq., PRICKETT, JONES & ELLIOTT, P.A., Wilmington, Delaware; Stephen L. Ascher, Esq., Ali M. Arain, Esq., JENNER & BLOCK LLP, New York, New York; Barbara R. Steiner, Esq., Stephen R. Brown, JENNER & BLOCK LLP, Chicago, Illinois; Attorneys for Plaintiff LNR Partners, LLC.

Stephen E. Jenkins, Esq., Phillip R. Sumpter, Esq., ASHBY & GEDDES, Wilmington, Delaware; Stephen B. Meister, Esq., Stacey Ashby, Esq., MEISTER, SEELIG & FEIN LLP, New York, New York; Attorneys for Defendant C-III Asset Management, LLC.


PARSONS, Vice Chancellor.

This action arises from a dispute between two companies that service commercial real estate mortgage loans. The dispute relates to which of the two companies is the rightful troubled loan servicer, or "special servicer, " for a commercial mortgage securitization trust. The defendant has been acting as the trust's special servicer. The plaintiff asserts that it has been properly designated by its affiliate, a substantial investor in the trust, to replace the defendant in that role. The defendant maintains that the plaintiff's affiliate lacks the authority to designate the trust's special servicer and that the affiliate's attempted designation, therefore, was ineffectual.

In its complaint, the plaintiff alleges that the defendant has breached its obligations under the trust agreement by refusing to cooperate in transitioning the special servicer role to the plaintiff. The plaintiff seeks a declaratory judgment that it is the trust's rightful special servicer and a decree of specific performance requiring the defendant to comply with its obligations under the trust agreement.

The defendant has moved to dismiss the complaint for lack of subject matter jurisdiction and for failure to state a claim, on the grounds that the plaintiff lacks standing. The defendant has since dropped its challenge to the Court's jurisdiction. Concurrent with its opposition to the defendant's motion to dismiss, the plaintiff moved for summary judgment on the grounds that the trust agreement is unambiguous and it is entitled to the relief it seeks as a matter of law.

This Memorandum Opinion reflects my rulings on these motions. For the reasons that follow, I deny both the defendant's motion to dismiss and the plaintiff's motion for summary judgment.


A. The Parties

Plaintiff, LNR Partners, LLC ("LNR Partners"), is a Florida limited liability company that specializes in commercial real estate mortgage loan servicing. LNR Partners is a successor by statutory conversion to LNR Partners, Inc.[2] LNR Partners is also an affiliate of nonparty LNR Securities Holdings, LLC ("LNR Securities"), which is an investor in the securitization trust to which this dispute relates.

Defendant, C-III Asset Management, LLC ("C-III"), is a Delaware limited liability company that is engaged in the same line of business as LNR Partners. C-III is an affiliate of nonparty C3 Initial Assets, LLC ("C3 Initial Assets"), which is, or was until recently, also an investor in the securitization trust.

B. Facts

1. The Citigroup Commercial Mortgage Trust 2006-C5

At issue in this case are certain loan servicing rights to the pool of commercial mortgage loans held by the Citigroup Commercial Mortgage Trust 2006-C5 ("CGCMT 2006-C5" or the "Trust"). CGCMT 2006-C5 is a securitization trust that issues commercial mortgage-backed securities ("CMBS"). The Trust is governed by a pooling and servicing agreement dated November 1, 2006 (the "PSA"), which is over 300 pages long and contains over 100 pages of definitions.[3] The PSA is governed by New York law.[4] Concurrent with execution of the PSA, the Trust issued CMBS "Certificates, -[5] which represent beneficial ownership interests in the pool of mortgage loans held by the Trust. The Certificates were backed by commercial real estate mortgage loans with an aggregate principal value of $2, 238, 772, 692.[6]

a. Allocation of distributions and losses to Certificateholders

Investors in the Trust, or "Certificateholders, " are entitled to receive monthly distributions from the cash flows generated by the Trust's underlying pool of commercial mortgage loans, to the extent of available funds.[7] The Certificates issued by the Trust are arranged in 27 tranches, or "Classes, " which have differing levels of seniority, ranging progressively from most senior to most junior.[8] Distributions are made to Certificateholders in the most senior Class first, until all required payments of principal or accumulated interest have been made.[9] Certificateholders in the next most senior Class are paid next, and so on as to the remaining Classes, in "waterfall" fashion, until there are no funds left to distribute.

Under certain circumstances, the Classes will suffer "Realized Losses." Losses, as defined by the PSA, are realized when the amount ultimately recovered on one of the Trust loans is less than the amount owed on the loan plus the expenses incurred in obtaining the recovery.[10] For example, Realized Losses will accrue if a property underlying one of the loans in the Trust pool is foreclosed upon and sold for less than the amount owed on the loan plus the costs of foreclosure.

Because Certificateholders in the most subordinate outstanding Class are the last in line to receive distributions, they are the first to be affected by Realized Losses. Specifically, Realized Losses reduce the underlying loan principal that one or more Classes of Certificates is ultimately entitled to receive—i.e., the "Class Principal Balances-—in reverse order of seniority.[11] In that regard, Realized Losses are first applied to the most junior outstanding Class until its Class Principal Balance has been reduced to zero. They are then applied to the next most junior Class in the same manner, and so on as to the remaining Classes, until all Realized Losses have been allocated. [12] If the Class Principal Balance for a given Class has been fully eroded by Realized Losses, that Class is "out of the money" and is no longer entitled to receive distributions from the Trust.[13]

b. Administration of troubled loans by the Special Servicer

The PSA bifurcates the administration, or servicing, of performing and nonperforming, or troubled, Trust loans.[14] Performing loans are administered by a Master Servicer. Nonperforming loans, by contrast, are administered by a Special Servicer. Nonperforming loans include, among others, loans for which there has been a default or material payment deficiency, loans to borrowers who have been declared bankrupt or insolvent, or loans secured by property that has become subject to foreclosure proceedings.[15]

Once a mortgage loan qualifies as nonperforming under the PSA, the Master Servicer transfers the loan to the Special Servicer.[16] The Special Servicer is broadly authorized to take whatever actions it deems necessary or desirable to maximize the recovery on a troubled loan.[17] Among other options at its disposal, the Special Servicer can negotiate a modification, extension, or early payoff of the loan, foreclose on the property securing the loan, or sell the loan.[18]

In executing their duties, the Master Servicer and the Special Servicer are obliged to abide by a contractually defined "Servicing Standard."[19] Under that standard, the Master Servicer and the Special Servicer are required to service and administer the mortgage loans for which they are responsible:

in the same manner in which, and with the same care, skill, prudence and diligence with which, such Master Servicer or the Special Servicer, as the case may be, generally services and administers similar mortgage loans with similar borrowers and/or similar foreclosure properties, as applicable, (i) for other third parties, giving due consideration to customary and usual standards of practice of prudent institutional commercial mortgage loan servicers servicing and administering mortgage loans and/or foreclosure properties for third parties, as applicable, or (ii) held in its own portfolio, whichever standard is higher . . . .[20]

As compensation for its work on behalf of the Trust, the Special Servicer is paid a monthly special servicing fee.[21] The Special Servicer also is entitled to liquidation and workout fees, which are based on the Special Servicer's efforts as to specific nonperforming loans.[22]

c. The Controlling Class

As noted previously, Realized Losses are applied in reverse order of seniority, with new Realized Losses reducing first the Class Principal Balance of the most junior Class whose Class Principal Balance has not yet been fully eroded. Thus, the most junior Class with a positive Class Principal Balance will be the first to suffer from the realization of additional losses. For this reason, most pooling and servicing agreements, including the PSA, designate the Class inhabiting or soon to be inhabiting the most junior outstanding position the "Controlling Class" and provide it with certain special authority, discussed infra.[23]

Under the PSA, the Controlling Class is defined as "the most subordinate . . . outstanding Class of Sequential Pay Certificates, that has a Class Principal Balance that is greater than 25% of the Original Class Principal Balance thereof."[24] Thus, the Controlling Class is the most junior Class that has greater than 25% of its original Class Principal Balance remaining. Once the Class Principal Balance of the Controlling Class drops below 25% of its original value, the next most junior Class becomes the new Controlling Class.

The Controlling Class has certain contractually established representatives, including the "Majority Controlling Class Certificateholder" and the "Controlling Class Representative." The PSA defines the "Majority Controlling Class Certificateholder" as:

any single Holder . . . of Certificates . . . entitled to greater than 50% of the Voting Rights allocated to the Controlling Class; provided, however, that if there is no single Holder . . . of Certificates entitled to greater than 50% of the Voting Rights allocated to such Class, then the Majority Controlling Class Certificateholder shall be the single Holder . . . of Certificates with the largest percentage of Voting Rights allocated to such Class.[25]

Thus, the Majority Controlling Class Certificateholder is the majority holder of the Voting Rights allocated to the Controlling Class or, if there is no such majority holder, the plurality holder of those Voting Rights. Under the PSA, the "Controlling Class Representative" is defined simply as "[t]he representative designated as such by the Majority Controlling Class Certificateholder."[26]

d. The Controlling Class's control over the Special Servicer

The actions of the Special Servicer have a significant influence on when and to what extent losses on the mortgages underlying the Trust will be realized. For this reason, the PSA enables the Controlling Class, via its representatives and Certificateholders, to exercise control over the Special Servicer in various ways. There are two primary means for the Controlling Class to exert its influence.

First, the Controlling Class can influence the Special Servicer through the Controlling Class Representative, to which the PSA gives a qualified veto power over the conduct of the Special Servicer.[27] Specifically, the Controlling Class Representative, by filing an objection in writing, can prevent the Special Servicer from taking any of a list of actions enumerated in Section 6.11(a) of the PSA. The listed actions include, among others: (1) foreclosing upon a mortgage property; (2) modifying the principal terms of a Trust mortgage loan; (3) selling property owned by the Trust for less than the purchase price; (4) releasing collateral, or accepting substitute collateral, for a Trust mortgage loan; or (5) accepting an assumption agreement releasing a mortgagor from liability under a Trust mortgage loan. The Controlling Class Representative also is authorized to "direct the Special Servicer to take, or to refrain from taking, such other actions . . . as the Controlling Class may deem advisable."[28] The Special Servicer is entitled to disregard, however, any direction or objection that would cause it "to violate any applicable law, [or] any provision of [the PSA], " or that would require it "to act, or fail to act, in a manner which in the reasonable judgment of . . . the Special Servicer is not in the best interest of the Certificateholders or is inconsistent with the Servicing Standard."[29]

Second, Certificateholders in the Controlling Class that meet certain requirements may designate a person to serve as Special Servicer, thereby replacing the existing Special Servicer. Specifically, Section 6.09(a) of the PSA provides that:

the Holder or Holders of the Certificates evidencing a majority of the Voting Rights allocated to the Controlling Class may at any time and from time to time designate a Person . . . to serve as Special Servicer hereunder and to replace any existing Special Servicer without cause or any Special Servicer that has resigned or otherwise ceased to serve in such capacity . . . .

Thus, the power to designate the Special Servicer (the "Designation Power") is vested in "the Holder or Holder of the Certificates evidencing a majority of the Voting Rights allocated to the Controlling Class." The precise definition of "Voting Rights" in the context of this provision is, therefore, crucial to determining who is entitled to exercise the Designation Power and is the major point of dispute between the parties.

The PSA defines "Voting Rights, " in relevant part, as follows:

The portion of the voting rights of all of the Certificates which is allocated to any Certificate. At all times during the term of this Agreement, 100% of the Voting Rights shall be allocated .... [T]he Voting Rights shall be allocated among the various Classes of the Principal Balance Certificates in proportion to the respective Class Principal Balances of such Classes of Certificates; [Proviso 1] provided that, solely for the purpose of determining the respective Voting Rights of the various Classes of Principal Balance Certificates, the aggregate Appraisal Reduction Amount allocated to the respective Classes of the Principal Balance Certificates in accordance with Section 4.04(d) shall be treated as Realized Losses with respect to the calculation of the Certificate Principal Balances thereof; and [Proviso 2] provided, further, that the aggregate Appraisal Reduction Amount shall not reduce the Class Principal Balance of any Class for purposes of determining the Controlling Class, the Controlling Class Representative or the Majority Controlling Class Certificateholder. . . . Voting Rights allocated to a Class of Certificateholders shall be allocated among such Certificateholders in standard proportion to the Percentage Interests evidenced by their respective Certificates.[30]

The Voting Rights definition includes the term "Percentage Interest." A Certificate's Percentage Interest is roughly equal to the percentage of the Class Principal Balance corresponding to that Certificate.[31] The Voting Rights definition also makes reference to the "Appraisal Reduction Amount." The Appraisal Reduction Amount reflects the extent to which a given mortgage loan is underwater because the value of the real estate securing the loan is insufficient to ensure its repayment. It is approximately equal to the amount by which the balance owed on a mortgage loan exceeds 90% of the appraised value of the underlying collateral.[32] Appraisal Reduction Amounts, which represent as-of-yet unrealized losses, are assessed when a loan becomes subject to a "Required Appraisal."[33] A Required Appraisal is triggered, among other circumstances, when a loan becomes delinquent, the loan's payment terms are lowered by the Special Servicer, or the borrower of a loan declares bankruptcy.[34] Under Section 4.04(d) of the PSA, Appraisal Reduction Amounts are distributed to the Classes in reverse order of seniority (from most junior to most senior), up to the amount of each Class's Class Principal Balance. The aggregate Appraisal Reduction Amount for the Trust mortgages is referred to in this Memorandum Opinion as the "ARA."

2. C-III Replaces LNR Partners as Special Servicer

LNR Partners, Inc. was the original Special Servicer of CGCMT 2006-C5 and began serving as Special Servicer for the Trust at its inception in November 2006.[35] At some later point, LNR Partners, Inc. underwent a statutory conversion to become LNR Partners, LLC (the Plaintiff).[36] Because it is not apparent from the record precisely when that conversion occurred, I refer to LNR Partners, ...

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