Matter of U.S. Bank N.A.

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Matter of U.S. Bank N.A. 2018 NY Slip Op 32875(U) November 9, 2018 Supreme Court, New York County Docket Number: 150183/2018 Judge: Eileen Bransten Cases posted with a "30000" identifier, i.e., 2013 NY Slip Op 30001(U), are republished from various New York State and local government sources, including the New York State Unified Court System's eCourts Service. This opinion is uncorrected and not selected for official publication. [*FILED: 1] NEW YORK COUNTY CLERK 11/15/2018 10:41 AM NYSCEF DOC. NO. 63 INDEX NO. 150183/2018 RECEIVED NYSCEF: 11/15/2018 SUPREME COtJRT OF THE STATE OF NEW YORK COUNTY OF NEvV YORK: IAS PART 3 ----------------------------------------X In the matter of the app11cat1on of tLS. BANK NATIONAL ASSOCIATION IN ITS CAPACITY A.SPAYING AGENT OF 1v10RGAN STANLEY CAPITAL I TRUST 2007-IQ14, Index No. 150183/2018 Mot Seq, 001 Petitioner, For Judicial Instructions under CPLR Article 77 Concerning the Proper Allocation oflosses arising from a permanent interest rate modification. - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -X BRAl'fSTEN, J.: This is a special proceeding brought pursuant to CPLR Articles 4 and 77, in ;,vhich petitioner U 5. Bank National Association, in its capadty as paying agent (the Bank), seeks instructions concerning the proper allocation of realized losses in two commercial mortgage loans held by the l\tforgan Stanley Capital One Tmst 2007-IQ14 (the Tmst), f?~ij,{;JS'.J1RQ1[t{Q The facts herein are taken from the Petition (Pet) the underlying transactional documents and other submissions of the parties. The Trust is an express Trust consisting primarily of fixed-rate Mortgage loans secured by first mortgage liens on multifa:rnily and commercial properties" Pet 4[ 22, It is governed by a Second Amended and Restated Pooling Servicing Agreement (the PSA) Id. at 4f 10, id., Ex. l (the PSA). For :federal income tax purposes, the PSA creates three real estate mmigage investment conduits (RElVHCs), REI\,1IC I, REivIIC II, and REJVUC HL Id at 414122-25. RElVIIC III issued various classes of certificates, which coilecti vely represent the right to all of the cash 2 of 15 [*FILED: 2] NEW YORK COUNTY CLERK 11/15/2018 10:41 AM NYSCEF DOC. NO. 63 INDEX NO. 150183/2018 RECEIVED NYSCEF: 11/15/2018 lifatter of US. Bank Index No. 50183/2018 Page2 flow derived frmn the mortgage loans held by the Trust Id. at iir 25-26. As relevant here, Class A-J, Class A-JFX and CI ass C were three of the classes encompassed by RE1vHC Ill. Id. at~ 25; PSA § 1.1. Two commercial mortgage loans owned by the Trust, reforred to as the '1PDG1 loan' and the irBeacon Loan/' and co1lective]y knmvn as the "Modified Loans," -..vere subject to permanent interest rate reductions in 2010 and 2011. Pet at 41~ 2, 28, 32. Following the modifications} US Bank follmved instructions received from the Tvfaster Servicer and Spedal Servicer \vith respect to the treatment of fonds on those loans subsequent to the modifications and the application of losses resulting from the modification. Id. at 41, 2, 35, Generally speaking, the lost interest resulting from the reduction was applied to the Certificates in the Trust as a Realized Loss, which reduced the outstanding principal balance of the most junior Certificates in the Trnst Id. at 41 2, As such, in the period after modification and prior to November 2015} the principal funds collected from the I\.fodified Loans were reduced by the lost interest, thereby increasing the amount of cash collected that was treated as interest id. In July 2015, three Certificate O\·vners 9 (the Class A-J Owners) represented by their common investment manager, infonned the Trustee and Paying Agent in -..vriting that they believed the aHocation of losses relating to the permanent reduction in interest rate for the 3 of 15 [*FILED: 3] NEW YORK COUNTY CLERK 11/15/2018 10:41 AM NYSCEF DOC. NO. 63 ~~.fatter of U.S. INDEX NO. 150183/2018 RECEIVED NYSCEF: 11/15/2018 Bank l.ndex No. 50183/2018 Page 3 Nfodified Loans was not applied in accordance with tlle Trusf s governing documents. ld. After conferring with the l\11aster Servicer, US Bank adopted the interpretation of the Class A-J Owners. In November of 2015, the fvfaster Servicer for the PDG Loan changed its treatment and reporting of the forgiven interest, which \Vas reflected in the monthly CS!v1A Loan Periodic update File for the mortgage loans. Id. at~ 4. Specifically, the 1vfaster Servicer allocated and reported the amount of forgiven interest in 1 each month as an ' 0ther Interest Adjustment, 1' which reduced the amount of interest paid on Certificates but did not reduce the amount of collections treated as principal or reduce the outstanding balance of any Certificates. ld. For the Beacon Loan, US Bank treated and reported the forgiven interest as an "Interest Adjustrnenf' or other reduction of the interest funds, and did not reduce the outstanding plincipal balance of any Certificates in the Trust. Id. In July 2017, US Bank issued a notice to the Certificateholders describing the 2015 change in procedure: Two loans ([the Beacon Loan and the PDG Loan]) were modified several years ago. Since that time and until the November 2015 period, the monthly distribution reports reflected interest forgiven resulting from the interest rate modifications as a Realized Principal Loss rather than solely as Realized Interest Loss. As a result of this treatment as a Realized Principal Loss, most classes of Certificates \Vere overpaid interest over time~ with Class C having received a larger overpay111ent of interest compared to other classes of certificates. (Ogden DecL. Ex. 4 at 1). ~ . 4 of 15 [*FILED: 4] NEW YORK COUNTY CLERK 11/15/2018 10:41 AM NYSCEF DOC. NO. 63 INDEX NO. 150183/2018 RECEIVED NYSCEF: 11/15/2018 Afatter of US. Bank fodcx No. 50183/2018 Pagc4 US Bank, however, has now concluded that the Class A-J Owners were incorrect and that the pre-November 2015 application of the forgiven interest as a Realized Loss that reduced the outstanding principal balance of the most junior Certificates in the Trust \vas cmTect. Id. at ~f 6. As a result, US Bank contends that Certificate holders of Class A!e ,. J ce1iificates and Class A-JFX Certificates have received $18.9 million more in principal payments than they should have received, Conversely, Certificate holders of Class C Certificates were underpaid interest by a corresponding an:wunt ld, at ir 7. In April of 2017, the Trust received a large payment settlement of litigation concerning difforent loan, known as the "City Vie'~' Loan.r• For the April 2017 Distribution Date, US Bank applied those proceeds that were received in settlement based on Class Cs entitlement to fi.mds according to the pre-November 2015 allocations. In other words, US Bank excluded an overpayment of interest to Class C in the amount of $9,253,505.66, \Vhich otherwise reimbursed Class C for Realized Losses, and included a payment in the same arnount as principal to Classes A-M and.A-TvIFX to reduce their outstanding Certificate Balance, This change was disclosed in the monthly Certificate holders! statement for April 2017, Id. at~ 44, The Trust has been in existence for 1nore than ten years and currently all Certificates senior in priority to Class A through J and 1\-JFX have been paid in foll all principal due on their certificates. The only Certificateholders that are entitled to receive 5 of 15 [*FILED: 5] NEW YORK COUNTY CLERK 11/15/2018 10:41 AM NYSCEF DOC. NO. 63 INDEX NO. 150183/2018 RECEIVED NYSCEF: 11/15/2018 lvfatler of US. Bank Index No. 50183/2018 Page 5 remaining cash flmv received by the Trust are Certificateholders in Class A-J and Class A-JFX. Id. at ii 8, On January 10, 2018, this Comi signed US Bank's Order to Show Cause~ and granted this request to segregate up to approximately $18,9 million of funds from cash collected by the Trust to pay for the proper Certificate holders. (Dkt 11} The Court also authorized US Bank to disseminate notice to any Interested Person who may vvish to be heard on the merits of the Petition, The Court received seven responses to the petition from: (1) SBNC Holdings LLC and NAL USA, LLC ("Class C I-fo1dersi 1) (holding 100%i of the Class C Certificates), (2) C-III Asset Management LLC, as the former Special Servicer for the Trust (also an affiliate of the managing member of SBNC), (3) Elliot J\.fanagement Corporation (as investment advisor for Elliott Associates, LP., El11ott International, L.P,, and The Liverpool Limited Partnership (Elliott), holding 50.57% of the Class A-J and A-JFX Certificates, (4) DW Partners LP, (D\V), holding an unspecified percentage of the Class A-J Certificates, (5) Appaloosa Investrnent Limited Partnership I, Palomino l\!faster Ltd., and Azteca Partners LLC (Appaloosa), holding a unspecified but substantial percentage of the Class A-J and Class A-JFX Certificates, (6) JVLH. Davidson & Co., Davidson Kempner Partners, Davidson Kempner Institutional Partners, L.P., Davidson Kempner International, Ltd., Davidson Kempner Distressed Opportunities Fund LP. Davidson Kempner Distressed Opportunities International Ltd., Davidson Kempner Long-Term Distressed Opportunities Fund H LP, and Davidson Kempner Long-Term Distressed Opportunities International Master Fund II LP (the DK funds), holding an unspecified percentage of the Class A-J and A-JFX Certificates, and 6 of 15 [*FILED: 6] NEW YORK COUNTY CLERK 11/15/2018 10:41 AM NYSCEF DOC. NO. 63 INDEX NO. 150183/2018 RECEIVED NYSCEF: 11/15/2018 ,Matter of l.ZS. Bank Index No. 50183/2018 Page 6 (7) O\VS COF I f\,faster, LP., O\VS Credit Opportunity I LLC, One \Villiam Street Capital i\1aster Fund, Ltd, Baldr Fund Inc,, OWS ABS }vfaster Fund II, L.P,, and OWS Credit Opportunity I LLC (the OWS Funds). The Class C Holders and Class C~III support US Bank's interpretationo Elliot, Appaloosa and DvV Partners (the Objectors) object to the Petition. Finally, the DK Funds and the O\VS Funds (the Respondents) assert that they lack the infmmatio:n necessary to respond to the facts alleged in the Petition or fcn111 a final position regarding the relief sought US Bank seeks to obtain judicial instructions, pursuant to Article 77 of the CPLR, concerning the proper allocation of the realized losses with respect to .rnodified loans. Pursuant to Section 15,4 of the PSA, the lavvs of the State of New York govern the rights and obligations of the Petitioner and Certificate holders in the Trnst. New York Law pennits bringing a special proceeding to determine a matter relating to any express trust, CPLR 7701; see also In Re Ray Greene v Finley Kwnble, FVagner, Heine & Underberg:~ 88 AD2d 547, 548 ( l st Dept 1982) (finding CPLR 770 I should be broadly construed to cover any matter of interest to trustees, beneficiaries, or adverse claimants concerning the trust). 7 of 15 [*FILED: 7] NEW YORK COUNTY CLERK 11/15/2018 10:41 AM NYSCEF DOC. NO. 63 INDEX NO. 150183/2018 RECEIVED NYSCEF: 11/15/2018 lvfafler of US Bank Index No. 50183/2018 Page 7 The pm1ies agree that the lost or forgiven interest resulting from the pennanent rate reduction constitutes a "l\1odification Loss", which in tum constitutes a '<Realized Loss;' (see PSA § 1.1 ), They also agree that section 6.6(f) of the PSA addresses how Realized Losses are allocated to the certificates. The sole issue here is 1,vhether the Hlost 1 interest' on the Modified Loans should result in a reduction of the interest payable to Certificate holders, or whether that !'lost interest 11 should instead result in reduction of the outstanding principal amount on the Certificates held by the Certificate holders. US Bank asserts that the language of Section 6.6(f) is dispositive. That section provides, in pertinent part: RE:r...11C Ht On each Distribution Date, all Realized Losses, . , shall be allocated to the REiv1IC Regular Ce1tificates and the Floating Rate Regular Interests in Reverse Sequential Order~ with such reductions being allocated among the Class A-1, Class A-lA~ Class A-2, Class A-3, Class A-AB and Class AA Certificates and the Class A-2FL and Class A-5FL Regular Interests and, in the case of interest, the Class X Certificates, pro rata (treating principal and interest losses separately), in each case reducing (A) the Certificate Balance of such Class (excluding the Class X Ce1tificates) until such Certificate Balance is reduced to zero; (B) Unpaid Interest mving to such Class to the extent thereof; and (C) Distributable Certificate Interest owing to such Class~ provided that Realized Losses and Expense Losses shall not reduce the Aggregate Certificate Balance of the RE.IvHC Regular Certificates and tlle Floating Rate Regular Interests below the sum of the Aggregate Ce11ificate Balances of the RE1v1IC II Regular Interests. US Bank argues that this language requires that 11 all Realized LossesH are first allocated to reduce the Certificate Balance of Certificates issued by the Trust under subsection (A) of 6,6(f} The Objectors contend the correct interpretation is to treat the 8 of 15 [*FILED: 8] NEW YORK COUNTY CLERK 11/15/2018 10:41 AM NYSCEF DOC. NO. 63 INDEX NO. 150183/2018 RECEIVED NYSCEF: 11/15/2018 fl.fatter of US. Bank Index No, 50183/2018 Page 8 pe1111anent reduction of interest payments on the two loans as a reduction in interest distributions to the junior Certificates, not as reductions in principal. In favor of this construction, they argue that (1) the allocation of Realized Interest Losses to Distributable Certificate Interest in section 6o6(a) is a procedure that should -~now through" and control the aHocation as to the certificates in RENHC III; (2) the purported requirement in section 6.6( t) that Realized Losses of any kind be allocated to both interest and principal is inconsistent \Vith the common sense approach of applying interest losses to interest only, as well as with the parenthetical reference to treating principal and interest losses "separately" in 6.6(t), and with the repeated application of Realized Interest Losses in the later sentences of 6,6(i); (3) the language of 6.6(f) does not unambiguously prioritize the application of Realized Losses to the Certificate Balances designated in 6.6(t)(A); and (4) US Bank should be charged \vith its prior admissions regarding the propriety its employn:1ent of the Objectors' approach. Additionally, the Objectors assert that section 6.5 of the PSA actually governs the distribution of loan principal and interest among the classes, mandating that the principal certificate balances of the most senior classes be paid down by reference to the Principal Distribution Amount, without reduction for Realized Losses of any kind. The Objectors further contend that US Bank did not even correctly apply its nm.v-preferred interpretation of 6.6, in that it applied Realized Losses class-by-class only to the principal Certificate Balance under 6.6(f)(A) unti1 reduced to 9 of 15 [*FILED: 9] NEW YORK COUNTY CLERK 11/15/2018 10:41 AM NYSCEF DOC. NO. 63 INDEX NO. 150183/2018 RECEIVED NYSCEF: 11/15/2018 };fatter of U.S. Bank Tndex No. 50183/2018 Page 9 zero, but not also the Unpaid Interest and Distributable Certificate Interest items designated in 6.6(f)(B) and (C). US Bank rejects all of the Objectors' arguments as contrary to the plain language of the PSAs asse1ting that drafters were careful to distinguish between Realized Losses, Realized Principal Losses, and Realized Interest Losses where appropriate. Specifically, it argues that if the drafters had intended to aHocate Realized Interest Losses solely to the items designated in 6(±) (B) and (C), the PSA could have so specified, and then provided that Realized Principal Losses were to be allocated to the Ce1tificate Balances under section 6(f)(A). It also notes that section 6.6(a) applies only to REI\1IC I and REMIC II Regular Interests, none of which are held by the O~jectors or Respondents. As to the later references to Realized Interest Losses in 6.6(f), US Bank contends that the lan~'Uage only applies to the rernaining subclasses of Certificates in 6.6(t). Similarly, it argues that the parenthetical requirement to treat principal and interest separately applies only to the pro rata reductions allocated among the nine classes of Certificates listed irnmediately before the parenthesk US Bank also contends that the need fiJr the PSA to specify that the losses are applied ~'first" to the Ce1iificate Balances is obviated by the requirement that the losses be applied "untlln the balances are reduced to zero, signifying that they cannot be applied to the items in section 6.6(f)(B) and (C) until that process is first completed. 10 of 15 [*FILED: 10] NEW YORK COUNTY CLERK 11/15/2018 10:41 AM NYSCEF DOC. NO. 63 INDEX NO. 150183/2018 RECEIVED NYSCEF: 11/15/2018 Afatter of US. Bank Index No. 50183/2018 Page 10 With respect to section 6.5, US Bank argues that it only governs the distribution of cash "dm:vn" the waterfall in sequential order, not the allocation of Realized losses "up), in the opposite direction. Petitioner thus urges that the ITi.ore specific provisions regarding Realized Losses in 6,6(f) must controL It also contends that is mvn prior erroneous interpretation of the PSA is irrelevant, and that the only question is what the agreement legally requires. Finally, US Bank asserts that the Prospectus Supplement (ProSupp), issued ln com1ection with the marketing of the Certificates, supports its interpretation because it specifically represents that Realized Losses "will reduce (i) first, the Certificate Balance of such Class until such Certificate Balance is reduced to zero .... ; (ii) second, Unpaid Interest owing to such Class and (ii) third Distributable Cmtificate Interests Amounts mvning to such Class." Under New York law, "written agreements arc construed in accordance with the parties! intent and the best evidence of what parties to a written agreement intend 1s what they say in their writing." Schron v Troutnum Sanders LLP, 20 NY3d 43(\ 436 (2013). Thusi ~'a written agreement that is complete, clear and unambiguous on its face must be enforced according to the plain meaning of its terms.') Greerifield v Philles Records, Inc., 98 NY2d 562, 569 (2002). Extrinsic evidence may be used to interpret a contract only where it is arnbiguous, and the determination as to ambiguity is a question of law to he answered by the court. (Id., at 570.) A contract is arnbiguous if "on its face [it] is 11 of 15 [*FILED: 11] NEW YORK COUNTY CLERK 11/15/2018 10:41 AM NYSCEF DOC. NO. 63 INDEX NO. 150183/2018 RECEIVED NYSCEF: 11/15/2018 /Matter of US. Bank Index No. 50183/2018 Page 11 reasonably susceptible of more than one interpretation" Chimart Assoc. v Paul, 66 NY2d 570, 573 ( l 986). There must be "no reasonable basis for a difference of opinion," Greenfield v Philles Records, Inc., 98 NY2d 562, .569, but ambiguity does not exist "simply because one of the parties attaches a different, subjective meaning to one of its terms!' Sasson v TLG Acqm~·dtion LLC, 127 AD3d 480, 481 (F Dept 2015). Furthermore, "[t]he existence of ambiguity is deter.mined by examining the entire contract and conslder[ing] the relation of the parties and the circumstances under which it was executed~ vdth the vvording viewed in the light of the obligation as a whole and the intention of the parties as manifested thereby." Banco Espirito Santo, S.A. v Concessionaria Do Rodoanel Oeste S.A., 100 AD3d 100, 106 (1st Dept 2012) (internal quotations and citations omitted). The petition is denied and the parties are directed proceed with discovery. As a preh111inary rnatter, it is of some significance that the alleged error in allocation was not discovered by the Objectors for three years, and that US Ba.nk then found the new interpretation to be sufficiently reasonable that it employed it for two years. Indeed~ the bank was so persuaded that the new procedure -;,vas correct that it did not seek judicial instructions at that time. And even after reversing its conclusion, US Bank has asserted only that the original allocation procedure was the "best reading.'' Pet ,-r 45. Assuming that that is so, it still does not mean that it is the only reasonable reading. The case thus 12 of 15 [*FILED: 12] NEW YORK COUNTY CLERK 11/15/2018 10:41 AM NYSCEF DOC. NO. 63 INDEX NO. 150183/2018 RECEIVED NYSCEF: 11/15/2018 lvfatter of US. Bank Index No. 50183/2018 Page 12 presents something more than merely one of the parties attaching a sul~jective meaning to the language of a contract; rather, it is a case of a third party, disinterested sophisticated financial instJtutfon attaching conflicting meanings to the same language on three different occasions. The court finds this confusion to be understandable and holds that the PSA is ambiguous regarding the proper allocation of the lost interest. Read in context with sections 6.5, 6.6(a) and the later passages of 6.6(f), the PSA can reasonably be construed as either pennitting, or prohibiting, application of the interest losses to the Certificate Balances. The parties have attempted to support their positions by apply~ng competing axioms of contractual construction to selected passages of the PSA. Hm.vever, those tools are too blunt to be applied to such a complex financial transaction and do not meaningfally resolve the conflict And even if the language were suil1cient1y clear to permit the court to commit to one interpretation or the other, the parties' submissions have failed to provide an easily comprehensible explanation (if one is possible) of how the payments are calculated and distributed to the various classes of Certificates, The mechanism is apparently something to be pieced together from the 300page PSA's Prelirninary Statement, the Definition section and the schedules contained therein, and the various paragraphs of section 6. In this connection, the court notes that the status of the Class A-JFX Certificates is unclear, counsel having stipulated at oral argument as to the seniority of the Class A-J 13 of 15 [*FILED: 13] NEW YORK COUNTY CLERK 11/15/2018 10:41 AM NYSCEF DOC. NO. 63 INDEX NO. 150183/2018 RECEIVED NYSCEF: 11/15/2018 Afotter ~f U.S, Bank lndex No. 50183/2018 Page 13 Certificates hut indicated that Class A-JFK vvas a "'difforent story" (Dkt 61~ Tr. 33). Those Certificates are mentioned in footnote (c) of the schedule ofREl\/HC III Class designations, which indicates that they represent the "Class JFX Percentage Interests of the Class JFL Regular Interests." Later in that footnote, it is stated that '~[f]ol!owing the Second Restatement Date the Aggregate Certificate Ba.lances of the [Class JFX Certificates and three other classes] wUl be subject to further re-designations as henveen such Classes pursuant to Section 3, 10." Expert affidavits or testimony may thus be required to clarify this and other issues, especially because apart from appeals to "common sense" and contractual construction, some of parties' arguments center around the financial purposes, tax policies and other considerations underlying the complicated structure of the Trust Their resolution may implicate business judgments rather than legal considerationso Finally, the court concurs that the ProSupp may have some evidentiary value, in that it provides a clear sequence to the allocation of Realized Losses am.ong the items in 6.6(f)(A), (B) and (C). But that also raises the question of why the clarifying language was not incoqmra.ted into the PSA itself Resort to the intent of the drafters, and witnesses with expertise in REfv1IC structured trusts~ will be needed. Similarly, their assistance would be helpful in explaining the relevance and import of the guidance 14 of 15 [*FILED: 14] NEW YORK COUNTY CLERK 11/15/2018 10:41 AM NYSCEF DOC. NO. 63 INDEX NO. 150183/2018 RECEIVED NYSCEF: 11/15/2018 lvfatter of US Bank Index No. 50183/2018 Page 14 provided the Commercial Real Estate Finance Council \:vith respect to the reporting of a modification resulting in a permanent rate reduction. Accordingly, it is hereby ORDERED, that the Petition is denied~ and 1t is further ORDERED~ that all parties am to appear for a Preliminary Conference on January 15, 2019 at 11:00 am. ENTER: 15 of 15

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