Last week, the Supreme Court of the State of New York handed down a decision in the battle between CWCapital, representing the senior mortgage debt as special servicer, and Pershing’s andWinthrop’s joint venture, who recently bought the mezz debt in this transaction at a deep discount.  Everyone knows what’s going on here.  The mezz debt was bought as a lever to attempt to get control of the property through, or in the shadow of, bankruptcy.  A successful workout would, by definition, compromise the senior debt.  To prevent that, CW sought injunctive relief to prevent the foreclosure of the mezz debt and they got it.  Unless this is reversed, it’s game over for the mezz because the foreclosure of the mortgage debt is coming up very soon. 

So what do we think?  This is the first major test of one of the central provisions of the standard industry intercreditor agreement.  In a thumbnail sketch, here’s what this is about.  The industry standard intercreditor agreement typically says that while a qualified transferee may acquire the mortgage borrower equity, “all defaults under the senior loan…will on the date of acquisition have been cured….”  There’s also some nifty language in many intercreditors that prohibits the mezz lender from soliciting, directing or causing the borrower to commence any proceeding in bankruptcy against the mortgage borrower.  All this makes sense from the senior lender’s point of view and from the rating agency perspective that, in large measure, drove the development of these intercreditor agreements:  it protects the senior rated debt. 

So, this loan defaulted, all $5.5 billion of it.  The senior lender began a mortgage foreclosure, Pershing/Winthrop bought some of the mezz debt and began a mezz foreclosure.  The stage was set.  The court enjoined the mezz foreclosure because of the anticipated failure of the mezz lender to cure the senior loan default upon acquisition of the mezz collateral.  (Practice note for opportunistic mezz buyers:  do not publicly trumpet your intention to jam the senior debt.)

Since I may have to take one side or the other of this dispute in the future, I’m loathe to comment in my normally hyperbolic style on the quality of the arguments.  Nonetheless, I will observe that I was surprised that the mezz lender didn’t appear to make an argument that it was impossible to cure an accelerated loan and, hence, the obligation to cure should be read out of the documents, nor an argument that the senior lender had a remedy in damages and injunctive relief was inappropriate.  But there you go.  This is going to be a much cited case, and it will probably chill the ambitions of some with Blackbeard envy to do to players in large, overleveraged projects, what the Somalis are doing to Indian Ocean shipping.

But the broader lesson here for everyone in our markets is to remember the process of enforcing legal rights does not occur in a Newtonian universe, but in the universe of the uncertainty of quantum  mechanics.  For anyone including judicial action as part of your strategic plan for buying or enforcing debt, I’ve got some advice:  beware of dudes wearing robes.  Judicial action is very hard to predict.  Any apparent mechanistic neatness of legal rules and precedents rapidly deteriorates in the heat of proceeding in a real court in front of a real judge.  This is true in state and federal court, and it is perhaps even truer in the bankruptcy court with its baked in preference for reorganizations. 

If anyone needed a reminder that cutting a business deal that works for both sides is better than rolling the dice in court, this case makes a good read.

By Rick Jones.