Back in 2006, investing in the Little Rock Regions Bank Building sounded like a great deal. That year, the real estate market nationwide was quite hot. Few knew that within two years, the bubble would burst. In September of that year, a company called NNN 400 Capitol Center and several dozen investors signed a $32,000,000.00 note with Bank of America.
Bank of America securitized and sold the note into a Commercial Mortgage Backed Security (CMBS) called the COMM 2006-C8 Commercial Mortgage Pass Through Certificates. In return for their investment, the investors became the proud owners of a Regions Bank building in Little Rock, Arkansas. Like many CMBS financed deals of that time, the note had a maturity of 2016. Of course, the maturity date couldn’t come at a worse time.
According to court records and press reports, the owners of the Little Rock Regions Bank building are in default and facing foreclosure.
Many of the investors in these deals are quite sophisticated. We routinely represent tenant in common (TIC) groups, limited partners and others that pool their resources so that they can participate in larger building projects. Many of our investor clients are doctors, lawyers, retired businessmen and women and even some bankers. Their backgrounds are quite diverse but all have one thing in common, they are or were quite successful in their respective professions.
In 2006, the full purchase price of the 30 story, 600,000 sq. ft. Regions Bank office building was $37 million. Chances are quite high that none of the individual owners could have put down that type down payment or qualified for a $32 million mortgage. With 34 others and a professional manager, however, the deal becomes realistic.
This CMBS investor deal is not one of our cases. Unfortunately, we have recently seen dozens of these deals head south, however. Most of them have striking similarities.
First, there is always a promoter who put the deal together. 35 random people with money to invest didn’t just find one another. The promoter in this case was most likely an entity affiliated with NNN 400 Capitol Center LLC.
The promoter and its affiliates may have responsibility to the individual investors depending on the representations and disclosures made in the offering documents. For example, many of these deals are sold as non-recourse deals meaning the only money a purchaser has at risk is his or her initial capital contribution. If the project goes south, they have no individual liability for any deficiency that occurs after the property is foreclosed.
This is an important concept and one where we have seen fraud. Because of its importance, we will spend a few minutes explaining how these promoters sometimes lie.
In the Little Rock Regions Bank building, the primary owners of the building are 35 individual investors. The names of these owners are NNN 400 Capitol Center 1 through NNN 400 Capitol Center 35. Because we are not involved in this project, we don’t have the offering documents but from experience, this looks like each individual investor is a single purpose LLC and that deal may be set up as a TIC project for tax purposes.
Typically, each of the numbered investor LLC consists of an accredited investor, husband and wife investors or a family trust. In other words, these are real people who are about to lose their savings, not some large institutional investor. That is important because it imposes an extra duty on the people marketing these investment deals to insure the purchasers understand the intricacies of these deals and what could go wrong. Unfortunately, we routinely see stockbrokers and accountants pitching these deals and not having a clue what they are selling.
Springing Guaranty and Other Pitfalls of Investor Funded CMBS Deals
One of the big dangers in investor funded CMBS deals is the prospect of a lurking springing guaranty. The foreclosure complaint filed by the special servicer LNR Partners seeks only to foreclose. It does not seek to hold the individual investors personally responsible for any deficiency. That doesn’t mean they are off the hook, however.
In many states, the party foreclosing on a note and mortgage isn’t obligated to also sue on the guaranty at the time of foreclosure. The process is then quite simple. Get the foreclosure quickly (foreclosure proceedings usually do not permit jury trials). Once the property has been foreclosed and sold, then the note holder can sue each of the investors in the event of a deficiency.
Worse, usually the individual investors are jointly and severally liable meaning that an investor could be on the hook for more than his or her share of the $32 million mortgage.
How is this possible? How is this possible if the investment was sold as a nonrecourse loan?
Enter the so-called “springing guaranty,” also known as a “bad boy” provision. Again, we don’t have the offering documents in this case. The foreclosure complaint says, however, that “The Borrowers are in further default under the Loan for failing to pay the Lender for Rents following the Events of Default.”
The complaint also says that each of the numbered NNN 400 Capitol Center LLCs (the investors) all shared the same address. That may sound strange but often the promoter sets up these deals so that all notices go to the promoter. Promoters like this to insure each of the LLC entities don’t forget to file their annual reports with the Secretary of State and pay their annual fees to the state of incorporation.
The downside, of course, is that if the promoter “goes dark,” the individual investors don’t know that anything has gone wrong. The complaint claims that LNR Partners as special servicer “sent multiple notices of default.” Did the investors get these notices immediately? We don’t know.
In many of these CMBS deals, taking rent monies after a notice of default is enough to trigger a springing guaranty. In layman’s terms, if the promoter or master tenant accepts rent after a notice of default and doesn’t turn it over to the special servicer, the springing guaranty goes is in effect. What was once a nonrecourse loan could become a recourse loan meaning individual investors become personally liable for any deficiency.
We don’t share these stories to scare the folks that own the Little Rock Regions Bank Building. Rather, we tell these stories so that tenant-in-common and other investors are warned and prepared.
Another pitfall of loans that go into special servicing is the special servicer itself. We have plenty of experience with servicers like LNR partners and CWCapital. These folks are the face of the noteholder.
Once upon a time, these notes were held primarily by banks. There was at least someone you could speak to if you wanted to extend your loan or work out new terms. Not anymore. Now these notes are packaged and sold into CMBS trusts. Each trust consists of hundreds of loans and is owned by multiple tranches of institutional investors. There is no single point of contact except the special servicer. And the special servicer has no incentive to help borrowers get out of a jam.
Sometimes, we even see special servicers try to acquire the distressed property for their own account. At that point, they want to push the price of the property down, not up.
If all of this sounds hopeless, it is quite that bad. Investor groups often do poorly in negotiations with special servicers because they aren’t organized. With a little help, however, it is possible to renegotiate or avoid default.
MahanyLaw and Judge, Lang & Katers for All Your CMBS Needs
MahanyLaw and Judge, Lang & Katers are two national boutique law firms that join forces to represent TICs and property owners. We don’t represent banks, trustees and special servicers.
Our representation of TICs, individual investors and investor groups falls into three categories.
Representation of Individual TICs Against the People Selling These Investments
As noted earlier, many of these investment deals are sold by people who don’t understand the mechanics of the deal or the risks involved. Frequently they are sold by stockbrokers interested in high commissions. Other times they are sold by insurance agents and even accountants.
These financial professionals are responsible if they have failed to perform proper due diligence, failed to fully explain the risks associated with these investments or if the investments are “unsuitable” for your needs. If the investment contains a springing guaranty or other so-called “bad boy” provision, it is probably unsuitable for almost all but the wealthiest and sophisticated investors.
We can help you go after these individuals and their employers and insurance companies for any losses you may have sustained. These cases can also frequently be handled on a contingent fee basis too.
In addition, we can often represent groups of investors bring claims against the promoter, loan servicer and trustee for their failure to act or for their participation in any wrongdoing.
Foreclosure and Pre-Default Representation
We like to get involved with investor groups long before there is a default. Many of the investors in these projects are just learning that their notes are coming due now. A large chunk of CMBS financed loans were written in 2006 and 2007 and mature in 10 years. In other words, now. Investors are waking up to a new reality that even though they never missed a payment, the trust has no desire to extend the terms of the loan. Remember, the loan may have been written by a bank but is now held by a trust consisting of institutional investors.
If we become involved early enough, we can help investors with alternative financing and bridge loans to avoid maturity defaults. Often we can get around the special servicer and deal directly with the controlling class representative of the trust that holds the note.
Unfortunately, many people come to us after the special servicer has declared a default. That immediately triggers huge default interest and fees. Reserves are commonly swept away too. Any equity that investors may have enjoyed can be wiped out virtually overnight. Worse, if there are springing guarantees, not only can you lose your entire investment you may be on the hook for millions of dollars more.
This is a situation that faced many investors in projects promoted by Carlton Cabot. (Cabot was recently convicted for fraud connected to those projects. Most of the projects we see do not involve criminal fraud but the results for the investors can be equally disastrous.)
Foreclosure and pre- default representation is best handled when we represent a group of investors. Fees per person are dramatically lower too. We are two of the few firms that have extensive experience in group representation.
For more information about our CMBS and TIC group services, contact attorney Chris Katers at [hidden email] or attorney Brian Mahany at [hidden email] or (877) 858-8018. All inquiries are confidential and without obligation.
MahanyLaw and Judge, Lang & Katers – America’s Lender Liability Lawyers. “We Sue Banks.”