Anyone commercial property owner facing a special servicer soon learns the deck is stacked. Many commercial loans today are securitized and packages into loan pools. These pools are sold to a trust that is owned by institutional investors. Unlike a bank that has offices and employees, a CMBS trust is a single purpose entity that owns a pool of mortgages. There is no live person “manning the store” … there is not even the “store” or an office.”
When the trust is created, a servicer and special servicer are typically named. Most trusts have a Pooling and Servicing Agreement (“PSA”) that sets out the duties of the servicer and special servicer. The PSAs are typically 500 to 1000 pages in length!
We aren’t going to write a 1000 word blog post, don’t worry. In simple terms, the loan servicer collects the mortgage payments and makes sure taxes and insurance is paid. When certain trigger events occur, the special servicer steps in. These companies do have real people and they have extraordinary powers.
Missing a mortgage payment is obviously a trigger event but often we see loss of a major tenant as grounds for the special servicer to step in.
And once they step in, all Hell can break loose.
Some special servicers are better than others. A few work hard to get the borrower back on its feet and keep the property solvent. Others, however, simply want to steal the property for themselves. Under many PSA agreements, they are allowed to do just that (although we can’t actually call it “stealing” even though that is what is occurring.)
On paper, special servicers are paid to look after the interests of the trust owners (the institutional investors.) But because the trust has no office, manager or even employee, there is no one to police the special servicers.
Special servicers typically only get paid when the loan is in default or in special servicing. That creates an inherent conflict of interest. If the special servicer is successful and gets a property back on their feet, they stop getting paid! And if they think they can buy the property at a steep discount, they have another incentive to simply bleed the owners dry. When the owners are too broke to fight, the special servicer can swoop in and acquire the property for itself.
If you read this blog, you have heard all of this before. We have reported on many incidents of special servicers behaving badly. Special servicers like CWCapital and our all-time “favorite,” LNR Partners.
So what is new? An article this week in the Commercial Observer asked the question, “Why Have Special Servicers Owned Some CMBS Properties for Half a Decade?” I think we just answered that question.
Because property values have been appreciating in most markets, CMBS loan defaults are quite low. Even if a property is in danger, investors can sell before they default and earn enough from the sale to pay off the property’s debts. But to quote the article, “In the most severe cases, special servicers—the companies tasked with resolving distressed credits—take possession of insolvent buildings with the aim of rapidly selling them off to repay lenders. Data on these so-called “real-estate owned” (REO) properties reveal, however, that even during a bullish commercial real estate sales market, the discharge process drags on far longer than any investor would hope.”
The article claims that 615 assets worth almost $22 billion worth of commercial real estate is owned by special servicers. These loans were on the special servicer’s books for approximately 650 days. And in many of the larger properties, it took these servicers over 45 months to sell off the properties.
One property has been setting on CWCapital’s books for more than 6 years!
IRS rules give special servicers 3 years to sell their REO (real estate owned) properties but those rules are frequently ignored.
If the special servicer has a duty to the investors who make up the trust, holding a property for years doesn’t appear to be in the trust’s best interest. As noted above, however, the trust has no manager. If anyone comes to close to filling that role, it is the special servicer.
Expressed differently, the special servicer is the cop hired to keep troubled borrowers in line. As a cop, they are given all the tools… the proverbial gun and badge. But there is no police chief, no city manager, no city council to watch over the cops.
The rating agencies are starting to get concerned. That gives some hope but again, the special servicer has no real master but it does have a PSA that typically allows the special servicer to be judge, jury and executioner. Rating agency Fitch called out CW Capital but no one really is listening.
The difference in how long a property is held is a really big deal. If the Commercial Observer is correct (and they cite highly reliable data from Moody’s Investors Service), a loan resolved in 6 months incurs an average 22 percent loss. Hold that loan for 5 years and the value plummets by 85%!
We have been making the same claims echoed in the Commercial Observer for years. Special servicers have a vested interest in dragging their feet (fees) and in driving down the price of the property so they can purchase it.
Until those conflicts are addressed, we will probably continue to butt heads with companies like LNR Partners.
Hope for Distressed CMBS Borrowers
It wouldn’t be fair to end this post on a doom and gloom note. Property owners can fight back. Fighting a special servicer isn’t cheap, however. They will do everything in their power to fight a procedural war complete with repetitive motions. Their goal is to bleed the borrower of both cash and hope.
One thing that special servicers dislike, however, is facing a jury. It takes but five minutes for the average juror to figure out the dirty dealing in many of these cases.
How does one fight back? First, unless there was a missed mortgage payment, so-called non-monetary defaults frequently are disliked by courts. If you haven’t missed a payment but have received a default notice, you will likely find judges more sympathetic.
We were recently involved in a case where the borrower was defaulted because it’s fence was in disrepair and some of the apartment buildings had peeling paint outdoors. What was the real reason for “default”? We think the property had good cash flow and equity. It was a prime target for a squeeze play.
Second, protracted litigation at some point will wake up the investors in the trust. They – or least some investors in the trust – have the ability to fire the special servicer. If an investor realizes they are not going to get paid for years they can get cranky.
Special servicers will argue that they owe no legal duty to borrowers. They may not owe a fiduciary duty to borrowers but in most states, they have an obligation of “good faith and fair dealing.” A counterclaim AGAINST the special servicer suddenly puts them on the defensive.
That means suing them for their own malfeasance and misconduct. It is incredible that in most cases, the borrowers simply react to the nonsense filed by the special servicers. The best way to beat a special servicer is by being proactive, not reactive.
Many of our CMBS special servicer cases come from other lawyers. Great lawyers that just don’t have experience in suing special servicers or dealing with CMBS financed transactions. They also are used to people and companies behaving ethically. In our opinion, special servicers will often push the limits.
Once a property is in default – whether legitimate or not – the PSA gives the special servicer extraordinary powers. They can reapply payments, increase reserve requirements, impose default interest, require receivers and the like. These do nothing to help the borrower and often do nothing to increase the value of the property either.
In most cases you should be able to figure out instantly whether the special servicer is there to help or just drain your equity and / or steal your property. The sooner we get involved, the more successful we can be. Despite being litigation lawyers, we don’t think lawsuits are the solution to most business disputes. Unfortunately, with rogue special servicers litigation is sometimes the only option.
You worked hard to build a successful business. If the property is worth saving or if you are on the hook for a personal guarantee, call us immediately. We are CMBS special servicer lawyers, this is what we do. And we never represent special servicers or banks.
For more information, visit our CMBS special servicer information page. Have a specific question? Contact attorney Chris Katers at [hidden email] or by phone at 414-777-0778. All inquiries protected by the attorney – client privilege and kept completely confidential.