So many shopping centers are struggling to stay afloat during the pandemic. Even with a vaccine, many experts say that the face of retail shopping has changed forever. How many people will permanently shop online once things return to normal?
Since the pandemic began, mall owners have had to contend with stay at home orders, orders limiting occupancy, extra precautions for workers and shoppers, retail tenants who refuse or can’t pay rent, eviction moratoriums and fewer shoppers even where shopping centers are allowed to open. Despite all of these hardships, many struggling shopping centers have remained current on their mortgages. Yet some say that their lenders are interfering with them anyway.
A group of shopping centers in Pittsburgh have sued their loan servicers claiming they are interfering with their operations despite being current with mortgage payments. The two loan servicers being sued are Key Bank NA and Midland Loan Servicing. (Midland is owned by PNC Bank.)
At issue is millions of dollars of reserves held by the servicers for tenant improvements.
In a typical shopping center loan, several reserves are set up. The most common is for tenant improvements. Each month after the bondholders, tax escrows and insurance payments have been made, loan documents usually require various reserves to next be funded. When the parking lot needs to be repaved or a new tenant wants improvements to its space the property owner can use the reserve monies for these purposes.
The five shopping center owners say the loan servicers are withholding the money for improvements and threatening to take it.
In the current lawsuit, Key Bank is the master servicer and Midland Loan Services is the special servicer. Absent a default, the loan servicer (Key Bank) has day to day control of the loan although its authority is limited to collecting mortgage payments, making sure that all bills are paid and collecting financials. In the event of a default, control goes to the special servicer (PNC Midland).
In all the loan agreements we have reviewed, the special servicer takes control when the loan is in default. They also have authority, however, to assume control when they view the loan as troubled. Of course, that term is speculative and we take a dim view of heavy handed special servicers taking control of otherwise performing loans.
At one of the centers who are part of the lawsuit, the owner attempted to use tenant improvement funds to transform a space being vacated by the now bankrupt JC Penney. Any property owner knows how important it is to keep a shopping center fully occupied. No one wants to shop at an empty center where many stores are vacant.
According to the complaint,
“Without a legitimate basis to do so, and in contravention of principles of good faith and fair dealing in contract, [Key Bank and Midland Loan Servicing] have proposed taking an extreme and outrageous "cash sweep" action that would deprive Plaintiffs of funds necessary for the operation and continued vitality of the shopping centers.
“In this instance, [the shopping center owner] worked in cooperation with then-existing tenant JC Penney, in connection with JC Penney's bankruptcy, to keep JC Penney in place as a rent-paying tenant and shopping center occupant for as long as possible. This permitted JC Penney to remain open within the shopping center beyond original projections, and, indeed, all the way up to October 18, 2020. JC Penney is now in the process of transitioning out of its leased tenant space; and— importantly, and in connection with this—[the shopping center owners] have arranged for a substitute tenant to take JC Penney's place after JC Penney's tenancy terminates and it vacates the shopping center.
“These arrangements for seamless transition to a substitute tenant further the core purposes of the Loan Agreement, which include keeping storefronts within the shopping centers In lieu of acting in good faith to assist in facilitating these arrangements, [the servicers] have—instead—threatened to use JC Penney's situation as an excuse to invoke a punitive Loan Agreement measure through which [the servicers] would "sweep" working capital away from Plaintiffs and the shopping centers, thereby effectively lining [the servicer's] pockets in the short term but causing the shopping centers to potentially fail as a result.
“Such a sweep would deprive Plaintiffs of the working capital necessary to keep the shopping centers open as a going concern and would otherwise jeopardize the ability of the shopping centers to operate as a going concern.
“[Key Bank and Midland’s] threats to do so—in the midst of a global pandemic and financial crisis—create additional uncertainty to the detriment of the Borrowers.”
Earlier we spoke about the ability of the trust to declare a loan to be troubled. Aggressive special servicers such as Midland, LNR Partners and CWCapital often say that the loss of a major or “anchor” tenant is enough to declare a loan troubled. We feel that is counterproductive, however, especially if the property owner isn’t delinquent on its mortgage payments.
Sweeping the borrowers’ reserves means the shopping center has no money to help a new tenant move in or make improvements. That starts the vicious cycle of empty storefronts, declining foot traffic, deteriorating fixtures and more stores moving out.
Unfortunately, special servicers often have a more fatalistic view requiring them to grab every penny they can.
The key in this case is getting the case beyond a motion to dismiss. As much as courts hate aggressive lenders who seek to grab cash, judges have to weigh the wording of the loan documents which are almost always drafted in favor of the lender and against the borrower. If the borrower survives the motions to dismiss, however, special servicers will usually settle.
Having the right lawyers in your court therefore becomes critical.
Thus far we have talked about shopping centers and their tenant improvement reserves. Hotels have similar problems with furniture and seasonality reserves.
When times are tough, special servicers are often in the mood to grab any cash they can. If hotels can’t access their own money to purchase new bedding, for example, they begin to face the same vicious cycle facing the five Pittsburg mall owners.
Experienced CMBS Borrowers Counsel
There are many experienced real estate lawyers in this country. Only a few, however, have real experience with CMBS borrowing. And most of those law firms represent lenders, not borrowers. We are the exception. The lender liability lawyers at MahanyLaw and Judge, Lang & Katers have years of experience representing only borrowers. We represent shopping center, apartment complex, factory and hotel owners. Our lawyers are well known in the special servicing arena making us well respected by our adversaries.
If you own a shopping center or commercial property and are in trouble with your lender, give us a call. (If you have a CMBS loan, visit our CMBS loan modification and recent multimedia presentation called COVID-19 Crisis Management for Hotel Owners.
Need our help now? Contact us online or by phone at 877-858-8018. (Please make sure you let us know if you receive voicemail that you are calling about a hotel, shopping center or other commercial property. We want to make sure the correct person calls you back.) You can also reach our principals directly: Christopher Katers at [hidden email] or the author of this post, Brian Mahany at [hidden email].