In this alerter, we highlight the recent High Court case of Titan Europe 2007-1 (NHP) v U.S. Bank and others1, which gives guidance on the interpretation of special servicer termination provisions set out in the Servicing Agreement for the Titan commercial mortgage-backed securitisation.
The judgment discusses a number of matters that are likely to be of interest to participants in structured finance transactions, including the occurrence of inconsistencies between the description of transaction document terms in an offering circular and the actual terms themselves, the difficulties of satisfying the preconditions that may need to be met before a controlling party has the right to terminate the appointment of a special servicer and the approvals that a trustee may need to provide in relation to the appointment of a successor.
In May 2007, Titan Europe 2007-1 (NHP) Limited (the "Issuer") issued several classes of commercial mortgage backed securities and acquired the most senior tranche (the "A Loan") of a £1,172 million loan (the "Whole Loan"). The remaining six subordinated tranches of the Whole Loan (the "Subordinated B Loan") were acquired by a variety of institutions. The underlying property portfolio securing the Whole Loan compromised of several hundred healthcare properties originally let to the Southern Cross Healthcare group.
The arrangements between the lenders of the different loan tranches were governed by the terms of the Intercreditor Deed and the Whole Loan was serviced by a single servicer pursuant to the Servicing Agreement. The Intercreditor Deed and Servicing Agreement provided that a representative could be appointed for each tranche of debt. The controlling holder of debt (the "Controlling Party") was determined by reference to the principal amount outstanding of the tranche, a valuation of the property portfolio and any realised losses. Where the value of the property portfolio declined, as each tranche of the Subordinated B Loan moved further underwater from a loan to value perspective, the representative of the next most senior tranche of the Subordinated B Loan would become the Controlling Party.
Among other rights, the Controlling Party had the right to issue a notice to the Note Trustee requiring that the Note Trustee terminate the appointment of the Special Servicer without cause. The termination of the appointment could not take effect unless certain preconditions were met. These included the requirements that:
- the Servicer or Note Trustee notified the Rating Agencies (S&P, Moody's and Fitch) of the identity of the successor Special Servicer and that the Rating Agencies confirmed that the appointment of the successor Special Servicer would not result in a downgrade, qualification or withdrawal of the current rating of the Notes; and
- the successor Special Servicer had experience in servicing mortgages of commercial property on similar terms to that required under the Servicing Agreement and ihad been approved by the Note Trustee and the Issuer.
As a result of a loan-to-value covenant breach, the servicing responsibilities for the Whole Loan were transferred in November 2008 to the Special Servicer.
The Whole Loan matured in January 2009 but it was not repaid and after certain restructuring actions had been implemented, the Special Servicer announced in September 2013 that it was exploring an "exit strategy" in relation to the property portfolio.
By December 2013, the property portfolio value had declined to such an extent that the whole Subordinated B Loan had become "underwater" and the A Loan had become the controlling debt. It was not thought likely that there was sufficient value to cover any Class of Notes below the Class A Notes.
The representative of the Class E Notes ("Anchorage") disagreed with the proposed portfolio sale process and served a notice on the Note Trustee instructing the Note Trustee to terminate the appointment of the current Special Servicer.
The instruction from Anchorage was met with opposition from parties involved in the sales process. A significant group of Class A Noteholders contended that certain pre conditions to an effective termination of the appointment had not been satisfied and that it was the Issuer, rather than Anchorage, that was the Controlling Party. The Note Trustee sought the court's instructions and guidance on the matter.
Amongst other things, the court held that:
- The Controlling Party in the current circumstances was the "Representative of the A Loan", being the Issuer, in accordance with the terms of the Servicing Agreement. Although the Offering Circular stated that the Controlling Party was the "Controlling Class Representative", being the entity appointed by the holders of the most junior class of Notes outstanding (Anchorage), the court noted that the Offering Circular was not a contractual agreement and that it contained a qualification that all statements and information contained within it were qualified in their entirety by the terms of the transaction documents themselves.
- Where a rating agency declines to provide a rating confirmation on the replacement of a Special Servicer, in accordance with the terms of the Servicing Agreement, the relevant provision shall be read and construed as though the confirmation was not required. The court noted that it would not make any commercial sense that a Special Servicer could not, for example, validly terminate its own appointment in the event that one rating agency declined to provide a rating confirmation whilst the other two agencies had done so.
- The successor Special Servicer must have the relevant experience and separately, the Issuer and the Note Trustee must approve the successor. Their approval was not restricted to an assessment of the experience of the proposed successor and they could withhold their approval if the Special Servicer was considered to be, for example, incompetent, insolvent or in serious financial or regulatory difficulties.
- In the event that the Note Trustee receives a termination notice from the Controlling Party, it is required to do those acts and take those steps which will be necessary in an attempt to satisfy the preconditions. The provisions of the Servicing Agreement were not intended to be prescriptive but if, whilst taking those steps, it became apparent that the preconditions would not be achieved, the Note Trustee would not be obliged to serve the termination notice. Alternatively, if the preconditions were satisfied, the Note Trustee would be obliged to serve the notice.
The judgment discusses issues that may affect other structured finance transactions that are in difficulties and which have not yet been fully unwound.
The analysis of inconsistencies that may arise between offering document descriptions and the terms of the underlying transaction documents themselves reaffirms the importance of investors reviewing both the offering document and transaction documents to have an accurate understanding of all the provisions that may affect their noteholding. In order to make commercial sense of certain provisions, it may be appropriate for parties to waive rating confirmation preconditions in circumstances where the documents do not contemplate rating agencies declining to give them. The case also highlights that trustee approvals may always be necessary to fully protect the interests of noteholders on matters such as the suitability of a replacement special servicer, where it is not possible to contemplate all the factors that should be taken into account at the time that precondition provisions are drafted.
1 Titan Europe 2007-1 (NHP) v U.S. Bank and others  EWHC 1189 (Ch)