Posner Securitization Case

8/8/2019 Posner Securitization Case

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CWCapital Asset Mgmt. LLC V. Properties (7th Cir., 2010)

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properly insured; attend to any default, either bysuing the borrower and if necessary foreclosingthe mortgage or by modifying the mortgage tomake its terms less onerous to the borrower; anddischarge the mortgage when it is paid off (andif it is prepaid, collect the prepayment penalty if

the mortgage provides for one). Ordinarily theoriginal lender would be the servicer, or wouldhire one. But when hundreds of mortgages arepackaged into a debt security it is infeasible foreach security holder to be or to hire its ownservicer. The reason is the structure of thesecurity and specifically the conflicts of interestlatent in the tranching of them.

Remember that the buyer of the seniortranche in our example (for simplicity weassume only two tranches,

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though usually there are more) is entitled toreceive income from all the mortgages ahead ofthe buyer of the junior tranche. Faced with achoice between modifying one of the mortgagesand foreclosing, the servicer might make adifferent decision as a representative of thesenior tranche holder from the decision he'dmake as a representative of the junior one.Suppose a borrower gets into financial troubleand asks the servicer to modify the mortgage byreducing the monthly payment of principal andinterest by 20 percent. The servicer may preferdoing this to foreclosing the mortgage, becauseforeclosure is costly and the market value of theproperty may be depressed. The holder of thesenior tranche wouldn't object to themodification; the diminished income from themortgage would still fully cover his 80 percentinterest in the revenue from mortgages in themortgage-backed security. But the holder of thejunior tranche might object because he might bebetter off if the servicer gambled on obtaining

more money by foreclosing or by holding out fora less generous modification. The servicer mustbalance impartially the interests of the differenttranches as determined by their contractualentitlements.

CWCapital, the servicer in this case,confused matters by stating in its complaint thatthe trust which holds title to the mortgage onChicago Properties' building is the real party ininterest, and by arguing that by disclosing thatfact it has dispelled any objection to pursuing

the suit in its own name. What is true is that bydisclosing who the lender is, CWCapital hasenabled the district judge and us to determinethat if the lender were

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substituted for CWCapital, or added as anadditional party, there would still be completediversity of citizenship. But whether there iscomplete diversity is separate from whether asuit is being maintained by the real party in

interest, or by an interloper. A lawyer for thereal party in interest could not bring suit in hisown name merely because he disclosed theidentity of his client and acknowledged that theclient, and not he, was indeed the real party ininterest.

The trust holds the legal title to themortgages. The servicer is the trust's collectionagent. The delegation to it is comprehensive: theservicer "shall... have full power and authority,acting alone, to do or cause to be done any andall things in connection with such servicing andadministration which it may deem necessary ordesirable." The servicer is much like an assigneefor collection, who must render to the assignorthe money collected by the assignee's suit on hisbehalf (minus the assignee's fee) but can sue inhis own name without violating Rule 17(a). SeeSprint Communications Co. v. APCC Services,

Inc., 128 S. Ct. 2531, 2541 (2008) (dictum);Staggers v. Otto Gerdau Co., 359 F.2d 292, 294(2d Cir. 1966); Kilbourn v. Western Surety Co.,187 F.2d 567, 571-72 (10th Cir. 1951).

The Supreme Court's holding in the Sprintcase was merely that an assignee for collectionhas standing to sue, within the meaning ofArticle III of the Constitution. 128 S. Ct. at2542; see also W.R. Huff Asset Management Co.v. Deloitte & Touche LLP, 549 F.3d 100, 107-10


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(2d Cir. 2008). There is no doubt about ArticleIII

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standing in this case; though the plaintiff may

not be an assignee, it has a personal stake in theoutcome of the lawsuit because it receives apercentage of the proceeds of a defaulted loanthat it services. But in an aside on real party ininterest, the Supreme Court intimated agreementwith 6A Charles Alan Wright, Arthur R. Miller& Mary Kay Kane, Federal Practice &Procedure 1545 (2d ed. 1990), that a real partyin interest differs from a lawyer, or someone elsewith a mere power of attorney, in having a claimto the proceeds of the suit even if its claimderives from legal rather than equitable title

legal title being the sort held by a trustee. 128 S.Ct. at 2541.

Unfortunately, it is less clear than it shouldbe whether the Pooling and ServicingAgreement between the trustee of the mortgagesbacking the mortgage-backed security and theservicer made the latter an assignee or a mereattorney. It says that the servicer "shall... havefull power and authority, acting alone, to do orcause to be done any and all things in connectionwith such servicing and administration which itmay deem necessary or desirable." The trusteeshall at the servicer's "written request... promptlyexecute any limited powers of attorney and otherdocuments furnished by the [Servicer]... that arenecessary or appropriate to enable [the Servicer]to carry out [its] servicing and administrativeduties hereunder." The trustee is thus requiredtoconfer on the servicer whatever authority thelatter needs to perform his servicing duties,which include suing. For it is the servicer, notthe trustee, who is empowered to decide whetherto sue. The agreement further states that withoutthe Trustee's written

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consent, "except as relates to a Loan that the...Servicer... is servicing pursuant to its respectiveduties herein (in which case such servicer shallgive notice to the Trustee of the initiation), [the

Servicer shall not] initiate any action, suit orproceeding solely under the Trustee's namewithout indicating the... Servicer's...representative capacity." The word we'veitalicized indicates that the servicer can sue in itsown name if the suit relates to a loan that it's

servicing, or in the trustee's name withoutindicating that it's doing so in a representativecapacity implying that it is not doing so in arepresentative capacity if it is suing in regard toa servicing-related loan.

It is thus the servicer, under the agreement,who has the whip hand; he is the lawyer andtheclient, and the trustee's duty, when the servicer iscarrying out his delegated duties, is to providesupport. The securitization trust holds merely thebare legal title; the Pooling and Servicing

Agreement delegates what is effectivelyequitable ownership of the claim (albeit foreventual distribution of proceeds to the ownersof the tranches of the mortgage-backed securityin accordance with their priorities) to theservicer. See Greer v. O'Dell, 305 F.3d 1297,1302-03 (11th Cir. 2002), and cases cited there.For remember that in deciding what action totake with regard to a defaulted loan, the servicerhas to consider the competing interests of theowners of different tranches of the security.

But if, contrary to what we think, theservicer is not the real party in interest in thiscase, there still is no need to

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dismiss the suit. Rule 17(a)(3) provides that acase should not be dismissed because it has notbeen brought in the name of the real party ofinterest "until, after an objection, a reasonabletime has been allowed for the real party ininterest to ratify, join, or be substituted into theaction"; and "after ratification, joinder, or

substitution, the action proceeds as if it had beenoriginally commenced by the real party ininterest." The trustee (Bank of America)submitted an affidavit to the district court, whichwas not contradicted, ratifying the servicer's suiton the bank's behalf. The district court rejectedthe affidavit as untimely, because earlier the


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plaintiff had failed to respond to an interrogatoryconcerning its authority to sue. The judge'saction was precipitate. The affidavit was filed inresponse to the defendants' motion for judgmenton the pleadings, in which they argued that theplaintiff lacked standing to bring suit. So while

the affidavit was submitted only three daysbefore the trial began, it was nonetheless atimely response to the defendants' motion.

So we come to the merits.

Blockbuster is the well-known but fast-fading chain of movie rental stores. Its businessmodel has been devastated by direct mail rentalservices like Netflix, by DVD vendingmachines, and increasingly by the directtransmission of movies to home computers and

television sets. "Blockbuster Shares Fall onChapter 11 Warning," N.Y. Times, Mar. 17,2010, www.nytimes.com/2010/03/18/business/media/18blockbuster.html (visited May 31, 2010); Brooks Barnes,"Studios and Cable

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Unite in Support of Video on Demand," N.Y. Times, Mar. 17, 2010,www.nytimes.com/2010/03/18/business/media/18demand.html (visited May 30, 2010);

"Blockbuster's Loss Exceeds Forecast," N.Y.Times, Aug. 13, 2009, p. B4,www.nytimes.com/2009/08/14/business/media/14blockbuster.html?_r=1 (visited May 30,2010); Sarah McBride, "Blockbuster to ShutterMore Stores," Wall St. J., Sept. 16, 2009, p. B1,http: //online.wsj.com/article/SB125303731573912777.html (visited May 30,2010). Unable to make a profit at the premisesthat it had leased from Chicago Properties,Blockbuster abandoned the lease. ChicagoProperties sued. The suit was settled by

Blockbuster's agreeing to pay ChicagoProperties $161,000, though it owed rent ofsome $471,000 for the time remaining on thelease. (The plaintiff is seeking a judgment forthe full $471,000, plus attorneys' fees and costs.)Chicago Properties tried to find a substitutetenant, but failed. Nevertheless it continued to

make full, timely payment of the principal andinterest due each month on the mortgage.

The basis of the plaintiff's claim againstBlockbuster is a "Subordination, Non-Disturbance and Attornment Agreement"

(SNDA) to which Chicago Properties,Blockbuster, and the trust are parties. This is astandard agreement that defines the rights oflender and tenant in the event that the landlorddefaults on his mortgage and the lenderforecloses. See Scott W. Dibbs, "Looking Downthe Road," Probate & Property, Sept.-Oct. 2008,at 49, 52-54; Arnold B. West & Sidney A.Keyles, "Does the A in SNDA Work?" id.,Sept.-Oct. 1993, at 54; Robert D. Feinstein &Sidney A. Keyles, "Foreclosure: Subordination,Non-

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Disturbance and Attornment Agreements,"id., JulyAug. 1989, at 38. The subordinationprovision subordinates the lease to the mortgage;the attornment provision requires that the tenantagree to continue the tenancy if as a result of thedefault and foreclosure there is a new landlord;and the nondisturbance provision assures thetenant that his lease will continue in the event offoreclosure. But nowadays, despite the name, anSNDA often and in this case contains additionalprovisions for the protection of the lender or thetenant.

A critical provision in this case is that thelender isn't bound by any rent that the tenantmay have paid in advance, nor by anymodification of the lease made without thelender's consent that reduces the term of thelease or the tenant's monetary obligations underit. The concern is that a landlord who is orforesees soon being in default may, perhaps incollusion with the tenant, collect rent far in

advance, or otherwise modify the terms of thelease in a way that reduces its value to a futurelandlord, depriving that landlord (the foreclosingmortgagee or the purchaser of the property at theforeclosure sale) of rent for occupancy of theproperty by the tenant after the original landlordis no longer the owner. Joshua Stein, "Needless


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Disturbances? Do Non-Disturbance AgreementsJustify all the Time and Trouble?" 37 RealProperty Probate & Trust J. 701, 709-12(2003); see, e.g., Dime Savings Bank of NewYork, FSB v. Montague Street Realty Associates,

686 N.E.2d 1340, 1341-42 (N.Y. 1997);

Prudence Co. v. 160 West Seventy-Third St.Corp., 183 N.E. 365, 367 (N.Y. 1932); KirkebyCorp. v. Cross Bridge Towers, Inc., 219 A.2d343, 344-46 (N.J. Super. Ct.

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Chancery 1966). What is strange about theplaintiff's invocation of this provision is that thelandlord, Chicago Properties, has continued tomake its monthly mortgage payments in full andso there has been no event that could trigger

Blockbuster's liability under the SNDA.

Another provision requires the tenant onthe lender's instructions to deliver his rentpayments to the lender. The plaintiff complainsthat Blockbuster disregarded its instructions todo that. But the instructions were sent after thelease had been terminated, so there were nomore rent payments to be made. Nor was theplaintiff injured by not receiving rent paymentsfrom Blockbuster, for had it received them itwould have applied them to reduce the debt thatChicago Properties owes it, and it has notpresented evidence that Blockbuster's failure todirect rent to it has impaired the value of itscollateral. Remember that Chicago Propertieshas continued to make its monthly mortgagepayments in full.

The claimed liability of the landlord and itsowners is based on other documents themortgage note and the owners' guaranty of thenote. The guaranty makes the owners liable forany losses to the lender arising from "grossnegligence or willful misconduct... relating to

the [mortgage] Loan and/or the Property," and(under a provision similar to a provision in theSNDA that we've already discussed) for lossesarising from the misapplication or conversion ofrent paid more than a month in advance. Nothingin the settlement with Blockbuster violates these

provisions. The money paid in the settlementwas not a payment of rent. It was a

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payment in settlement of a lawsuit that sought

rent for a future period, namely the remainingterm of the lease after Blockbuster abandonedthe premises. And although the mortgageagreement prohibits the borrower fromcancelling a lease without the lender's writtenconsent, it makes an exception for cancellationsmade when the borrower "is acting in theordinary course of business and in acommercially reasonable manner." It would beodd if the defendants could be exposed toliability for doing something contemplated bythe mortgage agreement. In light of

Blockbuster's financial difficulties, there is nobasis for thinking that Chicago Properties wasbeing commercially unreasonable in settlingwith Blockbuster on the terms it did. AndCWCapital argues neither that ChicagoProperties violated a covenant of the loanagreements by failing to reduce the rent itcharges, in order to secure a replacement tenant;or that it should have made greater efforts to findsuch a tenant; or (what is critical) that leavingthe building unoccupied has impaired its valueas security for the mortgage loan a related point

is that there is no evidence of what the buildingwas worth either before or after Blockbuster'sabandonment of the lease.

The loan was nonrecourse (with someconditions as we're about to see). A mortgageloan is nonrecourse when the mortgage lendercan't obtain damages against the borrower if theloan is defaulted and the lender can't be madewhole by foreclosing on the lender's collateral.This may have given Chicago Properties anincentive to hold out for a high-paying tenanteven if that reduced

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the value of the collateral (its building). But thatisn't argued either.


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The mortgage agreement (which is separatefrom the mortgage note) requires the borrower toplace in escrow "all funds received byMortgagor from tenants in connection with thecancellation of any Leases, including, but notlimited to, any cancellation fees [or] penalties."

This language covers the proceeds of the$161,000 settlement of Chicago Properties' suitagainst Blockbuster for unauthorizedabandonment of the lease; and breach of thisprovision is a default under the mortgageagreement, requiring immediate payment of theunpaid balance of the mortgage note. But theplaintiff is not seeking enforcement of themortgage agreement. (Perhaps ChicagoProperties has complied with the escrowprovision; it seems not to have, but the record isunclear.) The only relief it seeks against Chicago

Properties is a money judgment for the entireamount of rent owed by Blockbuster, plusattorneys' fees and costs.

A final issue involves the district court'saward of attorneys' fees to Blockbuster on thebasis of a provision in the SNDA that "shouldany action or proceeding be commenced toenforce any provisions of this Agreement or inconnection with its meaning, the prevailing partyin such action shall be awarded, in addition to

any other relief it may obtain, its reasonablecosts and expenses, not limited to taxable costsand reasonable attorney's fees." The plaintiffargues that Blockbuster is not a prevailing partybecause it lost on a counterclaim charging aviolation of a provision of the SNDA which

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said that "Tenant [Blockbuster] shall not be joined as a party/defendant in any action orproceeding which may be instituted or taken byreason or under any default by Landlord in theperformance of the terms, covenants, conditionsand agreements set forth in the Mortgage." Thedistrict court found this provision inapplicablebecause the claims against Blockbuster aroseunder the SNDA independently of any claims

against Chicago Properties under the mortgage.But all that Blockbuster could have obtainedfrom its counterclaim were attorneys' fees andcosts. That was an unimportant part of the case,so, on balance, Blockbuster was indeed aprevailing party.

The judgment is reversed with directions toenter judgment for the defendants.

Reversed with Directions.

Posner Securitization Case

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