December 2012 Butterworths Journal of International Banking and Financial Law700

TEA

CHIN

G N

EW D

OG

S O

LD T

RICK

S

Feature Key points�� Noteholders have an interest in the “equity of redemption” which potentially gives them

remedies for mismanagement against the receivers of mortgage-backed securities (MBS). �� Increasing risk of default is making enforcement of these schemes more likely. �� Junior noteholders probably also have a right to redeem against senior noteholders.

Author Nicola Rushton

Teaching new dogs old tricks: the remedies available to unhappy noteholders on a CMBS defaultThe CMBS market may be a recent phenomenon, but the remedies available to unhappy noteholders are ones with a long heritage. In the October 2012 edition of JIBFL ([2012] 9 JIBFL 585) David Shearer asked how much noteholders can direct the actions of a receiver of commercial mortgage-backed security (CMBS). This article looks in detail at some of the options available to noteholders who are unhappy with the actions of a receiver appointed to manage a mortgage-backed security (MBS) scheme which has defaulted. The law is that of England and Wales.

nSo far, there has been only limited enforcement action taken over

European MBS schemes. However, commentators are expecting commercial mortgage defaults to increase as loan restructuring fails to help borrowers in trouble and the commercial property market continues to stagnate. This will increase the risk of defaults in the CMBS markets. As more enforcement action is taken by Trustees on behalf of noteholders, there will be increased scope for competition

and disputes between the noteholders as to whether a receivership or other enforcement has been properly handled. But in crafting remedies for dissatisfied noteholders, lawyers will need to go back to some venerable principles of equity governing the remedies of mortgagees and the obligations of receivers.

In a typical MBS scheme, by the deed of charge the Issuer will have granted a fixed charge over all of the loans and mortgages made to the borrowers and a floating charge over all of the Issuer’s undertaking, property and assets. Those charges are granted to

the Security Trustee, who holds them on trust for the noteholders. The noteholders therefore have an interest in these fixed and floating charges.

If a default event occurs, the most likely action by the Security Trustee will be to appoint an administrative receiver under the fixed and floating charges, to manage and dispose of the assets and pay the noteholders in accordance with the altered priorities following default. The noteholders will generally have the power to direct the Trustee

to take action to enforce the security, by passing a resolution, but their power to do so will be subject to the usual priorities between noteholders. Under the terms of the deed of charge and the trust deed, the noteholders will have accepted “no action” clauses agreeing not to take steps to enforce the security unless the Trustee has failed to do so and in any event not to petition for the winding up of the Issuer until the notes have been paid and discharged in full. This makes administrative receivership the key enforcement mechanism. Even just selling the underlying mortgaged properties will probably require a receiver

to be appointed, since the secured assets of the Issuer are the mortgages rather than the properties themselves.

Administrative receiverships are passing into history for most branches of English insolvency law, following the general ban introduced by the Enterprise Act 2002. However, under 72B of the Insolvency Act, as amended by the Enterprise Act, securitisations are one of the important exceptions to that prohibition. That section allows an administrative receiver to be appointed under a floating charge which forms part of a capital market arrangement and where the debt is at least £50m. The definition of “capital market arrangement” in para 1 of Sch 2A covers all common forms of securitisation.

So the enforcement will be carried through by an administrative receiver, but he or she will be managing the property for several demanding and competing groups of clients in the form of the noteholders. The usual intention in the contractual documents is that following default, noteholders in the same group will share recoveries pari passu, but there will be a strict order of priority between groups. This is no single lender, but is more akin to a series of successive mortgagees, albeit under one charge and represented by one receiver. Furthermore, the large scale of most MBS schemes creates a large incentive to take points. In many cases, even though the scheme is in default, there will still be a good income stream and prepayments from the underlying loans and mortgages. The potential for challenges to the receiver’s decisions is clear.

This makes it important to identify to whom the administrative receiver will owe a

There is no single lender, but [the structure] is more akin to a series of successive mortgagees, albeit under one charge and represented by one receiver.

Butterworths Journal of International Banking and Financial Law December 2012 701

Biog BoxNicola Rushton is a barrister at Five Paper specialising in lender claims, particularly mortgages, securitisations and related insolvency and professional negligence. Email: nicolarushton@fivepaper.com

Feature

TEACH

ING

NEW

DO

GS O

LD TRICKS

duty. This is a duty in equity, not a common duty of care, and the authorities draw a clear distinction as to whom it may be owed. The receiver will owe a duty to anyone who has an interest in the “equity of redemption”, that is those who have a direct interest in the security, but not to the unsecured. In Medforth v Blake [2000] Ch. 86 at 102, Vice-Chancellor Sir Richard Scott said: “A receiver managing mortgaged property owes duties to the mortgagor and anyone else with an interest in the equity of redemption.” In Raja v Austin Gray [2002] EWCA Civ 1965; [2003] B.P.I.R. 725, which concerned a mortgage of mortgages and a claim by the original mortgagor, Lord Justice Clarke re-affirmed Medforth, saying at [27]:

“Equity imposes duties to ensure that a receiver whilst discharging his duties, in this case to sell the properties, in doing so takes account of the interests of ‘the mortgagor and others interested in the mortgaged properties’, which, as [the Vice-Chancellor in Medforth] says a little later, include ‘anyone else with an interest in the equity of redemption’..”.

In contrast, claims against receivers brought by shareholders or employees of the mortgagor or its unsecured creditors have been rejected. In Burgess v Auger [1998] 2 B.C.L.C 478, claims by the plaintiff as director, shareholder, employee and unsecured guarantor of the mortgagor were all struck out.

Thus, if particular groups of noteholders are unhappy with the conduct of the receiver and wish to bring a claim for failure to exercise due diligence, the first step will be to show that they have an interest in the equity of redemption of the Issuer’s property and assets. This must surely be the case. The Trustee holds the security on trust for them, but the existence of this trust is unlikely to prevent them from having the necessary interest in the equity of redemption. The very fact that they have agreed that in general they will not bring enforcement proceedings in respect of the secured assets shows that they have an interest in them. It is likely therefore that a group of noteholders would have capacity to bring such

a claim against the receivers. This of course assumes that the noteholders as a whole are not so dissatisfied with the receivership that they pass a resolution directing the Trustee to remove the receiver, but rather that it is one group which is dissatisfied.

There is still some uncertainty as to the extent of the duty owed by administrative receivers. They certainly have a duty to act in good faith and for proper purposes, that is primarily the enforcement of the security to repay the secured debt (Downsview Nominees v First City Corporation [1993] AC 295). Further, a receiver cannot remain passive. Once appointed he or she has a

duty to preserve and protect the charged assets and cannot do nothing if this would damage the interests of the mortgagor or others interested in the equity of redemption (Silven Properties v Royal Bank of Scotland Plc [2004] 1 W.L.R. 997 at [23]). They are free to choose when to sell the assets and have no obligation to improve them, but if they choose to sell, receivers are under a duty to obtain the best price reasonably available at the time (Silven). In Medforth, the Court of Appeal further concluded that if the receivers chose to carry on the business of the mortgagor, they owed a duty to those interested in the equity of redemption to do so with due diligence (at 102). The Vice-Chancellor held that the scope of this duty, which was additional to the duty to act in good faith, would depend on the facts of the particular case. The trajectory of the more modern authorities is therefore to allow those interested in the equity of redemption to hold the receivers to account for incompetence, while at the same time recognising that the receivers are entitled to act in the best interests of the mortgagee, even where those interests conflict with those of the mortgagor or junior mortgagees.

This means that if a receiver of an MBS scheme manages and sells the assets and distributes the proceeds in accordance with

the priorities in the trust deed and deed of charge, it is unlikely that junior noteholders will have grounds to complain against the receiver. However if a receiver acts in a way which unreasonably disregards the interests of junior noteholders, or acts incompetently in a way which impacts primarily on them, then they are likely to have a claim. The remedy is that the account is restored as if the breach of duty had not occurred.

Those who are interested in the equity of redemption also have an established “right to redeem”, by discharging all sums due to those who have priority to them. The Privy Council in Downsview applied this principle

to successive mortgagees, holding that a junior mortgagee is entitled to require the senior mortgagee to assign its debenture, on an offer of payment of all sums due (or to make an equivalent offer to take an assignment of the junior debenture). Since the root of this right is an interest in the equity of redemption, it would seem that a group of junior noteholders could also claim to be entitled to “pay off” the interests of senior noteholders. Since their interests all arise under the same securitisation documents, no formal assignment of a mortgage will be necessary, but such a power inter se could be useful especially where the obligations to the senior noteholders have already been mostly discharged.

It should be noted that these duties of a receiver can always be subjected to contractual modification. It is possible that in some cases, noteholders may have waived rights of action in the securitisation documents.

In conclusion, these are traditional remedies which have long been available to those interested in the equity of redemption. More recent authority has given them renewed vigour. However, the more general phasing out of administrative receiverships means that it is in the context of MBS schemes and other securitisations that they may continue to be useful. n

...the first step will be to show that they have an interest in the equity of redemption of the issuer's property and assets.