Opinion
004457/2009.
July 1, 2009.
The following papers read on this motion:
3211 3211
Notice of Motion, Affirmation Exhibits Annexed ................................... 1 Memorandum of Law in Support of the Motion to Dismiss the Complaint against Defendants Wells Fargo, Centerline and the Trustee ......................... 2 Notice of Motion ................................................................... 3 Affirmation of Joshua A. Zielinski in Support of Motion to Dismiss Pursuant to C.P.L.R. § (a)(1) and § (a)(7) Exhibits Annexed ............................................................................ 4 Brief of Principal Life Insurance Company and Principal Global Investors LLC in Support of their Motion to Dismiss Plaintiffs' Complaint ........................ 5 Affirmation of Russell L. Penzer in Opposition to the Respective Motions Exhibits Annexed ................................................................... 6 Memorandum of Law in Opposition to Pre-Answer Motions to Dismiss ................... 7 Affirmation of Jennifer S. Kozar in Support of the Reply Memorandum of Law in Further Support of the Motion to Dismiss the Complaint against Defendants Wells Fargo, Centerline and the Trustee Exhibits Annexed ......................... 8 Reply Memorandum of Law in Further Support of the Motion to Dismiss the Complaint against Defendants Wells Fargo, Centerline and the Trustee ............... 9 Reply Brief of Principal Life Insurance Company and Principal Global Investors LLC in Further Support of their Motion to Dismiss Plaintiffs' Complaint ............ 10Motion by defendants Wells Fargo Bank, Centerline Capital Group, and Bank of America National Association to dismiss the complaint for failure to state a cause of action is granted without prejudice to plaintiffs' right to seek leave to replead. Motion by defendants Principal Life Insurance Company and Principal Global Investors, LLC to dismiss the complaint on the ground that a defense is founded upon documentary evidence and failure to state a cause of action is similarly granted without prejudice.
This action for fraud and breach of contract arises from the pooling of plaintiffs' mortgage loan into an issue of commercial mortgage-backed securities. Plaintiffs Mass OP LLC and Mass One LLC are the owners of Phillips at Sunrise Shopping Center, located in Massapequa. Defendant Principal Life Insurance Company is an Iowa insurance company which engages in the business of originating commercial loans. Defendant Principal Global Investors, LLC, an affiliate of Principal Life, administers commercial loans which Principal Life originates.
On or about July 17, 2006, plaintiffs, acting through an intermediary, BJG Realty Advisors, delivered to Principal Life a "potential loan investment memorandum," requesting a loan to refinance the "existing securitized first mortgage on the property." The memorandum described plaintiffs as "special purpose bankruptcy remote entities set up for financing purposes pursuant to the existing securitized mortgage." The memorandum provided information as to the ownership of plaintiffs, the historical and current operating income of the shopping center, and the gross income provided by each of the major tenants. The memorandum indicated that plaintiffs were seeking "non-recourse, fixed rate, permanent" financing which would be payable "interest-only" for ten years. Although the memorandum stated that plaintiffs desired to "maximize proceeds," it did not specify the balance of the existing mortgage, the amount plaintiffs were seeking to borrow, or the value of the property.
Defendant Principal Life's ex. B at 4. A firm "securitizes" assets by conveying them to a separate entity, which pays it with the proceeds of newly-issued securities backed by the transferred assets (See Student Loan Marketing Ass 'n v Riley, 104 F.3d 397 [D.C. Cir. 1997]).
A "bankruptcy-remote" company, also known as a single purpose or special purpose entity, is created in conjunction with certain types of secured loan transactions. Such an entity is unlikely to become insolvent as a result of its own activities and must be adequately insulated from the consequences of any related party's insolvency (See LaSalle Nat'l Bank v Paloian, 2009 U.S. Dist. LEXIS 21594 [N.D. Ill. 2009]).
Following receipt of the memorandum, Principal Life entered into negotiations with plaintiffs concerning the terms of the financing. In early September, Principal Real Estate Investors, an affiliate of Principal Life, sent plaintiffs an e-mail, setting forth the terms which, if accepted by plaintiffs, would constitute the loan "application." The application stated that the lender intended to "securitize" the loan and the borrower was to "cooperate in connection with any such securitization." The application recited that each borrower was a "single purpose, bankruptcy-remote entity . . . formed exclusively for the purpose of owning and operating the property." The application stated that the loan amount would be not less than $65 million, provided, among other conditions, that the loan amount would be equal to 80% of the appraised value of the property "pursuant to an appraisal approved by lender." The application provided that the loan was to be "limited recourse," i.e. non-recourse except that Philip Pilevsky, one of plaintiffs' principals, would provide a personal guarantee of certain limited obligations, including environmental liability.
Brief of Defendants Principal Life and Global Investors at 4-5.
Defendants Principal Life and Global Investors' ex. C.
Although the application did not refer to it explicitly, Principal Life had already obtained an appraisal of the property. On August 29, 2006, Cushman Wakefield had submitted a written report to Principal Real Estate Investors, finding the market value of the property to be $82 million. The valuation was based on income capitalization, as well as the cost approach and sales comparison methods of valuing property. The valuation report recites that it was prepared to assist in the determination whether to make a loan secured by the property. The "reliance letter" transmitting the report provides that the report may be relied upon by i) Principal Commercial Funding, or its affiliates, ii) a trustee in connection with a securitization of the mortgage note, and iii) any other purchaser or assignee of the mortgage note, upon consent to the terms of the reliance letter. Plaintiffs allege that they did not gain access to the Cushman Wakefield appraisal until after the closing.
Defendants Principal Life and Global Investors' ex. E.
Defendants Principal Life and Global Investors' ex. A, complaint at ¶ 15.
The loan transaction closed on November 8, 2006. On that date, plaintiffs and Principal Life entered into a "Consolidation, Extension, and Restatement of Notes Agreement." The agreement recites that the aggregate principal amount owed on the "existing notes" was $36,903,310.79. Pursuant to the agreement, plaintiffs executed a "Gap Note," evidencing $28,096,689.21 in "new money" which was being advanced. The existing notes and the Gap Note were consolidated into a new note in the amount of $65,000,000, which carried interest at the rate of 5.75%. The new note was due on December 1, 2016 and provided that interest was payable on a monthly basis. The new note further provided that the borrower could not prepay any portion of the note until six months prior to the maturity date.
Defendants Principal Life and Global Investors' ex. F.
Plaintiffs also granted Principal Life a mortgage on the property to secure the amount of the indebtedness evidenced by the Gap Note. Defendants' ex. G. There is no dispute that the various mortgages secure the entire indebtedness.
In December 2006, plaintiffs' mortgage was securitized with other mortgages to provide the collateral for certain commercial mortgage-backed securities offered by Bear Sterns. The mortgages were originally held by LaSalle Bank National Association as trustee for the securities holders. Defendant Bank of America National Association is the successor to LaSalle. The mortgages are subject to a "Pooling and Servicing Agreement" which sets out procedures for administering the loans.
Plaintiffs' ex. 3.
Defendant Wells Fargo Bank, N.A. was named as a "Master Servicer" of the loans in the Pooling and Servicing Agreement. A complete copy of the agreement has not been provided to the court. However, it appears that the Master Servicer's duties include collecting the loan payments and passing the funds to the trustee, enforcing loan documents for untroubled loans, and providing performance reports to the securities holders (See Super Future Equities, Inc. v Wells Fargo Bank, 2007 WL 4410370 [N.D. Tex 2007] [unreported]). If a mortgage is in default, the Master Servicer may transfer it to the "Special Servicer," who will "work out" the loan or commence foreclosure. Plaintiffs allege that the Special Servicer with responsibility for their loan was defendant Centerline Capital Group, Inc.
Plaintiff's ex. 4. A traditional mortgage loan is serviced by a correspondent of the mortgage banker that originated the loan. When a mortgage is securitized, it is serviced by a stranger to the original loan transaction (See Super Future Equities, Inc. v Wells Fargo Bank, 2007 WL 4410370 [N.D. Tex 2007][unreported]).
Affirmation of Jennifer Kozar, ex. E at 2.
The Special Servicer named in the Pooling and Service Agreement is Arcap Servicing, Inc., which is not named as a party to the action.
Shortly after the mortgage was securitized, plaintiffs lost two major tenants and began to experience financial difficulties. While plaintiffs became unable to make the required debt payments, it appears that defendants have not declared plaintiffs to be in default on the mortgage. However, plaintiffs attempted to contact Principal Life and Global Investors seeking to modify the loan terms or advice on attracting new tenants. Plaintiffs allege that Global asserted that it had no authority to consider their proposals and that neither the Master Servicer nor the Special Servicer was available to meet with plaintiffs. Plaintiffs further allege that the identity of the trustee was not disclosed to them. Plaintiffs allege that they have suffered continuing loss and damage with respect to the "value, income, and cash flow" relating to the property.
The present action was commenced on March 11, 2009. The first cause of action is for fraudulent inducement. Plaintiffs allege that they were induced to enter into the loan transaction by Principal Life's false representations as to the value of the property. Plaintiffs assert that their damages cannot be readily ascertained and request "reformation of the loan" by reducing the principal to 80% of the fair market value of the property.
The second cause of action is for fraud. Plaintiffs allege that they relied upon Principal Life's false representations that "it would be extraordinarily accessible and attentive in servicing the loan and would be responsive to borrower even after the loan [was] securitized." Plaintiffs request compensatory and consequential damages in an amount not less than that of the Gap mortgage.
The third cause of action is also for fraud. Plaintiffs allege that they relied upon Principal's representations with respect to "assurances of post-closing service." Plaintiffs request compensatory and consequential damages or, in the alternative, an injunction prohibiting defendants from declaring the loan in default until "plaintiffs' issues regarding the loan are fully, fairly, and reasonably addressed."
The fourth cause of action is for breach of the loan agreement. While no formal loan agreement or commitment has been submitted, plaintiffs rely upon the loan application and "other documents." Plaintiffs allege that defendants breached the loan agreement by refusing to disclose to plaintiffs the parties currently responsible for making "decisions and determinations with respect to the loan."
Defendant Principal Life's ex. A, complaint at ¶ 59.
The fifth cause of action is for breach of the implied covenant of good faith and fair dealing in the loan agreement. Plaintiffs allege that defendants breached the implied covenant by unreasonably refusing to communicate with plaintiffs regarding the property and the loan. Plaintiffs request not only compensatory and consequential damages, but also punitive damages in the amount of $50 million on all of their causes of action.
Defendants Principal Life and Global Investors move to dismiss the complaint on the ground of a defense founded upon documentary evidence and failure to state a cause of action. With respect to plaintiffs' fraud claims, defendants assert that plaintiffs were "sophisticated business entities" who failed to rely upon defendants' representations. Defendants argue that plaintiffs' claim for reformation fails because there is no evidence of fraud. Finally, defendants argue that plaintiffs' fraud claims are not pled with sufficient particularity as required by CPLR 3016(b).
With respect to the breach of contract claim, defendants argue that plaintiffs fail to identify any contractual provision requiring defendants to disclose the trustee or master or special servicer of the loan. Defendants further argue that plaintiffs have failed to allege how defendants' breach caused plaintiffs to sustain any damages. With respect to the implied covenant of good faith, defendants argue that they did not seek to prevent performance of the contract or to withhold its benefits from plaintiffs. Finally, defendants argue that plaintiffs may not recover punitive damages in an ordinary breach of contract action.
Defendants Wells Fargo Bank, Centerline Capital Group, and Bank of America National Association move to dismiss the complaint for failure to state a cause of action. These defendants argue that they did not enter into any contract with plaintiffs and plaintiffs' fraud claims are not pled with sufficient particularity.
The court will begin by considering the sufficiency of plaintiffs' breach of contract claims. "In cases of contract interpretation . . . when parties set down their agreement in a clear, complete, document, their writing should be enforced according to its terms. This principle is particularly important in the context of real property transactions, where commercial certainty is a paramount concern, and where the instrument was negotiated between sophisticated, counseled business people negotiating at arm's length" ( South Road Assoc. v IBM Corp., 4 NY3d 272, 277). In the case at bar, the loan application is a clear document, and is complete except as to the loan amount and interest rate. While plaintiffs rely upon all of the mortgage loan documents, they do not allege that any of these documents contradict the loan application. As the financing was negotiated between sophisticated, counseled business people, the concern of commercial certainty requires the court to enforce the loan documents according to their terms. Plaintiffs point to no language in the loan documents which obligates defendants to provide plaintiffs with the name of the party authorized to modify the consolidated note or grant a forbearance.
Nevertheless, "[A]ll contracts imply a covenant of good faith and fair dealing in the course of performance. This covenant embraces a pledge that neither party shall do anything which will have the effect of destroying or injuring the right of the other party to receive the fruits of the contract. While the duties of good faith and fair dealing do not imply obligations inconsistent with other terms of the contractual relationship, they do encompass any promises which a reasonable person in the position of the promisee would be justified in understanding were included" ( 511 West 232nd Owners Corp. v Jennifer Realty Co., 98 NY2d 144, 153).
Plaintiffs in effect argue that a reasonable mortgagor would be justified in understanding that the mortgagee, or its successor, would be willing to discuss a modification of the loan whenever economic conditions are unfavorable. To recognize such an implied obligation would not only undermine the value of commercial certainty but also shift to the lender the risk of property ownership. The court concludes that the implied obligation of good faith and fair dealing does not require a commercial mortgagee, or the mortgage servicer, to discuss a proposed modification with the mortgagor. This conclusion is consistent with cases holding that the mortgagor is not a third-party beneficiary of the pooling and service agreement ( 767 Third Avenue v ORIX Capital Markets, 26 AD3d 216, 218 [1st Dept 2006]). Defendants' motions to dismiss the fourth and fifth causes of action for failure to state a cause of action are granted.
However, the court hastens to add that it is not insensitive to plaintiffs' predicament. Traditionally, mortgage assignments were recorded with the County Clerk. By searching the mortgage records, the mortgagor could determine the present mortgage holder and attempt to negotiate a "work out" or forbearance. In 1993, several large participants in the mortgage industry created the Mortgage Electronic Registration System ("MERS"). Pursuant to MERS, assignments of residential mortgages, instead of being publicly recorded, are tracked electronically in a private system (See MERSCORP, Inc. v Romaine, 8 NY3d 90). By visiting MERS' website or dialing its 800 number, a homeowner may access information regarding his or her loan servicer, but not the holder of the mortgage.
"This lack of disclosure may create substantial difficulty when a homeowner wishes to negotiate the terms of his or her mortgage or enforce a legal right against the mortgagee and is unable to learn the mortgagee's identity"(See 8 NY3d at 104, Kaye, J. dissenting). This "information deficit" may function to "insulate a note holder from liability . . . and hide predatory lending practices" (Id). The MERS system applies only to residential mortgages. However, as the present case illustrates, securitized financing creates the potential for the same abuses with commercial mortgages because of a similar "information deficit." While a breach of contract action against the lender does not lie, this court echoes Judge Kaye in calling the issue to the attention of the Legislature (Id). The court will now proceed to determine the sufficiency of plaintiffs' fraud claims.
To establish a prima facie case for fraud, plaintiff must prove that defendant made a representation as to a material fact, such representation was false, and defendant intended to deceive plaintiff ( Ross v. Louise Wise Services, 8 NY3d 478, 488). Additionally, plaintiff must prove that he believed and justifiably relied upon defendant's statement and was induced by it to engage in a certain course of conduct and that, as a result of such reliance, plaintiff sustained pecuniary loss (Id).
A mere failure to fulfill a promise will give rise to an action for breach of contract but not a fraud claim ( Highland Securities Co. v Hecht, 145 AD2d 393 [1st Dept 1988]). However, a false statement of intention is sufficient to support an action for fraud, even where that statement relates to an agreement between the parties ( Graubard Mollen v Moskowitz, 86 NY2d 112, 122). Mere "puffery," or sales talk, is not a statement of intention upon which plaintiff may reasonably rely, even if the statement relates to defendant's performance under the contemplated contract ( Elghanian v Harvey, 249 AD2d 206 [1st Dept 1988]).
The court concludes that defendants' statements that they would be "extraordinarily accessible in servicing the loan," and similar statements concerning "post-closing service," are mere puffery which will not give rise to a fraud claim. As sophisticated borrowers, whose mortgage had previously been securitized, plaintiffs were in all likelihood aware that a different servicer would be assigned to their loan. Thus, plaintiffs could not reasonably rely upon defendants' puffery concerning loan service. Defendants' motions to dismiss the second and third causes of action for failure to state a cause of action are granted.
With respect to the first cause of action, plaintiffs allege that they agreed to refinance their existing indebtedness at 5.75%, and borrow an additional $28 million, in reliance upon defendants' representations, overstating the value of the property. On a motion to dismiss pursuant to CPLR 3211, the pleading is to be afforded a liberal construction. The court must accept the allegations of the complaint as true and provide plaintiff the benefit of every possible favorable inference ( AG Capital Funding Partners v. State Street Bank and Trust Co., 5 NY3d 582, 591). Thus, the court must give plaintiffs the benefit of every possible inference that they relied upon defendants' representations.
As the Cushman Wakefield appraisal illustrates, the valuation of commercial property is often based upon factors other than income capitalization. Thus, while plaintiffs had first hand knowledge of the income-producing potential of the shopping center, the court must assume that plaintiffs did not know that their property had been overvalued.
A sophisticated investor who acquires a business is under an affirmative duty to protect himself from misrepresentations by the seller by investigating the business he is acquiring and the details of the transaction ( Global Minerals Metals Corp. v Holme, 35 AD3d 93,100 [1st Dept 2006]). Defendants argue that a sophisticated borrower is under a similar duty of "due diligence," and thus may not rely upon the mortgagee's representations as to the value of the property.
Were the financing with recourse, defendants' argument would be more apt. Thus, a sophisticated mortgagor, who intends to assume the mortgage debt, is under a duty to investigate the property to assure that its value is sufficient to satisfy the mortgage debt upon foreclosure. However, where the financing is without recourse, the mortgagor is not liable on the mortgage debt. Where the mortgagor is not liable for a deficiency judgment, he is not concerned with the value of the property and thus cannot be faulted for failing to get an appraisal.
Because the subject transaction was a refinancing with "limited recourse," plaintiffs' principals, the real parties in interest, have no real exposure on the mortgage debt. Thus, the court cannot rule that plaintiffs could not reasonably have relied upon defendants' representations simply because plaintiffs failed to get their own appraisal.
Nevertheless, because the financing was with limited recourse, Principal Life's rosy prediction as to the value of the property could not have been a factor in plaintiffs' decision as to how much, or on what terms, to borrow. As BJG Realty Advisors frankly stated in their initial solicitation, plaintiffs were seeking to "maximize proceeds." Thus, the amount of cash which plaintiffs decided to take out of the property was determined by the interest rate and their own needs, or desires, for capital. Since plaintiffs could not have relied upon defendants' representations as to the value of the property in entering into the mortgage transaction, defendants' motion to dismiss the first cause of action for failure to state cause of action is granted.
Although plaintiffs have not stated a claim for common law fraud, because their mortgage was packaged into an issue of securities, plaintiffs may nonetheless have a cause of action. An underwriter is not ordinarily in a fiduciary relationship with an issuer of securities. However, a fiduciary relationship may arise if the underwriter, based on its knowledge and expertise, advises the issuer as to the initial public offering price ( EBC I v Goldman Sachs, 5 NY3d 11, 20-21). Thus, an underwriter may have a fiduciary duty to disclose to the issuer compensation arrangements with its customers that provide the underwriter with an incentive to underprice the security (Id at 18). An underwriter may have a similar duty to disclose to the issuer of mortgage-backed securities compensation arrangements which provide an incentive to overvalue the collateral.
Bear Stearns' prospectus characterizes the "Mortgage Securities Trust" as the issuer of the mortgage-backed securities. However, Bear Stearns and Principal Life may actually have been functioning as underwriters in the transaction, and the mortgagors, who assume the debt and receive the proceeds, may, at least for purposes of state trust law, be the "issuer" of the securities. While mortgagor and mortgagee ordinarily deal at arm's length, the mortgagor may repose confidence in the mortgagee's knowledge and expertise, if the mortgage is to be pooled into an offering of commercial mortgage-backed securities. Thus, the mortgagor may repose confidence in the mortgagee's advice as to the amount of debt which can safely be "issued." The mortgagor may repose confidence in the mortgagee's advice even if the mortgagor has some familiarity with the securitization process, and other factors, such as the interest rate and the desire for cash, impact on the mortgagor's decision.
Plaintiffs' ex. 3.
The term "security" includes "any note . . . [or] evidence of indebtedness" 15 USC § 77b(a)(1). The term "issuer" means "every person who issues or proposes to issue a security" § 77b(a)(4). The term "underwriter" means "any person who has purchased from an issuer with a view to, or offers or sells for an issuer in connection with, the distribution of any security. . . ." § 77b(a)(11).
While plaintiffs have not alleged the compensation arrangement between Bear Stearns and Principal Life, it may very well have provided an incentive for Principal Life to overvalue plaintiffs' property. Thus, a cause of action for breach of fiduciary duty may lie if the compensation arrangement with Bear Stearns was not disclosed prior to the mortgage transaction. Accordingly, defendants' motions to dismiss the complaint for failure to state a cause of action are granted without prejudice to plaintiffs' right to seek leave to replead a cause of action for breach of fiduciary duty (See Antel-Oldsmobile Cadillac v Sirus Leasing Co, 101 AD2d 688 [4th Dept 1984]).
See plaintiffs' ex. 6.
This shall constitute the decision and order of the court.