A hedge fund vehicle, formerly managed by Cambridge Place Investment Management (CPIM), is suing the Royal Bank of Scotland in the High Court of Justice for in excess of £30m over the collapse of a junior loan beneath Dunedin’s former Industrious UK second property portfolio.
Two special purpose vehicles (SPV) – known as Torre Asset Funding Limited and Torre II Asset Funding Limited – are suing RBS for the once economic value of their combined participations in a junior loan beneath the EPIC Industrious securitisation.
Torre I and Torre II – represented by Field Fisher Waterhouse – claim RBS failed to disclose to the junior lenders material financial information as to the declining health of the property company, Dunedin Property Group Limited, which borrowed £631m in senior and mezzanine debt to refinance a UK industrial portfolio, known as Industrious.
Further, it is alleged that RBS failed to disclose events of default in the complex structured finance transaction – first known to the bank by “at least 5 July 2007” – which underpinned the 120-strong Industrious property portfolio.
These non-disclosures, argued the two SPVs in a written submission to Chancery Division’s Queens Bench Division – dated 1 May 2013 – ahead of an estimated 10-day hearing, prevented CPIM from seeking to sell its junior loan interests or enter a timely restructuring of the junior debt, to mitigate losses.
As a result, Torre I and Torre II is seeking loss damages from RBS amounting to £28.3m – the estimated economic value of its positions in the junior loan – for breach of contract and duty, negligent misstatement of material financial information, plus interest at 2% until the judgement is passed.
RBS – represented by Norton Rose – entirely denies all these charges and has mounted a forceful defence.
The outcome of this case will be keenly monitored, possibly setting legal precedents, inter alia, around: where the lines of professional liability are drawn for real estate debt investors, arranging banks, loan servicers and trustees; potential conflicts of interest which arise from competing legal and economic interests; as well as in respect of timely and appropriate information disclosure.
The undisputed background facts
In late 2005 and early 2006, Dunedin Property Group Limited, a Scottish property company formed out of a management buyout from ING in 1996, acquired three separate UK industrial portfolios – the William, Ruby and Florence portfolios – with financing provided by RBS.
RBS combined these separate portfolios and merged them with an existing larger portfolio, dubbed Industrious, which Dunedin acquired from Brixton in May 2006 which at the time of the portfolio’s merger had a value of around £460.5m.
The enlarged 120-strong, 9.47m sq ft Industrious property portfolio was refinanced through an agency-style securitisation through RBS’s EPIC CMBS conduit programme, as well as four junior loans below the securitisation.
Dunedin received a £631m total debt facility – against an August 2006 valuation by DTZ Debenham Tie Leung of £655.39m – which put the closing LTV for the Industrious portfolio at 96.3% LTV.
Underneath the £487.5m EPIC Industrious CMBS, sat four junior loans: the most senior junior loan was the B-note sliced from the EPIC Industrious CMBS, with a value of £32.5m.
Below this there was a separate “mezzanine loan”, and a “junior mezzanine loan”, both with a £32.5m value and, completing the capital stack, was the most subordinated position, the £46m “junior subordinated mezzanine”, with the latter held by RBS.
The CPIM-managed Torre I and Torre II took a majority position in the £32.5m mezzanine loan below the equally-sized B-note and above the junior mezzanine loan: Torre I invested £10.85m and Torre II invested £16.53m, for a combined £27.38m.
Also in the same tranche, the Cheshire Building Society and Marathon Asset Management invested.
In addition, CPIM took a position in the £32.5m junior mezzanine loan, on behalf of Torre I and Torre II, as well as separately on behalf of Noosa Asset Funding Limited, an investor in CMBS and junior real estate debt also managed by CPIM.
According to RBS’s submitted amended defence – dated 13 May 2013 – Noosa’s investment was part of an intended commercial real estate collateralised debt obligation, to be managed by CIPM, which was ultimately aborted amid the market turbulence at the time.
Across the transaction, RBS acted as the super senior lender, the junior subordinated mezzanine, the mandated lead arranger, the agent, the security trustee, and the servicer to and lone note holders and hedging counterparty.
The case against RBS and the bank’s robust defence
The case against RBS, as articulated by Torre I and Torre II’s litigators, Field Fisher Waterhouse, concerns the failure of RBS to make available to the claimants materially significant financial information, as to the dramatic decline in financial health of Dunedin, which precipitated the erosion of economic value in the £32.5m mezzanine loan.
By mid-October 2007, contest the two SPVs, RBS was in possession of two separate financial documents – Dunedin’s “Business Plan for Annual Review” and “cash flow forecasts” for 2008 – which together revealed a worsening picture of the Dunedin financial health and an ICR covenant breach for the subordinated junior loan which RBS allegedly failed to disclose.
Furthermore, the documents allegedly showed that Dunedin failed to meet its 2007 business plan targets and would run out of cash by June 2008 – all of which would be negative drivers on the value of Torre I and Torre II’s mezzanine loan – and were it is contested undisclosed by RBS.
Torre I and Torre II argued that RBS’s failure to disseminate these documents and its failure to inform the claimants of subsequent events of default when the bank was first aware, amounts to a breach of duty, breach of contract and negligent misstatement.
As stated above, RBS vigorously contests these charges.
In its written submission, the claimants’ litigators wrote: “It is now apparent to the claimants that from at least 3 July 2007 the defendant was in possession of other cash flow forecasts which had been sent to it by Dunedin and which pre-dated the cash flow forecast which indicated clear events of default on the part of Dunedin in respect of which the defendant had an obligation to notify the claimants and of which the claimants should have been informed.”
These documents, according to the claimants’ submission, demonstrated that the property company would “likely be in breach of its ICR covenants and would be unable to pay interest on the junior subordinated mezzanine facility”.
It is claimed that RBS eventually drafted “the cash flows in such a way that they did not disclose breaches of the ICR covenants and the inevitably that Dunedin would run out of cash by mid-2008”.
While RBS does not contest that the bank was in possession of Dunedin’s business plan and cash flow forecasts by mid-October, the bank contests that these were not final, nor had been approved for implementation.
RBS maintains that both documents were extended by Dunedin, in its capacity as the £46m junior subordinated mezzanine lender, to seek the bank’s approval to roll-up all remaining interest due under the loan until the structure’s April 2011 maturity, due to Dunedin’s deepening cash flow shortage.
“The draft business plan did not indicate, and nor did the defendant consider, that this was a matter of significant concern. The reality was that the property sector, and in particular the commercial property sector, was encountering a period of turbulence at the time,” stated RBS’ written defence.
By the end of June 2008, a new valuation showed that the Industrious portfolio had collapsed in value to £521m, triggering an LTV covenant breach and an event of default.
In an email dated 6 August 2008, CPIM pressed RBS over its non-disclosure of Dunedin’s business plan and cash flow forecasts, to which, it is contested, RBS stated that the failure of the EPIC Industrious transaction, and the event of default, had “really been a development of the last couple of months”.
“Contrary to this assertion,” submitted the two SPVs in its written Particulars of Claim, “the seriousness of the situation was disclosed by the cash flow forecast”.
In its written defence, RBS denies this latter claim.
Ernst & Young was subsequently appointed as joint receivers over the Industrious portfolio on 18 September 2008.
Torre I and Torre II claim RBS was in breach of contract and of its duty at common low, and “failed to perform its obligations under Clause 19 in a number of material respects in a number of occasions in that financial information was either not passed on to the claimants by the defendant or the defendant failed to obtain such information pursuant to provide it”.
It is argued, by the claimants, that the contents of the cash flow forecasts “would have provided the claimants with material financial information on the basis of which they would have been altered to serious difficulties relating to the viability of the transaction and therefore would have been able to consider whether to retain or dispose of their interest in the lending to Dunedin”.
Determining junior debt value in the teeth of the global financial crisis
RBS provided “marks” as to the declining value of Torre I and Torre II’s interest in the junior mezzanine loan: which declined from 95% of par value in June 2008, to 75% in July 2008, to 25% in August 2008 and, finally, just 5% in September 2008.
The claimants stated in their written submission: “If the claimants had been made aware of the default they would have been given the opportunity to sell the debt in or shortly after July 2007 and, in any event no later than the beginning of 2008. The claimants could realistically have expected to achieve a price (after bid-offer spread) at or close to the valuations shown [detailed in the prior paragraph].
The claimants, therefore, assess that their loss was the opportunity to sell the junior mezzanine loan interests in Torre I and Torre II for a combined sale price of £28.81m, which by February 2008, would have been approximately £28.31m.
Alternatively, the claimants argue they would have mitigated their losses by participating in a restructuring of the debt obligations, preventing the collapse of the transaction.
In addition, Torre I and Torre II contest that “incorrect and/or questionable figures for Net Rental Income” were used in the preparation of the transactions compliance certificated from 20 June 2007.
“Had the compliance certificates been properly calculated they would have disclosed a breach of the ICR covenant of junior subordinated mezzanine facility from 30 June 2007,” added the claimants.
RBS denies that it failed to perform any obligation which it owed under the facility agreement or otherwise. Furthermore, the bank’s defence states that the business plan and cash flow forecasts, if provided to the claimants, “would have alerted them to serious difficulties relating to the viability of the junior mezzanine loan”.
RBS continued in its written defence: “Such allegedly serious difficulties were neither explicit in these documents but are the product of hindsight.”
Furthermore it contests that the claimant was privy to certain financial disclosures regarding Dunedin, as part of a sales process of the Industrious portfolio which was under consideration at the time by the property company, in a potential sales process – known as Project Highland – carried out by its adviser Morgan Stanley.
RBS’s defence states that the premise “namely that the defendant did not provide information which it ought to have provided and that it provided erroneous reassurances or explanations… is denied”.
In addition, the marks “do not purport to provide (and do not provide) evidence as to the underlying worth of the asset or as to the value that might be achieved in the secondary market in the event of the sale of the asset”.
RBS denies breach of contract and breach of duty and that the claimants have suffered any loss. Further, that RBS contests that CPIM would have sold its junior loan participations, in the absence of the alleged breach, or that a sale price of £28.8m or £28.3m would not even have been achievable.
“It is further denied that, absent the alleged breach, the claimants would have achieved such a restructuring and it is not admitted that, even if they had done so, this would have made any difference,” stated RBS’ written defence.
On the contrary, argued RBS, if the facts of the alleged Particulars of Claim are true, the losses incurred were the result of, inter alia: “The failure of the claimants to properly analyse or draw the right conclusions form the information which they did receive as to the financial position of Dunedin.”
RBS argued that insofar that the “claimants establish that the information in the draft business plan and draft cash flow forecasts would have alerted them to problems in respect of the junior mezzanine loan, then they should equally have been alerted by the material” they did receive in the compliance certificates and other documents from which the same conclusions could be derived.
The hearing continues.