The Courts have seen many claims by lenders against valuers for overvaluing property taken as security for loan transactions, and the principles to be applied to such claims are well established. A number of recent high value claims against valuers relating to structured finance transactions, such as commercial mortgage-backed securitisations (‘CMBS’), have applied these principles to more complicated scenarios.
Norton Rose Fulbright LLP recently acted for the claimant issuer in respect of the biggest of all such claims, Gemini (Eclipse 2006-3) plc v CBRE Limited and Warwick Street (KS) LLP (Gemini), which settled on confidential terms shortly before trial. This article discusses a number of the unique and complex legal and evidential issues raised by CMBS valuation claims, including Gemini.
The Gemini claim
In August 2006, the lender, Barclays, in reliance upon a draft valuation report prepared by the defendant valuers, advanced just over £1.2 billion to Propinvest (the ‘Borrower’), on the security of a nationwide portfolio of 37 commercial properties including offices, shopping centres and industrial warehouses. A few months later, Gemini purchased from Barclays all of its rights and interest in the loan (including the security over the properties), funded by the proceeds from the issue, on a non-recourse basis, of notes to investors (the ‘Noteholders’).
Following the onset of the global financial crisis in 2008, the Borrower defaulted on the loan. The value of the 37 commercial properties was reassessed and considerably downgraded, and the market value of the notes fell dramatically, leaving the noteholders with substantial losses. Gemini issued proceedings against the valuers in 2012 and claimed that the valuers had negligently overvalued 35 of the 37 commercial properties, with an aggregate overvaluation of about £200 million.
For a lender to bring a successful claim against a valuer for negligently overvaluing property, it is necessary to establish negligence, causation and loss. We examine each of these aspects in relation to Gemini’s claim.
Duty of care
Did the valuers owe the claimant a duty of care?
Where a lender is bringing a claim against valuers there is usually no issue in establishing a duty of care. However, where the loan is sold on to a third party, as in a CMBS, the question arises whether or not the CMBS issuer is owed a duty of care by the defendant valuers. This may depend on how the valuers’ instructions were framed, the wording of the valuation report and the wording of the other securitisation documents. In Gemini, the definition of ‘addressee’ in the valuation report included not only Barclays, but also ‘any of its transferees, assignees or successors in title to the Facility Agreement’. It was therefore perhaps more difficult for the valuers to argue that Gemini (as assignee) was not owed a duty of care by the valuers, particularly as a securitisation was plainly envisaged before the loan was advanced. The position in other CMBS valuation cases has not been so straightforward.
Who is the correct claimant?
In a straightforward property loan, it will be the lender who brings a claim against the valuer for negligent overvaluation of the security (as it is the lender who will suffer loss following default and realisation of the security for less than the outstanding loan). In a CMBS claim, it is more complicated to identify the correct claimant because the bank has sold the loan to an SPV issuer which has funded the purchase by issuing debt to the capital markets on a non-recourse basis. Arguably, in economic terms, it is noteholders rather than the issuer who suffer any loss as a result of the declining value of their notes.
In Gemini, the defendant valuers argued that the issuer, Gemini, had assigned all of its interest in the loan and security and any cause of action to the Trustee (Bank of New York Mellon) under the Issuer Deed of Charge. Gemini’s response was that it had assigned that interest in equity only and by way of a charge that crystallised only upon default of the notes (which had not occurred). Gemini’s position accords more readily with securitisation practice and the relative autonomy allowed to issuers in relation to their assets in the absence of a note event of default; but ultimately, of course, this question was not tested in court.
Negligence and the ‘bracket’
In Gemini, the defendant valuers raised an additional argument that a valuer’s liability must be determined by looking only at the portfolio of all the properties as a whole, ie by considering whether the aggregate value of the portfolio fell outside the range of values that a reasonably competent valuer could have reached for the properties as a whole. This contrasts with the position for a single property, where the duty is to give a valuation within a certain ‘bracket’ around the correct value.
The ‘portfolio’ defence has some superficial attraction in that lenders and investors will frequently describe CMBS transactions in aggregate terms (eg, ‘a £1.2 billion portfolio of commercial properties’). However, it raises difficult conceptual issues because, by looking at the value at an aggregate level, a defendant valuer could be exculpated for valuing one property entirely negligently if the combined valuation of all of the properties falls within a reasonable range. In other words, the ‘portfolio’ approach allows a defendant valuer to offset any negligent valuations which are outside the bracket against those which it had valued within (and, conceivably, below) the applicable bracket, thus effectively reducing the standard of a valuer’s duty of care when valuing multiple properties.
The question of whether liability can (and should) be determined at a ‘portfolio’ level is ultimately likely to depend on the facts of a particular case, in particular the nature of the properties and the terms of the valuers’ instruction.
Gemini ultimately settled before any of these novel arguments were tested in court. However, it provides an interesting insight into how the well-established principles in claims by lenders against valuers apply to more complex structured finance transactions. Even if Gemini represents the high water mark of claims arising out of the collapse in CMBS following the financial crisis, those principles will determine future claims arising out of different markets and different asset classes.