2020 was a bad year… okay, it was a really, really bad year. CMBS borrowers, in particular, found themselves in default and often-times upside down on their CMBS loans. While 2021 has started to show signs of life, even showing a gentle decline in special servicing and delinquency rates, a closer look reveals that certain sectors remain in distress.

As forbearance periods expire, state moratoriums on commercial evictions and foreclosures end, and businesses exhaust federal PPP and other stimulus aid, more foreclosures and other loan enforcement solutions are inevitable. (The status of moratoriums on commercial foreclosures/eviction are as follows: Illinois—expired; Michigan—expired; Texas—expired; New York—expired May 1, 2021; California—county-specific; Ohio—expired; and Indiana—expired.) While the world remains hopeful for a more “normal” 2021, the impacts on CMBS borrowers will likely continue in a state of flux for some time.

Not All Sectors Have Performed Equally—Retail vs. Office vs. Hotel

According to CBRE, “[r]esearch forecasts that retail store closures in 2020 and 2021 will exceed the 2019 record of 9,800.” To many, this does not come as a shock given retail’s pre-pandemic decline at the hands of e-tailers. Analysts predict the retail sector will recover as consumer spending increases due to vaccine distribution and a growing desire to return to “revenge spending.”

In the office sector, tenants are usually locked into long-term leases. Some reduced their office footprints in 2020 while others attempted to sublet their excess office space. This is a trend that appears to be continuing in 2021. For this reason, foreclosures in this sector have been lower compared to foreclosures filed in the hotel and retail sectors. Office delinquency and special servicing rates are currently low, but this is expected to change as tenants reevaluate their future needs.

Stay-at-home orders and travel and occupancy restrictions severely depressed the hotel sector of the CMBS market. Most analysts predict a swift recovery in the second half of 2021, but this sector will experience a wave of foreclosures and receivership appointments before occupancy rates and revenue return to pre-pandemic levels. Government assistance has helped some hotel borrowers try to weather the storm, but those funds are drying up.

The Courts Have Focused on Contract Terms

CMBS loans are complex transactions entered into by sophisticated parties with the understanding that the benefits of CMBS loans are often unavailable to borrowers through traditional lenders. This comes with certain trade-offs, including the “relationship” aspect of banking. But the bottom line is this: the terms of the loan documents control.

Courts consistently give great deference to contractual terms and obligations in disputes involving CMBS loans, even during times of severe economic downturn. See generally Twin Holdings of Del. LLC v. CW Capital, LLC, 2010 NY Slip Op 50097(U), ¶ 5, 26 Misc. 3d 1214(A), 1214A, 906 N.Y.S.2d 784, 784 (Sup. Ct.) (holding that the global financial crisis was insufficient to excuse performance because “the parties are sophisticated entities with knowledge of the real estate industry, [and] they clearly understood the cyclical nature of the real estate market and could not have assumed that demand… would not decline”); Ebert v. Holiday Inn, 628 F. App’x 21, 23 (2d Cir. 2015) (noting that, under New York law, “[e]conomic hardship, even to the extent of bankruptcy or insolvency, does not excuse performance”); Iron Horse Credit LLC v. Eli Wilner & Co. Inc., No. 652134/2020, 2021 N.Y. Misc. LEXIS 1518, at *4 (Sup. Ct. Feb. 23, 2021) (“Nor is the existence of the pandemic an excuse for defaulting”).

Shelbourne BRF LLC v. SR 677 Bway LLC and other pandemic-era cases reflect the direction in which courts are moving as borrowers attempt to enjoin foreclosure sales and excuse their performance following events of default. The Shelbourne court initially enjoined the mezzanine lender’s foreclosure sale, concluding that the pandemic would prevent the property from being sold at fair market value. Index No. 652971/2020 (Sup. Ct. N.Y. Aug. 3, 2020), NYSCEF Doc. No. 38. However, the same court later reversed course, denying the borrower’s request for a second injunction while noting that the state of the property did not warrant lender-supplied cash infusions, that other similarly-situated properties were in the foreclosure process and, most importantly, that an injunction would contravene the express contractual terms and obligations for which both parties bargained—a cardinal sin. Shelbourne, Index No. 652971/2020 (Sup. Ct. N.Y. Oct. 27, 2020), NYSCEF Doc. No. 81. Ultimately, the First Department Appellate Division vacated the injunction because the borrower did not suffer irreparable harm, an element needed to obtain a preliminary injunction. Shelbourne BRF LLC v. SR 677 Bway LLC, 2021 NY Slip Op 01346 (App. Div. 1st Dept.). In effect, this ruling is a nail in a borrower’s coffin as it removes the threat of an injunction to blunt the contracted operation of the loan documents.

What Is Likely To Happen Next?

The pandemic severely affected the hotel and retail sectors throughout 2020 and the beginning of 2021, and the office sector may be next. Knowing that obtaining an injunction to postpone foreclosure proceedings will be difficult and that courts typically dismiss the financial distress argument as a means to excuse performance, CMBS borrowers must try to engage in realistic workout discussions with special servicers. Quite plainly, in CMBS deals, the parties get the benefit of their bargain.

Our work with CMBS special servicers informs our ability to steer complex workout and loan enforcement situations nationwide. For more information, reach out to us.

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Photo of Edward S. Weil Edward S. Weil

Edward S. Weil serves as a member of Dykema’s Executive Board and is a member and immediate past Director of the Firm’s Financial Industry Group, which brings together over 140 Dykema lawyers who represent financial services firms in various litigation, transactional, regulatory/compliance and…

Edward S. Weil serves as a member of Dykema’s Executive Board and is a member and immediate past Director of the Firm’s Financial Industry Group, which brings together over 140 Dykema lawyers who represent financial services firms in various litigation, transactional, regulatory/compliance and restructuring capacities. He is the co-team leader of the Firm’s Commercial Mortgage-Backed Securities Special Servicer Group. In his general commercial litigation practice, Mr. Weil represents companies in industries ranging from telecommunications, food technology solutions, airport technology, real estate developers, home security and home furnishing manufacturers, hospitality firms, and business services providers. Mr. Weil litigates a wide variety of commercial matters, including fraud, business tort, breach of fiduciary duty, and trade secrets misappropriation and competition-related claims, as well as partnership disputes and corporate governance claims. In his financial services practice, Mr. Weil represents large and mid-sized banks, large CMBS special servicers, purchasers of non-performing commercial real estate and C&I debt, investors and title insurers in litigation including loan enforcement and foreclosure actions, fraudulent conveyance cases, pursuit of guarantors, defense of lender liability claims, Creditor Committee litigation, mechanic’s lien and land-use claims, and bankruptcy litigation. He has litigated cases all over the U.S. and has had substantial international litigation experience.

Photo of Mark A. Silverman Mark A. Silverman

Mark Silverman is a member in Dykema’s Chicago office practicing in the areas of business and financial services litigation. He is a member of the Firm’s Financial Services Litigation Group and a co-team leader of the Firm’s Commercial Mortgage-Backed Securities Special Servicer Group.

Mark Silverman is a member in Dykema’s Chicago office practicing in the areas of business and financial services litigation. He is a member of the Firm’s Financial Services Litigation Group and a co-team leader of the Firm’s Commercial Mortgage-Backed Securities Special Servicer Group. Mark’s practice covers a wide range of complex commercial litigation, lender’s liability defense, banking, fraudulent conveyance and general fraud litigation, class action litigation, contract disputes, commercial foreclosures, commercial real estate transactions, post-judgment collections proceedings, and general business disputes. Mark represents banks, credit unions, large CMBS special servicers, purchasers of non-performing commercial real estate and C&I loans and investors in loan enforcement litigation and commercial foreclosure actions.