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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 required consideration of how these principles should be applied 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.
Gemini was a fairly typical CMBS transaction. 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’). The intention was for rental income from the properties to be used to pay interest on the loan and thereby the notes.
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. In particular, it must establish
There is then scope for the quantum of the claim to be reduced if the lender was itself negligent in its lending practices (contributory negligence).
Where a lender is bringing a claim again valuers there is usually no issue in establishing a duty of care. However, where the loan is sold onto 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
In addition to a direct claim against the valuers, Gemini also brought a claim as Barclays’ assignee, relying upon the Loan Sale Agreement, which provided that, together with the loan, Gemini had purchased ‘the benefit of all reports, valuations, opinions … given to or held on behalf of [Barclays]’. Again, however, not all CMBS transactions provide expressly for assigned claims, and it is therefore necessary to consider the question of duty of care on a case-by-case basis with regard to the relevant transaction wording.
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.
The Court of Appeal considered this question in Titan Europe 2006-3 plc v Colliers International UK plc (in liquidation)  EWCA Civ 1083 (Titan v Colliers). A CMBS issuer (Titan) claimed against a valuer (Colliers) for negligent overvaluation of the commercial property which secured the transaction. The Court of Appeal held that Titan was the correct claimant because, even though it had parted with the risk, it had retained the property in the loans and the securities and therefore had sufficient title to sue the valuer for negligence.
The Court of Appeal also held that Titan, as issuer, had suffered loss immediately upon the purchase of the loan for more than its true value. It was irrelevant that it had subsequently securitised the debt on a non-recourse basis, because the securitisation was an arrangement with third parties which should not benefit the defendant valuer. Titan’s relationship with the noteholders was analogous to that of a company with its shareholders: per Longmore LJ "no-one suggests that, because the shareholders may be the ultimate losers in a case of this kind, the company has not suffered a loss" (paragraph 38).
The decision in Titan v Colliers effectively extinguished similar arguments as to the correct claimant in Gemini. As an alternative, the defendant valuers sought to argue that 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.
In addition to arguments about duty of care, the defendants in Gemini argued that they had not been negligent in that their original valuations fell within the reasonable range of values that a competent valuer could have reached, otherwise known as the ‘bracket’. At first instance in Titan, Blair J noted that if a valuation is within the ‘bracket’ then it will not be negligent, even if some aspects of the valuation process fell below reasonably competent standards.
The size of the ‘bracket’ can vary depending on the state of the market and the type of property. If the market is particularly volatile or very flat (so that there are not many comparable sales or offers), then the bracket will be wide. Standard residential properties should be fairly straightforward to value and so may have a narrow bracket whereas commercial property and developments may be more challenging and hence may have a wider bracket. The bracket is likely to be narrower where there has been a recent purchase of a property on the open market. Generally the margin for error for residential property valuations is +/-5 per cent, whilst for commercial properties it is likely to be between +/-10 to 15 per cent. In Titan v Colliers the margin was +/-15 per cent.
Titan v Colliers was unlike many other CMBS valuation disputes as it concerned the valuation of just one property. Most CMBS valuation disputes involve multiple commercial properties, as did White Tower (a claim by CMBS vehicle White Tower 2006-3 against valuers in respect of five commercial properties that was discontinued after trial in 2016) and Gemini. In Gemini, the defendant valuers raised an additional (and in legal terms novel) argument that a valuer’s liability must be determined by looking only at the portfolio of all the properties as a whole, i.e. 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.
The ‘portfolio’ defence has some superficial attraction in that lenders and investors will frequently describe CMBS transactions in aggregate terms (e.g. ‘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 the facts of a particular case, in particular the nature of the properties and the terms of the valuers’ instruction. In our view, the ‘portfolio’ defence was untenable in Gemini because there was no exercise of judgment at the portfolio level: the valuers were instructed to value each individual property individually and to give no portfolio premium or discount.
However, the recent decision in Barclays Bank v Christie Owen & Davies  EWHC 2351 shows when the Court may take a portfolio-based approach to liability. This case concerned the valuation of three adjacent entertainment centres which the borrower was planning to develop as one combined complex. The court was prepared to assess liability at the portfolio level as it said the bank was looking at the security of all the properties together when deciding whether to make the loan. Here, the bank was making the loan to develop the properties into one complex. However, in a CMBS transaction, separate and diverse properties stand as security, defendant valuers are asked to value them individually and allocated loan amounts are attributed to each of them.
A claimant in a professional negligence claim against valuers must show that it relied upon the valuation and the valuation caused it loss -- possible stumbling blocks in even the most straightforward cases. In particular, a CMBS issuer bringing a valuation claim will need to show that
Where the lender is not a party to the action, evidence as to reliance and causation may not be available and, unless the loan sale agreement provides the issuer with clear and wide-ranging rights to documents, it may be necessary (as it was in Gemini) to obtain such evidence from the lender by way of third party disclosure order.
To defeat a CMBS valuation claim on the grounds of reliance would be a challenge: it would have to be shown that the valuation played no material role in the lender’s decision to advance significant amounts of money (often over £1 billion).
Causation in the context of structured lending claims presents more complicated considerations, particularly where it is alleged that the negligent act caused a lender to act in a certain way.
For instance, in Barclays Trust Company (Jersey) Limited (and others) v Ernst & Young LLP  EWHC 869 (Barclays Trust), which concerned the valuation of a company rather than commercial property, the claimant borrowers sued Ernst & Young LLP (EY) for due diligence services provided in connection with the claimants’ acquisition of the Esporta health and fitness business. The claimants argued that, had EY not negligently overvalued the Esporta business, then Societe Generale (SocGen), the lender, would have withdrawn its offer to finance the transaction or alternatively would have revised the terms of its finance and that this would have caused the claimants not to proceed with the purchase (by the end of the trial, the claimants had conceded that they would not have acted differently in the absence of a change of position by SocGen). The claimants did not field any witnesses from SocGen to prove causation and instead relied upon inferences which they said were to be drawn from the contemporaneous documents. Phillips J found for EY on the basis that the claimants had not sufficiently made out their case.
By contrast with Barclays Trust, Gemini conceded that, had the defendant valuers correctly valued the relevant properties, Barclays would still have advanced a loan but argued that it would have been considerably smaller, so that Gemini’s obligations to its noteholders would have been correspondingly smaller (i.e. an ‘alternative transaction’ rather than a ‘no transaction’ claim). This was on the basis that the original loan appeared to have been structured so that the securitised senior portion of that loan amounted to approximately 75 per cent of the aggregate value of the properties.
Yet loan to value ratios are not always determinative of causation arguments. In a ‘hot market’ such as the 2006 commercial property market, some lenders were willing to consider loan to value ratios of over 75 per cent for CMBS transactions, which in turn might have affected the credit ratings allocated to the notes and the coupon payable on those notes. Overall, a number of factors will have to be considered and evaluated by extrapolation from contemporaneous evidence to establish causation in a structured finance transaction.
In SAAMCO, the House of Lords effectively held that losses attributable to a subsequent fall in the property market fell outside the scope of duty of care owed by a valuer to a lender. Accordingly, a lender’s loss is to be capped at the amount of the overvaluation (i.e. the difference between the negligent valuation and the true value of the property as at the date of valuation). In Gemini, the parties accepted that the claim was capped in this way (as it was in Titan).
Whilst the SAAMCO cap is applicable to most claims against valuers, where a lender’s loss flows from a cause from which it has expressly sought protection (for instance in the unusual event that lender has asked the valuer to advise about likely future movements in the property market), then it might be possible to seek to recover losses flowing from a fall in the market.
The Court may reduce damages if it is satisfied that the lender’s approach fell below that of a reasonably competent lender (such as applying an excessive loan to value ratio) and that its negligence contributed to the loss. In Gemini there were only very limited assertions of contributory negligence, perhaps because anything more overt would have at least implicitly required the valuers to concede that certain aspects of their valuation were negligent.
Gemini 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. Complex professional liability claims are likely to recur as long as professional input is required in complex structured transactions.
On July 27, 2017, the FCA announced that they would no longer compel or persuade banks to make submissions to LIBOR as from the end of 2021.