Trade Division Allows Termination of COVID-Related Contract Under “Market Disruption” Clause | Patterson Belknap Webb & Tyler LLP
The onset of the COVID-19 pandemic in the spring of 2020 led to immense uncertainty in the market, which in turn strained contractual relationships. Amid this tension, a question that preoccupied many trading parties was the extent to which the underlying contract contained a termination option or other safety valve that could be exercised to relieve some of the burden of its obligations. While much has already been written on the subject, a recent ruling by Commerce Division Judge Joel M. Cohen adds an interesting angle to the discussion: whether a counterparty can unilaterally extinguish a market disruption termination option by actions considered as “off-market”. .” In Cascade Funding LP – Series 6 c. Bancorp Bank, Justice Cohen answered this question in the negative.
Plaintiff Cascade Funding, LP (“Cascade”) is an investment fund formed for the purpose of purchasing and securitizing mortgages. Defendant Bancorp Bank (“Bancorp”) is a commercial bank that, among other things, originates commercial mortgage loans and sponsors loan obligations secured by commercial real estate (“CLO”).
On the eve of the COVID-19 pandemic, on February 24, 2020, Cascade agreed to purchase a pool of over $825 million of commercial mortgage assets from Bancorp, with the intention of consolidating and securitizing these assets into commercial real estate CLOs which would be marketed and sold to investors no later than April 15, 2020. As part of the agreement, Cascade paid Bancorp an initial deposit of $12.5 million prior to the closing date April 15 target.
At the center of the dispute is a “market disruption” clause in the parties’ agreement which, as the Court explained, effectively gave Cascade a “securitization exit” based on an objective change in market conditions. between the execution of the contract and the closing date of the securitization. The provision stated, in relevant part:
if (i) the buyer elects to pursue a securitization to fund the purchase of the Mortgage Assets on the Closing Date and has worked in good faith to close such securitization on the Target Closing Date and (ii) no earlier than fifteen ( 15) days prior to the scheduled closing date of the Securitization, the Purchaser provides written evidence to the Seller (satisfactory to the Seller in its reasonable good faith) that, based on the levels provided by a rating agency retained for the Securitization, ‘AAA’ grade bonds in securitization would be . . . priced at a rate above LIBOR+200bp. . . , then the buyer will have the right to terminate the transaction and will have no obligation to purchase the mortgage assets.
In addition to terminating the transaction, the “market disruption” clause also provided for the repayment of Cascade’s initial $12.5 million deposit.
As the Court explained, this “market disruption” clause was an integral part of the agreement: “The magnitude of the LIBOR spread in the proposed securitization was critical to Cascade, as its return on the transaction depended on the existence of excess cash flow from the mortgage. post-payment loans to bondholders. The higher the interest rate paid to bondholders, the less likely there is to be a return on Cascade’s investment. At the time the parties signed the contract on February 24, 2020, similar securitizations were priced around LIBOR+100bp, leaving “a substantial cushion” over the LIBOR+200bp threshold that would allow Cascade to invoke the valve. “Market Disruption” security statement. .
But, as the Court put it, “then came COVID-19.” Due to the uncertainties associated with the pandemic, the market for commercial real estate CLOs has effectively dried up. Evidence on the record showed that there was not a single new primary issue between March 2, 2020 and May 19, 2020; that secondary market spreads have widened to levels ranging from LIBOR+300bp to LIBOR+500bp; and that Cascade’s own underwriter has provided written notice that the proposed issuance will be priced at LIBOR + 300 bps.
On March 31, 2020, fifteen days before the closing date, Cascade exercised the “market disruption” clause, provided Bancorp with a termination notice and demanded the return of the $12.5 million deposit. Cascade has attached to its notice a written determination of market conditions prepared by the underwriter. For the reasons discussed below, however, Bancorp rejected the notice. Cascade eventually sued, asking for the recovery of the original deposit, among other things. Cascade filed a motion for summary judgment, which the Court granted.
In objecting to summary judgment, Bancorp argued that (1) before concluding that the price of the bonds could not be at or below LIBOR + 200 bps and invoking the “market disruption” clause, Cascade should have gone through the process of soliciting real offers; and (2) had she done so, she would have learned that Bancorp itself was willing to buy the bonds (if offered) at LIBOR + 199 bps.
Regarding Bancorp’s willingness to purchase the offer, the Court explained that the summary judgment record shows that, faced with the prospect of losing the transaction, Bancorp internally decided to purchase the bonds in order to ” satisfy” the “market disruption” clause. However, it was undisputed in the record that Bancorp had not disclosed this intention to Cascade and had in fact stated explicitly upon execution of the contract that it had no intention of purchasing bonds. in the context of securitization.
The Court rejected Bancorp’s arguments and granted summary judgment to Cascade. With respect to Bancorp’s argument that Cascade was required to solicit actual offers, the Court held that the clause – as written – provided an objective measure to determine the disruption and did not say that the “actual offers” were the “only acceptable evidence of the existence of a market”. disturbance.” The Court concluded that the clause therefore did not require Cascade to “engage in objectively futile marketing efforts to prove the bond’s market potential in an admittedly frozen market.”
Regarding Bancorp’s “more intriguing” argument about its own willingness to bid on the offer, the Court noted “some logic” in the theory, but concluded that the “problem” was that she “collided[d] with clear wording and purpose of the contract, which focuses on whether or not there has been market disturbance measured against an objective standard. As the Court explained, Bancorp’s interpretation, if accepted, would give counterparties a “stopped-market” financial incentive the “unilateral option to extinguish [a] right of termination regardless of market conditions. The Court noted that the consequence of such an interpretation—that’s to say“locking Cascade into a 99 basis point adverse change in LIBOR spreads”, with incalculable ripple effects on the lower tranches of the bond – was not what the parties had anticipated or agreed.
The Cascading funding The decision offers an interesting insight into the operation of contractual clauses intended to allow termination in the event of a market disruption. According to Justice Cohen’s decision, to the extent that such a clause contains an objective reference by which the disruption can be determined, the counterparty cannot prevent the operation of the clause by actions considered “out of market”.
 2022 NY Various. LEXIS 1706 (NY Cnty. Sup. Ct. April 21, 2022).
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