A lawsuit that reflects frequent borrower complaints about commercial mortgage-backed securities lending practices is working its way through federal court in Texas, filings in the case show.
The case pits J&R Multifamily Group , a small-time multifamily landlord that operates out of a strip-mall office on the outskirts of Houston, against some of the biggest, best-capitalized institutions in commercial real estate: UBS , Wells Fargo and Rialto Capital , a subsidiary of real estate giant Lennar .
In the lawsuit, playing out in the U.S. District Court for the Southern District of Texas , J&R, led by its principal, Jay Shani , alleges that the lenders’ malfeasance began with a minimum insurance policy they required Shani to purchase on the collateral for a loan he took from UBS in 2012. That loan was secured by a development he bought in 2010 called Worthington on the Beltway , about 15 miles north of downtown Houston. As a precondition for the 2012 refinancing loan, the Swiss bank required Shani to increase the insurance coverage he maintained on the building, to $17.1 million from $5 million. Shani says he agreed to forward UBS cash to engage additional insurance for the building, and posted $80,000 to an escrow account at the time of the loan closing to pay for the expanded coverage.
But in March 2013, when a fire broke out on the premises, J&R filed an insurance claim only to find that UBS had never actually seen to the issuance of the expanded $17 million policy, even though it had accepted money from J&R to do so, J&R’s complaint alleges. Instead, J&R’s per-building coverage limit under its old policy was just $500,000, and, it claims, it had to cover the balance of the $3 million repair work on its own.
On a net operating income basis, the property’s debt service coverage ratio has never fallen below 1.44x, and dropped below 1.8x only one year since its closing, when the original DSCR was 1.76x, as per data from Trepp . Even so—and apparently without J&R understanding why—the loan was transferred to Rialto Capital, its special servicer, in February 2017.
Claiming that J&R had failed to provide financial documents to Wells Fargo and UBS—an allegation that J&R denies—Rialto then attempted to foreclose on the property, according to J&R’s lawsuit. To try to forestall that development, J&R says it found a buyer for the property willing to pay down the outstanding amount of the 2012 loan, which had been securitized as the smallest of 50 loans in the UBSBB 2012-C4 CMBS deal. But when Rialto presented Shani with a bill showing the amount it owed on the outstanding debt, evidence submitted to the court shows that Rialto slapped on nearly $1.5 million in “default interest” fees dating back to January 1, 2013.
Not only is that date before Rialto tried to initiate foreclosure proceedings—it’s even earlier than the fire that initiated any semblance of financial trouble at the property in the first place. J&R protested in court documents that it couldn’t possibly have been considered in default on that date.
Inquiries to J&R, Wells Fargo, UBS and Rialto and the law firms representing them in this case were not immediately returned. The lending and servicing institutions filed a motion asking for the claims to be dismissed outright, but the judge presiding over the case, Vanessa Gilmore , has not yet responded to that request. Instead, she gave the defendant companies until October 2 to organize their defense and any possible counterclaims.
The dispute follows a pattern typical of problematic lending arrangements that dot the landscape of CMBS collateral in the U.S. Often, loans that wind up in litigation carry smaller dollar values of under $25 million, in contrast with the more prominent—and better scrutinized—properties that headline CMBS transactions. And by nature of the parties involved, that litigation tends to force small property-management business to face off against some of the world’s largest banks and their affiliates in court.
A cottage industry of borrower-advocacy firms, like Texas-based 1st Service Solutions and Seattle’s Commercial Real Estate Loan Advisors , has sprung up to represent aggrieved borrowers.
J&R has requested a jury trial in the federal court proceedings.
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