[co-author: Christian Adams, Summer Associate]

On March 31, 2023, the U.S. District Court for the Southern District of New York partially dismissed a complaint against a master servicer and a sub-servicer under a Pooling and Service Agreement (“PSA”) in connection with an uncollected $47 million mortgage loan. The complaint, filed in 2020 by the trustee (which was also the lender under the mortgage loan) and the special servicer under the PSA, alleged the defendants breached their servicing obligations under the PSA by failing to (i) ensure the borrower compiled with its obligations to remit all rents to a lockbox account or take appropriate enforcement actions in connection therewith, and (ii) undertake immediate measures to reject the borrower’s refinancing attempts (which was not given the lockbox-related defaults) or reject as-is property appraisals (rather than as-stabilized appraisals in accordance with the credit agreement) delivered by the borrower in connection with its failed attempt to refinance the mortgage loan—which prompted the borrower’s earlier lawsuit in New York state court that caused the trustee and lenders alleged damages in the form of (a) millions of dollars in uncollected, unpaid cash collateral and interest, and (b) legal expenses in connection with the lawsuits.

After finding that the sub-servicer, as a representative of the trustee, had authority to sue because the PSA (i) granted it broad authority to act in ways it “may deem necessary or desirable” to carry out its obligations thereunder and (ii) did not expressly require an event of default under the PSA prior to initiating the action, the court then dismissed all of the claims relating to the appraisals and to the lockbox pre-dating March 2014 as barred under New York’s six-year statute of limitations for breach of contract claims. The claims related to the appraisals included allegations that the defendants allowed unauthorized waivers or loan agreement modifications with respect to borrower’s right to refinance the mortgage loan.

The court, however, denied defendant’s motion to dismiss plaintiffs’ timely-filed lockbox claims—including claims for (i) indemnity for expenses incurred by plaintiffs in connection with the state court lawsuit filed by borrowers, and (ii) wrongful indemnity in favor of defendants in connection with the same because such suit arose from defendants’ breach of their servicing obligations under the PSA.

The court found that plaintiffs plausibly alleged defendants breached their servicing obligations by failing to monitor or take appropriate action with respect to the borrower’s alleged diversion of substantial rents from the lockbox to its own accounts.The parties settled the lawsuit thereafter. The terms of the settlement were not publicly disclosed.

The case is U.S. Bank N.A. v. KeyBank, N.A., No. 1:30-cv-3577 (S.D.N.Y. Mar. 31, 2023). The plaintiff-trustee is represented by Allegaert Berger & Vogel LLP. The defendant master servicer and sub-servicer are represented by Polsinelli PC and Akerman LLP, respectively. The opinion is available here.