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Episode 1: Impending Wave of Distressed Assets & Common Types of Related Disputes

Opportunities in the New Reality: Asset Distress & Revitalization Series

Lawcast Podcast
February 16, 2021

   


Litigation Practice Group Leader, Phil Stein, discusses the impending wave in distressed assets, types of disputes that commonly arise when an asset goes into distress, and lessons from the last recession.

Transcript:

WAHAB: Hello everybody. I’m Omar Wahab and I’d like to welcome you to Bilzin Sumberg's Interview Series, Opportunities in the New Reality: Asset Distress & Revitalization, where we explore timely and salient issues as they relate to the distressed assets from both a business and legal perspective. Today, I have the pleasure of speaking with Phil Stein, the head of Bilzin Sumberg’s Litigation Group, about litigation and dispute resolution during the Coronavirus pandemic related to distressed assets.

The COVID-induced recession has led to a dramatic rise in distressed assets across the economy that has only served to underline the multi-faceted nature of dispute resolution. In joining us today, Phil will discuss the nuances of dispute resolution generally and then talk about recent developments affecting his practice. His extensive experience counseling a diverse array of parties from across different economic sectors makes him uniquely placed to give us important insight on this topic. Phil, thank you for joining us.

I will start with this question: Distressed assets often give rise to litigation. But what issues typically get litigated and are there other mechanisms for resolving disputes when an asset goes into distress?

STEIN: Yes, there are a number of issues that get litigated typically when there are distressed assets. Those can include, among other things, pretty high stakes partnership disputes. Often a joint venture partner will sue another joint venture partner because there is some real dispute as to who should bear the loss, or whether there was some form of misstatement made, or poor stewardship of the asset. You also have a whole lot of mortgage-related disputes. It could be mortgage foreclosure, for example. It can also be a different kind of litigation, which is litigation seeking contractual indemnification or litigation seeking a buy-back (or "put-back") of the mortgage when that mortgage has gone into default. That happen both with respect to residential mortgages and commercial mortgages.

We do, of course, anticipate there will be a rising number of defaults. There already is, both on the residential side and the commercial side as a result of the economic fallout from COVID-19. There are also likely to be some complications for the CMBS industry (commercial mortgage-backed securitization) that could give rise to litigation.

Now the second part of your question was whether there are mechanisms besides litigation for resolving disputes when an asset goes into distress. The answer is certainly yes. First, let's take the example of commercial foreclosures. There have been attempts to enter into workouts to try to modify the parties' obligations and stave off litigation by reaching an agreement as to how something should get worked out. Those are not always successful, of course, in resolving distressed asset issues, and that could give rise to other alternatives to litigation. Arbitration is something that is an option for the parties, either if they had agreed in their initial contract that they will resolve disputes through arbitration, or if they decide unanimously - if they are in agreement, in other words -- that this dispute should be arbitrated even though that wasn't something they previously planned for; they can shift course and arbitrate at that point. And I think the final alternative to litigation, in terms of how to resolve disputes related to distressed assets, is mediation. Often we all think of mediation as something that happens after the parties have been litigating in court for a while, or in arbitration, and they've come to a point where they want to try and get things resolved, and so they bring a mediator in and try to resolve their dispute. Increasingly, we're seeing parties try to get things resolved with the help of a mediator if they aren't able to work things out themselves, prior to any lawsuit being filed. So, that too is an option available to parties in the event of litigation being threatened after an asset has gone bad.

WAHAB: Very interesting. That is a great overview. You alluded a little bit to what is going on now. Most people would expect the volume of distressed assets to continue to rise dramatically with COVID-19. Is that what you are seeing going on so far, in terms of litigation and dispute? Are you seeing certain types of dispute resolutions being utilized more? Are you seeing any trends that are directly affected by COVID-19?

STEIN: Yes, a couple of things come to mind. First of all, I mentioned loan workouts to the extent that commercial foreclosures are being contemplated. We do see an interesting willingness - a frequent willingness - on the parts of the competing interests to try to resolve things through a loan workout. And if things can be worked out in that fashion through some sort of modification of the loan obligations, that is great. When it doesn’t happen, and of course often it doesn’t get resolved, then we go into the other avenues of dispute resolution that I talked about earlier, whether it’s litigation or arbitration or pre-litigation mediation. In terms of where things are headed, we see a lot of partnership disputes - people battling over who should bear the loss for a disputed venture deal or other partnership gone awry because of distressed assets. And we’re seeing a lot of activity around threatened claims related to commercial mortgages and residential mortgages.

WAHAB: Ok, interesting. Related to that question, we had distressed assets during the 2007/2008 global financial crisis and we have that today, in today's recession. What are the similarities and differences that you see between today’s market and that of the previous recession?

STEIN: It is interesting. We continue to litigate to this today - believe it or not - claims related to distressed assets from the 2007/ 2008 financial crisis that you mentioned. There are, though, big differences between that recession, and the litigation that flowed from it, and what we’re experiencing right now with COVID’s effects on the economy. In particular, in the previous recession, the assets that were in question were almost always under water. This time, it seems most of the assets that are the subject of litigation have a good deal more equity in them. I think also we’ve got a larger economic picture in which, in 2007/2008 we saw banks' continued existence very much in question. Really major banks, big names, many of which went under or there was concern that they would go under. Thankfully, knock on wood, we don’t seem to have those issues, at least so far, with what’s going on in the COVID economy. So, I think things are a little more stable in those senses. The fact that assets, this time around, do tend to have more equity in them, seems to incentivize the owners to fight harder for the asset and that can give rise to bigger and perhaps longer running battles, but at least there is something valuable and worth fighting for. And, also with regard to what’s going on with COVID and its effect on the economy, issues are being presented regarding discounted valuations. What is the true value of an asset when taking the pandemic into consideration? So, again, I think there are a number of differences, but I think just as in the 2007/2008 financial crisis, we are likely to see an uptick in litigation as a consequence of what we’ve been going through.

WAHAB: CMBS-related securities are quite popular for a variety of reasons. But, obviously, commercial property has been hit pretty hard by the pandemic. Are there particular issues that investors should be are recently aware of related to CMBS-related distressed assets or other securities?

STEIN: While things are still developing on that front, I would call people’s attention to a blog post that we put together on our Financial Services Watch blog. A partner of mine co-authored it with me and it is dated November 3, 2020. It is about what can be learned from the experience that parties and their attorneys went through in years and years of RMBS (residential mortgage-backed securitization) litigation, what lessons can be learned as we head into what might be a real uptick in commercial mortgage-backed securities litigation. So I would call people’s attention to that. But, most specifically, I think the issues that investors - and really any party - who might be involved in CMBS-related distressed asset litigation need to be aware of are the following.

I think, first of all, everybody is going to want to focus, and need to focus, on the statute of limitations. Would a claim that’s being brought now be timely? In the RMBS world, you have judges going both ways on that issue; sometimes depending on how a claim is characterized, or just the views of that judge.

Another big issue that will no doubt come into play, to the extent that CMBS litigation is contemplated, is just basically whether misrepresentations were made. That's kind of the fundamental issue. When a securities offering, in other words, was being put out for consideration by the investing public, were there real misrepresentations made about the quality of the asset, the loans that were going to populate the CMBS trust that parties were being solicited to invest in? If there were misrepresentations, the next issue becomes whether those misrepresentations were material. And then you move from that into damages-related questions that people would want to focus on. Those, of course, include the extent of the financial loss and, very importantly, whether the alleged misrepresentation really caused the alleged loss. Sometimes it’s easy to demonstrate that. In other cases, it’s much more difficult to establish if there’s a clear link - a clear causal connection - between the alleged misrepresentation that’s being complained of and the loss that an investor claims to have suffered. So, those are the big issues that we see, and it’s going to be really interesting to see just how much CMBS-related litigation activity there is. There certainly has been a whole lot of RMBS-related litigation activity for years and years - and we’ve been very heavily involved in that. As I said, almost since 2008, and continuing until today.

WAHAB: It’ll be very interesting to see how the courts interpret all these aspects. There’s so many moving parts and so many things to take into account.

Phil, thank you very much for this excellent interview. You’ve taught us a great deal about an area of commercial law that's so important to today's economy, but that appears so opaque to so many outside the legal profession. We look forward to speaking with you soon and thank you, again. This has been great.

STEIN: Thank you.

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Philip R. Stein

Philip R. Stein

Partner, Litigation Practice Group Leader
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