By Reenat Sinay

Law360 (May 26, 2020, 8:45 PM EDT) -- An asset-backed securitizer hit The Bancorp Bank with a suit in New York state court Monday, alleging the bank refused to honor a "market disruption" clause when the coronavirus pandemic and ensuing financial volatility killed their $900 million mortgage loan securitization deal.

In late February, Cascade Funding LP — Series 6, an affiliate of Waterfall Asset Management LLC, agreed to buy and securitize a pool of $900 million in mortgage loan assets from Bancorp which would then be sold to investors by April 15, the suit says.

But when COVID-19 severely impacted the market in late March, Cascade invoked the market disruption clause in their contract to shut down the deal and get its $12.5 million deposit refunded, according to the complaint.

In breach of their contract, Bancorp refused to return the deposit, telling Cascade that "actual bids" from investors were needed to prove that the market was too volatile to go through with the securitization deal — a stance that would force a "sham offering process" the bank knew Cascade couldn't accept in good faith, Cascade alleges.

"Bancorp's insistence that Cascade defraud the market in order to exercise its bargained-for contractual rights was an egregious, objectively unreasonable abuse of its contractual obligations for a singular purpose: to illicitly retain Cascade's multimillion-dollar deposit," Cascade said.

Under the terms of the agreement, a "pricing trigger" was set to determine when the market disruption clause could be exercised and the deal terminated. That trigger was when the most senior tranche in the mortgage loan securitization would be priced at 200 points over the London Interbank Offered Rate, the benchmark interest rate used for a variety of financial instruments, the suit says.

Pricing for the loan assets, repackaged as securitized commercial real estate collateralized loan obligations, was "so extreme" in late March and early April that "no new CRE CLOs were issued" on the market at all, according to Cascade.

In issuing CRE CLOs, the sponsor of the securitization — in this case, Cascade — sets the price range, or spread, at which it is willing to move forward, while the lead manager — JPMorgan Securities LLC, in this instance — determines the price at which investors are willing to buy. The securities will only be taken to market if that price falls within the sponsor's spread, the filing says.

Even though it became clear toward the end of March that price would definitely be outside Cascade's stated range, it made "good faith" efforts to go forward with the securitization by putting together an offering memo for investors, filing a report with the U.S. Securities and Exchange Commission, and seeking feedback from ratings agencies via JPMS, Cascade said.

As the country began to shut down, "forbearance requests from borrowers on the commercial mortgage loans underlying CRE CLO and CMBS transactions spiked, rendering the performance of loans increasingly uncertain and making it impossible to bring a deal to the market," Cascade said.

Cascade informed Bancorp that it was terminating the deal on March 31, providing the required "written evidence" that JPMS priced the securities at 300 points over the LIBOR that day, according to the suit.

"JPMS's expert determination — derived from market standard practices and based on JPMS's unparalleled knowledge and experience — was corroborated by overwhelming contemporaneous market evidence of spreads in the secondary market uniformly exceeding LIBOR+200bp by a substantial margin," Cascade said.

But Bancorp said it would only accept evidence of "actual bids from investors" in order to kill the agreement and refund the deposit — an "impossible" feat, according to Cascade.

"Bancorp's 'actual bids' requirement was also commercially unreasonable and, as a practical matter, impossible to satisfy," the securitizer said. "To obtain 'actual bids' from investors in a securitization that Cascade was neither prepared nor required to close at prevailing market prices, Cascade would have needed to either deceive JPMS about its willingness to close the securitization or JPMS would be required to deceive investors regarding the same."

"No prudent lead manager and no prudent securitization sponsor would ever take a CRE CLO to market after the lead manager determined that the spread at which the securitization would price exceeds the spread at which the sponsor would transact," it added.

Cascade asked the court to force Bancorp to return its $12.5 million deposit at a rate of "at least" 9% prejudgment interest, among other remedies, according to the suit.

JPMS is not a party to the suit.

An attorney for Cascade said Tuesday the securitizer looks forward to proving its claims in court and that Bancorp is liable for damages and other relief.

"In an apparent effort to retain funds given its own precarious financial position, Bancorp has refused to return Cascade's $13 million deposit and intentionally disregarded the bespoke 'Market Out' clause negotiated by sophisticated parties," said Michael A. Hanin of Kasowitz Benson Torres LLP. 

Representatives for Bancorp did not immediately respond Tuesday to requests for comment.

Cascade is represented by Michael A. Hanin, Edward E. Filusch and Jill L. Forster of Kasowitz Benson Torres LLP.

Counsel information for Bancorp was not available Tuesday.

The case is Cascade Funding LP — Series 6 v. The Bancorp Bank, case number unavailable, in the Supreme Court of New York, New York County.

--Editing by Janice Carter Brown.

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