Concord Real Estate Cdo 2006-1 v. Bank Of Am. N.A

• Decision Date: 14 May 2010
• Docket Number: C.A. No. 5219-VCL.
• Citation: 996 A.2d 324
• Parties: CONCORD REAL ESTATE CDO 2006-1, LTD., and Concord Real Estate CDO 2006-1, LLC, Plaintiffs,v.BANK OF AMERICA N.A., as Trustee under the Indenture Agreement referred to herein, Defendant.
• Court: Court of Chancery of Delaware

996 A.2d 324

CONCORD REAL ESTATE CDO 2006-1, LTD., and Concord Real Estate CDO 2006-1, LLC, Plaintiffs,v.BANK OF AMERICA N.A., as Trustee under the Indenture Agreement referred to herein, Defendant.

C.A. No. 5219-VCL.

Court of Chancery of Delaware.

Submitted: April 21, 2010.

Decided: May 14, 2010.

Gregory P. Williams, Rudolf Koch, Jennifer J. Veet, Kevin M. Gallagher, Richards, Layton & Finger, P.A., Wilmington, DE, for Plaintiffs Concord Real Estate CDO 2006-1, Ltd., and Concord Real Estate CDO 2006-1, LLC.

Andre G. Bouchard, Sean M. Brennecke, Bouchard Margules & Friedlander, P.A., Wilmington, DE; Robert C. Micheletto, Jayant W. Tambe, Marguerite S. Dougherty, Jones Day, New York City, for Defendant Bank of America N.A.

OPINION

LASTER, Vice Chancellor.

The plaintiffs are single-purpose entities that issued notes as part of a collateralized debt obligation known as Concord Real Estate CDO 2006-1 (the “Concord CDO”). The notes were issued subject to the Indenture Agreement for Concord Real Estate CDO 2006-1 dated December 21, 2006 (the “Indenture” or “IA”). The Indenture refers to plaintiff Concord Real Estate CDO 2006-1, Ltd. as the Issuer and plaintiff Concord Real Estate CDO 2006-1, LLC as the Co-Issuer. Defendant Bank of America N.A. has been sued in its capacity as the Trustee under the Indenture (as the successor by merger to LaSalle Bank N.A.). I refer to the parties using these designations. The Trustee also serves as Paying Agent, Calculation Agent, Transfer Agent, Custodial Securities Intermediary, Backup Advancing Agent, and Notes Registrar, all of which are roles defined by the Indenture.

The Issuer and Co-Issuer seek a declaration that they validly delivered for cancellation certain notes that their affiliate surrendered without consideration and with the intent that the obligations represented by the notes be discharged. The Trustee declined to cancel the notes on the ground that the Indenture did not provide for cancellation under those circumstances. Whether or not the notes should have been canceled determines how funds subsequently flow to the holders of various securities governed by the Indenture. If the notes remained outstanding, then the Concord CDO failed to meet one of its coverage tests, and funds must be diverted to redeem senior notes until all of the senior notes are redeemed or the coverage test is met. If the notes should have been canceled, then the Concord CDO passed its coverage tests, and funds will continue to flow to the holders of securities without any redemption of senior notes.

I hold that the notes at issue were discharged when the holder surrendered them voluntarily to the obligors with the intent that the notes be canceled. The Issuer and Co-Issuer properly delivered the discharged notes for cancellation to the Trustee in its capacity as Notes Registrar. Under the plain language of the Indenture, the notes at issue were not “Outstanding” as of January 5, 2010, the date on which they were delivered for cancellation. I therefore grant the plaintiffs' motion for summary judgment.

I. FACTUAL BACKGROUND

The parties have cross-moved for summary judgment. Neither side points to a disputed issue of fact material to either motion. Accordingly, pursuant to Court of Chancery Rule 56(h), the case is deemed submitted for decision on the written record. I find the facts to be as follows.

A. Concord Real Estate CDO 2006-1

In March 2006, Winthrop Realty Trust and Newkirk Realty Trust, Inc. formed Concord Debt Holdings LLC (“Concord Sponsor”) to act as a sponsor of collateralized debt obligations and other structured financial products. In December 2006, Concord Sponsor put together the Concord CDO.

To assemble the Concord CDO, Concord Sponsor formed the Issuer and the Co-Issuer. The Issuer and Co-Issuer then issued notes with a face value of approximately $413,850,000 (the “Notes”), divided into tranches designated from Class A through Class H. Each Note will mature at par in December 2046 unless earlier redeemed or repaid. During the life of the Notes, each earns interest at a fixed spread over a published reference rate. The Issuer and Co-Issuer also issued $51,150,000 of preferred shares (the “Preferred Shares”).

The Notes and Preferred Shares were issued subject to the Indenture, which is a lengthy and complex document. Its definitions alone cover 78 pages. Its substantive provisions span another 174 pages. It incorporates 15 schedules and 12 exhibits.

The Notes were not registered under the Securities Act of 1933. See IA §§ 2.2 & 2.5. Consequently, they were offered only to highly sophisticated investors who could purchase the Notes under exemptions to the United States securities laws. The investors fell into two basic groups: (i) foreign persons who acquired the Notes via offshore transactions in reliance on Regulation S and (ii) “qualified institutional buyers” within the meaning of Rule 144A who were also “qualified purchasers” as defined in Section 2(a)(51) of the Investment Company Act of 1940. The Indenture contains transfer restrictions that prevent the transfer of the Notes to any person who does not meet these qualifications. See IA § 2.5.

The Class G and H Notes and the Preferred Shares were not offered in the private placement. Concord Debt Funding Trust (“Concord Trust”), an affiliate of Concord Sponsor, holds the Preferred Shares and the Class G and H Notes. ¹

Using the funds from the issuance of the Notes, the Issuer and Co-Issuer acquired a mixed portfolio of assets, consisting of mortgage loans, mezzanine loans, real estate bank loans, collateralized mortgage-backed securities, other CDO securities, REIT debt, and other real estate related interests. The Indenture defines the assets as the “Collateral Interests.” Id. § 1.1 (“Definitions”) at 20. Cash flow from the Collateral Interests is used to make payments on the Notes. The Indenture also allows specified amounts of cash flow to be reinvested in the Concord CDO and used to acquire other Collateral Interests. Id. § 12.2.

The different classes of Notes enjoy different priorities in the cash flows generated by the Collateral Interests, and they pay different rates of interest to compensate for their relative risk. So-called “super senior Notes”-the higher tranches-have first priority in payments of interest and principal but pay a lower rate of interest. So called “mezzanine Notes” are subordinate to the senior notes but pay a higher rate of interest. The equity tranche of Preferred Shares has the lowest priority of payment and receives any remaining cash flows. The sequential payout of available cash as it flows down the tiers of securities is commonly referred to as the “waterfall.” Section 11.1 of the Indenture sets forth a detailed waterfall for distribution of proceeds to the various holders of the Issuer and Co-Issuer's securities.

B. The Coverage Tests

The distribution of funds under the waterfall changes depending on the outcome of two coverage tests: the Par Value Test and the Interest Coverage Test. See generally IA § 11.1. The Par Value Test resembles a leverage ratio, and the Interest Coverage Test resembles a debt service coverage ratio. See id. § 1.1 at 11-12, 46-48, 59. For purposes of this dispute, only the Par Value Test is relevant.

Par value testing is performed at the Class A/B/C level, Class D level, Class E level, Class F level, and Class G level. See id. at 59 &amp id. § 11.1. The Par Value Test works the same way at each level, except that each level has its own compliance threshold.

For example, the Class F Par Value Test is defined as “[t]he test that is met as of any Measurement Date on which any Class F Notes remain Outstanding if the Class F Par Value Ratio on such Measurement Date is equal to or greater than 118.0%.” Id. § 1.1 at 17. The Par Value Ratio thresholds for the Class A/B/C, Class D, Class E, and Class G tests are, respectively, 135%, 126%, 122%, and 113%. Id. at 12, 14, 15, 18. The Class F Par Value Ratio is defined as follows:

As of any Measurement Date, the number (expressed as a percentage) calculated by dividing (a) the Net Outstanding Portfolio Balance on such Measurement Date by (b) the sum of the Aggregate Outstanding Amount of the Class A Notes, the Class B Notes, the Class C Notes, the Class D Notes, the Class E Notes and the Class F Notes and the amount of any unreimbursed Interest Advances and any Class F Deferred Interest.

Id. at 16-17. The Par Value Ratio for the Class A/B/C, Class D, Class E, and Class G tests are defined similarly, except that “Aggregate Outstanding Amount” is defined only with reference to the level of the security being tested and those classes senior to it. Id. at 11-12, 14, 15, 18.

The Par Value Ratio is thus a fraction with two inputs: the Net Outstanding Portfolio Balance,² which serves as the numerator, and the Aggregate Outstanding Amount,³ which serves as the denominator. The numerator is basically the value of the assets securing the Notes, and the denominator is the aggregate principal balance on the Notes through the class being tested. The resulting percentage quantifies the leverage of the Concord CDO through the tested class. If the percentage is equal to or greater than the compliance threshold, then the CDO passes the test. If not, the CDO fails the test.

If a Par Value Test is not met as of a given Measurement Date, then funds that otherwise would be used to pay interest on the class of Notes at the level where the test failed and on any junior securities are instead used to redeem the most senior class of Notes then outstanding. See id. §§ 9.6 & 11.1. Redemptions continue until either the relevant Par Value Test is met or until the senior Notes are fully redeemed. Redeeming the senior Notes should result eventually in the Par Value Test being met, because redeeming Notes decreases the denominator in the test. Assuming that the numerator remains constant, decreasing the denominator increases the resulting percentage....