COVID-19 and Structured Finance Litigation: CMBS and CLO Disputes on the Horizon

Abstract

This article describes the structure of the trillion-dollar CMBS and CLO markets, and their current distressed states given the ongoing economic effects of the COVID-19 pandemic. It then outlines various disputes that may arise from this distress. For CMBS, these include control and valuation disputes; waterfall disputes; “busted deal” disputes; REIT, “repo” and margin call disputes; fraudulent selling and misrepresentation disputes; and repurchase claims. For CLOs, the potential disputes involve CLO managers, CLO arrangers, CLO investors and trustees, and CLO valuation issues. In each instance the article describes the parties involved, the legal issues that are likely to arise, and—where possible—the applicable law from prior litigation in respect of the same or similar issues. The article concludes that many of these disputes are likely to result in litigation again soon given the ongoing effects of the COVID-19 pandemic and current economic forecasts within the CMBS and CLO markets.

TOPICS: CLOs, CDOs, and other structured credit, CMBS and commercial mortgage loans

Key Findings

• • The world is facing a COVID-driven economic slowdown that many believe will expose flaws in the market for commercial mortgage-backed securities (“CMBS”) comparable to those seen in the residential mortgage-backed securities (“RMBS”) market in 2007/2008.

• • This broad, multi-sector, economic downturn is also likely to severely impact the hundreds of billions of dollars of Collateralized Loan Obligations (“CLOs”) that have been issued in recent years. Wide-ranging, cross-sector defaults are expected for the loans that collateralize CLOs, and extreme loss severity is expected when those defaults occur.

• • Both CMBS and CLO industry participants, and legal counsel involved or looking to become involved in the industries, should scrutinize potential disputes closely and prepare for potential litigation in the near future.