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The Lipstick Building: A Case Study in Commercial Real Estate Restructuring

Presented by

Janice Mac Avoy

11/9/16

The Lipstick Building

Building Facts: . 34 story commercial office building opened in 1986 and known for its distinctive elliptical shape . Located in Mid-town Manhattan . Major tenants:

. Latham & Watkins (which occupies 63.5% of the space)

. The building formerly housed the office of Bernard L. Madoff Investment Securities . Metropolitan 885 Third Avenue Leasehold LLC (“Metropolitan” or “Borrower”) bought the building, the land under it and a sliver ground lease* in 2007 for $607 million from Tishman Speyer Properties LP.

. Metropolitan financed the acquisition in a highly creative way:

. Metropolitan immediately sold a 79% interest in the ground below the building to SL Green Realty Corp. and Gramercy Capital Corp. for $317 million, in order to partially finance the acquisition.

* When the building was built, the original owner acquired nearly all of the land upon which the building was built, but a sliver of land could not be acquired, and so is leased pursuant to a long term ground lease.

2 The Lipstick Building Cont’d

. Metropolitan leased the land back from SL Green for 70 years pursuant to a ground lease, and has the right to repurchase it.

. Metropolitan borrowed $210 million from the Royal Bank of Canada; the loan was secured by the leasehold interest.

. SL Green recently announced the sale of the fee position for $453 million.

3 History of the Loan and the Economic Downturn

 Metropolitan holds a leasehold interest in the Lipstick Building pursuant to the ground lease.

 In 2007, Metropolitan received a loan for $210,000,000.00 from the Royal Bank of Canada (“RBC” or “Lender”) which was secured by a mortgage on the leasehold interest in the Lipstick Building. . The Loan was evidenced by two notes – an A Note and a B Note, with the intention that the A Note would be securitized. However, the Securitization market collapsed before it could be effectuated. . The loan was non-recourse to the Borrower – the Lender could only look to the Property not other assets of the Borrower – except for certain “Bad Boy” acts that made the loan recourse to the Borrower & Guarantors.

 Beginning in 2009 the commercial real estate market took a violent downturn--commercial property values fell on average more than 40%, vacancy rates increased to 18%, and rents declined over 30% for office and retail space. A 2010 Congressional Oversight Panel concluded that nearly half of the outstanding commercial real estate loans were “underwater.”

 The downturn caused an immediate impact on the Lipstick Building, making it difficult for Metropolitan to service its debt on the property. . Vacancy rates increased. . Renewal lease rates were lower than expected which negatively influenced cash flow.

 In the spring of 2010, Metropolitan approached RBC about a work out

4 Pre-Negotiation Agreements

 Need for Pre-Negotiation Agreements (PNA) . Once Metropolitan approached RBC about a workout, the parties entered into a Pre-Negotiation Agreement in order to protect their rights during business-level negotiations to protect against prejudice in the event a final agreement can’t be reached. See Tab 1. . A PNA:

. Sets the ground rules.

. Reduces risks of claims of promissory estoppel or waiver

. Acknowledges that negotiations are not binding until reduced to writing. . Properly worded PNAs will be enforced by courts and protect lender against claims of waiver or estoppel in a subsequent foreclosure.

 Key Provisions of a PNA . Confidentiality/inadmissibility of settlement discussions. . The “Yogi Berra” Clause: “It ain’t over till its over.” No binding agreement until signed writing by all parties. . No waivers. . Borrower should pursue alternative opportunities. . All correspondence with Borrower will contain an explicit reservation of lender’s rights.

5 Default of the Loan

 Despite attempts to re-negotiate the loan, Metropolitan defaulted in the spring of 2010. . In this case, the default was not a traditional maturity or “failure to pay” default, rather, the Borrower failed to comply with a requirement of the loan agreement—to maintain a minimum balance of $2.3 million in a debt service fund from which payments on the loan would be made—and failure to comply with that requirement constituted an Event of Default under the loan agreement, and would ultimately lead to a payment default.

 After the Event of Default occurred, but before any legal proceedings began, Borrower was notified of its default. Two notices were sent, each time notifying Borrower of its shortfall and providing an opportunity for the default to be cured.

 The Default was not cured.

6 The Foreclosure Action

 In June 2010, RBC brought a foreclosure action against Metropolitan. See Royal Bank of Canada v. Metropolitan 885 Third Ave. Leasehold, LLC, et. al., No. 650675 (N.Y. Sup. Ct., June 21, 2010). Tab 2.

 The complaint alleged that the Borrower failed to maintain a balance of $2.3 million in the debt service fund and requested relief including: . A sale of the mortgaged property; . Appointment of a Receiver; . Payment for all amounts due under the loan agreement, including expenses of the sale and payments made to protect Borrower’s lien in the mortgaged property, such as taxes, water and sewer charges, insurance, and maintenance costs.

 In addition, the complaint accelerated the entire indebtedness of the loan (which can also be done in the notice of default).

7 Foreclosure Actions in New York

 All foreclosures are “judicial”. . A non-judicial foreclosure, which is available is other states, is much faster, but Borrower may nonetheless assert defenses and convert to judicial foreclosure.

 One Action Rule . New York law provides that a lender may only proceed on the mortgage or the note—not both. (Unless judgment on note has been returned unsatisfied). . One Action Rule precludes suit against guarantors once the foreclosure has commenced until a deficiency is established.

. The foreclosure complaint should demand deficiency judgment to ensure ability to proceed against guarantors post-foreclosure.

8 Foreclosure Actions in New York

 Steps in a Judicial Foreclosure . Document default and acceleration of indebtedness. . Obtain title report and confirm proper parties. . Commence foreclosure with a summons and complaint. . Lispendens/Notice of Pendency: puts any unknown or future lienholders on notice that the mortgaged collateral is being foreclosed upon.

. Application for Appointment of Receiver (loan documents must provide for Assignment of Rents). . Motion for summary judgment — before discovery

. Lender’s interests and Borrower’s default must be clearly documented and there can be no extrinsic evidence of waiver, estoppel, etc. . Referee computes value of the property and all other amounts due (following summary judgment or trial.) . Final judgment of foreclosure and sale. . Typical time frame: 1 year if Borrower does not contest; 2 years or longer if Borrower asserts defenses that require discovery.

9 Foreclosures in New York

 Typical Borrower Defenses: . Waiver; . Loan Modification; . Equitable Estoppel; . Lender Liability Claims

. Tortious Interference

. Attempts by lender to exercise control over the property.

. Attempts to sell borrower’s interest without borrower’s participation.

. Involvement in management or leasing.

. Borrower may claim lender interfered with borrower’s property rights and caused borrower’s losses.

10 Lipstick Workout Negotiations

 After the foreclosure complaint was filed, Metropolitan once again became interested in negotiating with RBC.

 Typical work out structures may include: . Short Term Restructuring

. Forbearance is often an intermediate step while parties assess the situation and decide on a long term strategy. . Loan Extension

. Borrower negotiates for sale or refinancing of property while facing an impending maturity default.

. Lender may require a partial pay down or other cash infusion, additional guaranties such as “bad boy” guaranty for recourse liability, escrowed deed-in-lieu, stipulated order of foreclosure, personal guaranties if sale/refinancing deadlines are not met. . Loan Modifications

. Defer principal and/or interest: attractive when there are short term stresses on the property.

. Dual rates: lower current pay rate so that property cash flow is sufficient to meet debt services balance at higher rate and Borrower will need to demonstrate that property’s performance will improve in time.

. Contingent interest: accrue default interest with forgiveness of accrued interest if milestone events or principal paydowns are met

. Forgiveness of principal and/or interest.

11 Lipstick Workout Negotiations

 The parties entered into a term sheet, with later amendments, to guide the negotiations. See Tab 3. In this case, the term sheet provided: . Conditions precedent for re-negotiating the loan . Key Proposed Restructure Terms:

. Decrease the principal amount to a level the property could support;

. Modifications of the interest rate;

. Modifications of cash management provisions;

. Limitations on the incurrence of additional debt;

. Modifications to recourse liability;

. Requirement that Borrower file a pre-packaged bankruptcy by specified date;

. Requirement that if a restructuring was not completed, Borrower would consent to entry of foreclosure judgment or hand over the deed to Lender at Lender’s option (deed in lieu).

12 Forbearance Agreements

 A forbearance agreement, like the term sheet used in our case, is an agreement by parties to a loan whereby the Lender will agree to refrain exercising its rights and remedies, despite an existing or potential default, and the Borrower agrees to undertake certain actions to cure the default or restructure the loan. See Tab 4.

 A key feature of a forbearance agreement is that, by entering into the agreement, a lender does NOT waive any defaults during the forbearance period. Instead, all rights and remedies are reserved.

 Forbearance agreements typically: . Are for a limited period of time; . Specify that the agreement shall not modify terms of the loan documents; . Ratify and affirm the loan documents and their agreements, obligations, and promises; . May provide for penalties if restructuring hurdles are not met (e.g. “deed in the box” and consent to foreclosure).

 For the Lipstick workout, the Term Sheets served the same purpose as a forbearance agreement.

13 Negotiations Lead to Pre-Packaged Bankruptcy

 Prepackaged Bankruptcy in General . Pre-packaged bankruptcies are essentially a workout/bankruptcy hybrid that provides procedural and economic benefits over an out-of-court restructuring, and provides a quick confirmation process.

. The plan of reorganization is pre-approved by major creditors and interest holders prior to the debtor filing for bankruptcy under chapter 11 of the Bankruptcy Code.

 Advantages . Minimal time and money spent in bankruptcy. . Ability to bind creditors with a vote by 50% in number and two-thirds in amount of each class of creditors and/or interest holders, which reduces ‘holdout’ problems. . Better public relations for the company and a minimization of business disruptions. . Avoids loss of control to parties seeking to challenge the prepackaged plan. . Transfers made pursuant to a confirmed chapter 11 plan are exempt from state and local transfer taxes or other similar taxes.

 Risks . Time and cost of prepetition solicitation may have been futile if the bankruptcy court does not approve the prepetition vote on the plan.

14 Pre-Packaged Bankruptcy Process

 Process . Solicit and obtain votes of the pre-arranged plan; . File the chapter 11 petition, the pre-arranged plan and the voting results together; . A hearing to approve the adequacy of the company’s disclosure statement with respect to the pre-arranged plan (occurs promptly thereafter); . Confirmation hearing;

. The court will confirm the plan upon finding:

. (i) the solicitation of votes on the plan was proper; and

. (ii) the requisite majorities of impaired classes of creditors and/or interest holders voted in favor of the plan; . Exit chapter 11. . Process can take anywhere from 45 days to 6 months, if all goes well.

15 Lipstick Building Pre-Packaged Bankruptcy

 Key Elements . The entry into three plan support or commitment agreements in connection with the filing, confirmation and effective date of the prepackaged plan;

. From: RBC, the only secured creditor;

. Goldman Sachs, preferred equity;

. New equity – infusing at Least $15mm in cash into the Property; . The payment of at least $2,650,000 to the holders of existing membership interests in Metropolitan in exchange for the cancellation of their membership interests; . The issuance of 100% of newly authorized membership interests of Metropolitan to New Lipstick LLC (the new equity – an LLC created for the purpose of acquiring the membership interests); . The payment of the balance of RBC’s reduced secured claim in accordance with the terms and conditions of the Term Sheet between RBC and Metropolitan; . An equity commitment of at least $15,000,000 from the owners of New Lipstick LLC; . The impairment of two classes of claims and interests – one consisting of RBC’s $210,000,000 secured claim, and the second consisting of the holders of the existing membership interests in Metropolitan. Both classes were required to vote in acceptance of the prepackaged plan;

16 Lipstick Building Pre-Packaged Bankruptcy (cont.)

. A cap of no more than $1 million to pay general unsecured creditors of Metropolitan; . The exemption of all transfers under the prepackaged plan from any stamp tax or other similar tax.

 The bankruptcy judge stated at one of the first hearings in this case, that unlike some cases, Metropolitan’s appeared to be a “true” pre-pack and the judge was hopeful that a confirmation hearing could occur before the end of the year.

 Lipstick pre-pack scheduled to be confirmed December 22 – less than 45 days from filing.

17 Lipstick Structure Before Pre-Packaged Bankruptcy

18 Lipstick Structure After Pre-Packaged Bankruptcy

19 Loan Modifications Pursuant to Pre-Packaged Bankruptcy

 A key provision of the Bankruptcy Plan is the Exit Facility to be provided by RBC the modified Loan documents upon emergence from bankruptcy.

 Key Provisions of the Modified Loan to Metropolitan: . Reduction of principle from $210 million to $130 million; . Allows cash flow to fully service debt; . $15 million pay down of reduced principal (final debt will be $115 million); . Modified interest rate; . All cash flow remaining after debt service to be applied

. 40% to amortize loan

. 60% to fund Tenant Improvement Reserve;

20 Loan Modifications Pursuant to Pre-Packaged Bankruptcy

 In exchange for modification of principal, Lender obtained key concessions: . Changes lender enforcement mechanisms to make it easier for lender to foreclose if Borrower defaulted again. See Tab 6;

. Adds a pledge of equity of Borrower—allows lender to do a non-judicial UCC foreclosure—much faster than a judicial foreclosure (30-90 days vs. 1-2 years);

. Lender ends up owning shares of the Borrower rather than the property;

. Cannot foreclose out mechanic’s liens or other junior debt at property level, but much faster;

. Adds covenants of cooperation and non-interference—if Borrower defaults again, imposes penalties on guarantors for interfering with Lender (e.g., filing objections to foreclosure, except Borrower retains right to contest existence of a default in good faith);

. Provides that Borrower must cooperate with Lender’s foreclosure action following a default;

. Borrower covenants not to sue Lender, unless there was a good faith dispute regarding the occurrence of an Event of Default.

21  Janice Mac Avoy is a member of the Real Estate Department and the Litigation Department, head of the Real Estate Litigation Practice Group and co-chair of the Firm's Pro Bono Committee. Ms. Mac Avoy concentrates her practice in complex real estate-related transactions and disputes, commercial litigation and arbitration, complex commercial landlord tenant disputes and commercial fair market rent arbitrations. She also has extensive experience in creditor’s rights, including complex commercial real estate mortgage foreclosures and UCC foreclosures, workouts and restructuring of real estate secured debt. Ms. Mac Avoy works with the Firm’s Real Estate Department on transactions in order to resolve issues without resorting to litigation.

 Among Ms. Mac Avoy’s recent noteworthy representations are:

 Princeton Holdings LLC in the successful arbitration of a dispute regarding the acquisition of a 50% tenant-in-common interest in 14 Manhattan properties, valued in excess of US$450 million at the time of the agreement and currently worth significantly more.

 RBC in its foreclosure action and subsequent restructuring of debt on the iconic Lipstick Building in New York City.

 Lehman Brothers in connection with several foreclosure actions, including a significant development site adjacent to Hudson Yards in New York City.

 Boston Properties in a potential rent reset arbitration that was successfully negotiated with the tenant without the need to resort to arbitration.

 Ms. Mac Avoy’s clients include commercial landlords and tenants, lenders and investors, broker-dealers and multinational corporations as well as individuals involved in commercial disputes. A significant amount of Ms. Mac Avoy’s practice includes advising clients on complex securitized debt in which the underlying assets are real estate, including the enforcement of lender’s rights, acquisition and divestitures of real estate secured debt and the restructuring of real estate secured debt. She also advises clients in complex partnership and joint venture disputes.

 Ms. Mac Avoy has created seminars and CLE presentations on, among other things, the basics of real estate restructuring and workouts, mezzanine loan foreclosures under the UCC and the parameters of the attorney-client privilege in the corporate context. Ms. Mac Avoy has also published articles on lender liability claims, developments in the law of attorney-client privilege, electronic discovery and the appropriate use of email.

 Ms. Mac Avoy received the "Commitment to Justice Award" for her extensive work on and long-term commitment to family law cases referred to her by Her Justice.

 Ms. Mac Avoy is a member of the American Law Institute and the Association of Real Estate Women, a member of the board of directors of the Mexican American Legal Defense and Educational Fund and Sanctuary for Families, as well as a member and voting representative of the CRE Finance Council.

 Ms. Mac Avoy is a member of Fried Frank's Diversity Committee as well as the Women’s Forum Planning Committee, a representative group directing Fried Frank’s Firmwide women’s affinity group.

 Ms. Mac Avoy received her JD from Columbia Law School in 1988, where she was a Harlan Fiske Stone Scholar and associate editor of the Law Review. She received her BA, summa cum laude, from Washington University in 1985, where she was a member of the Phi Beta Kappa society and has since been recognized as a distinguished alumna. Ms. Mac Avoy is admitted to practice in New York; the United States District Courts for the Southern and Eastern Districts of New York; the United States District Court for the Eastern District of Michigan; and the United States Courts of Appeal for the Second, Third and Ninth Circuits.

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