The federal district court for the Southern District of New York denied a motion to dismiss filed by Morgan Stanley Mortgage Capital, Inc (MSMC)that it failed to adequately disclose environmental conditions at a shopping center and should not be required to buy back the $81MM loan. This case has some yummy nuggets.
In this case, MSMC originated a $81MM loan to City View LLC to finance the acquisition of a shopping center in December 2006. The shopping center had been constructed on a former landfill, was required to monitor methane gas and had been subject to a number of notices of violations. In 2006, Walmart which was the largest tenant of the shopping center and occupied nearly 29% of the net square footage began complaining about methane gas. Just before the loan was closed, Wal-Mart issued a Notice of Default accusing the seller of failing to manage the methane gas and alleging that methane gas levels had reached dangerous levels. The seller of the property and Wal-Mart then entered into a series of letter agreements where seller agreed to address the methane problem. The seller and borrower also entered into a Walmart Indemnity Agreement where the borrower agreed to assume the obligations to cure the methane problem. On the day of the closing, Wal-Mart also sent the defendant an estoppel certificate identifying the methane problem and setting forth the landlord’s obligations to cure the problem. Eventually, Wal-Mart terminated its lease in 2009 and the borrower defaulted on its debt service payments.
The phase 1 had not identified any RECs. However, it had identified methane as an “item of concern”. It has also disclosed that the shopping center had been constructed on a landfill, that it was required to monitor methane and that there had been notices of violations that would require at least $100K to repair.
Meanwhile, MSMC sold the loan in May 2007 to an affiliate entity pursuant to a Mortgage Loan Purchase Agreement (MLPA). The loan was then deposited into a Morgan Stanley CMBS Trust pursuant to a pooling and servicing agreement (PSA) with the plaintiff named as Trustee.
The MLPA contained an environmental warranty that an environmental assessment had been performed and that the MSMC had no knowledge of any material and adverse environmental conditions or circumstances affecting the property that was not disclosed in the report. MSMC also warranted that there were no material defaults.
The plaintiff through the special servicer filed a complaint seeking to require MSMC to re-purchase the loan. The complaint alleged that MSMC knew the loan was in default and failed to disclose it, and also failed to disclose the adverse environmental conditions affecting the property. Interestingly, Phase 1 did not flag methane as a REC but as an “item of environmental condition”. In a motion to dismiss, MSMC asserted that it had disclosed all of the environmental risks associated with the property including that the property had been built on a landfill, required monitoring for methane, was under the supervision of the Ohio EPA and an escrow of $100K had been established tp resolve outstanding environmental violations.
However, the court disagreed, noting that the phase 1 said its purpose was to identify Recognized Environmental Conditions (RECs), the report did not identify any RECs and characterized methane as an “item of concern”. The court said that an “item of environmental concern” was not congruent with a REC, and there was a material dispute if the phase 1 had disclosed the existence of a material environmental threat. Bank of New York Mellon Trust Company et al v. Morgan Stanley Mortgage Capital Inc., 11-0505 (S.D.N.Y. 6/27/11)