Servicer of Mortgages Held by Securitized Trusts Gets the Chapter 11 Vote - Not the Trusts' Certificate Holders

The 2002 decision in In re Shilo Inn, Diamond Bar, LLC, 285 B.R. 726 (Bankr.D.Or.2002)(Perris, J.) addressed the issue of whether the servicer of mortgage loan pools held by securitized mortgage trusts possessed the power to vote the trusts' claims with respect to the debtors' proposed chapter 11 plan of reorganization or whether the claims could only be voted by the trusts' certificate holders. The court concluded that the servicer held the power to vote under the provisions of the parties' pooling and servicing agreements ("PSAs"). The court's decision is quite timely due to the current subprime mortgage crisis facing the United States and the various proposals being expounded to modify the terms of subprime mortgages held by securitized mortgage trusts. Although the court's decision may have turned in part on the terms of the involved PSAs, many PSAs may contain similar provisions and the court's decision illustrates the typical nature of the relationship between the servicer of the trust's pool of mortgages, the trust, and the trust's certificate holders.

In this case, the chapter 11 debtors were the mortgagors on mortgage loans totaling $159,000,000.00 which became part of pools of loans held in three securitized trusts. As is typical, the trusts sold beneficial interests in the trust which held the pools of mortgages, including the mortgages of the debtors, to investors who received certificates evidencing their interests. The certificates were divided into different classes or tranches, each of which held different rights with regards to amounts collected by the trust on the pooled loans.

The debtors asserted that the provisions of the PSAs restricted the servicer from voting on the proposed chapter 11 plan of reorganization and that the certificate holders as the beneficial holders of the trusts' loans must be allowed to vote. It should be noted that the debtors did not dispute the servicers' authority to act on behalf of the trust aside from the power to vote. They argued the certificate holders should be allowed to vote just as is the bondholder in his relationship with an indentured trustees. The debtors also argued that in its favor that as a practical matter, the PSAs require the servicer to oppose the plan on behalf of the trusts as the PSAs limit the servicer's discretion in the servicing of the loans.

The servicer of the mortgage loans argued that pursuant to the PSAs that it was entitled to vote on behalf of the trusts. They pointed to the provisions of the PSAs that limit the rights of certificate holders to control the actions of the servicer on behalf of the trust.

The court noted that section 1129(a) provides that the holder of a claim allowed under section 502 may accept or reject a plan and that claims are deemed allowed unless a party in interest objects. In this case the trusts filed proofs of claims and that since no objections were filed, they were deemed allowed.
The court concluded that the claims belonged to the trusts and not to the individual certificate holders and that therefore the servicer as agent for the trusts may vote the trusts' claims. The court reasoned that the certificate holders merely held certificates evidencing a beneficial interest in the trusts' funds and that the chapter 11 debtors were obligated to the trusts and not to the certificate holders. That is, the certificate holders do not hold a direct interest in the obligations of the debtors, but hold an interest in the assets of the trusts.

The court noted the distinction between corporate bond issuance and securitized financing of assets. The court noted that in corporate bond issuance, a third party is often retained to administer a bond issue and act as the "indenture trustee". The court pointed out that although Bankruptcy Rule 3003(c)(5) authorizes an indenture trustee to file a proof of claim on behalf of all the bond holders, that the indenture trustee is not the holder of the claim and is not entitled to vote.

The court explained that in contrast to the bondholder-indenture trustee relationship, the trust, which is a special purpose entity, issues the securities and has the relationship with the investors and not the company that generated the loan, such as the chapter 11 debtor mortgagor in this case. The court furthermore pointed out that it would be unwieldy for each of the numerous certificate holders to have individual rights against each of the various obligors on the hundreds of loans held by the trusts. The court noted that the PSAs provide for the collective collection efforts on behalf of the certificate holders. In footnote seven, the court pointed out that the different classes of certificate holders hold different economic interests and would vote accordingly and it was unclear how the votes of the certificate holders would be calculated or weighed between the trust classes in determining the vote of the single plan class for each mortgage.

The court further noted that the PSAs in this case do not provide the certificate holder a right to vote on the chapter 11 plan of an obligor on the loans that constitute the asset pools in which the certificate holders hold an interest. The PSAs only provide the certificate holders certain limited voting rights, including relating to the termination of the servicer, the waiver of servicer defaults, the removal of trustees, etc. The representative of the controlling class of certificate holders were allowed to advise the servicer with regard to certain actions and the servicer was not allowed to take certain actions without the approval of the controlling class representative. This included the action to modify a term of a mortgage loan other than the extension of the maturity date for less than one year. It is interesting to note that the court pointed out that the certificate holder may have the right to enforce the pooled mortgage loans on their own if the trustee refused to pursue enforcement. The court stated that this was not the case herein.
The court also ruled that even if the PSAs restrictions precluded the servicers from voting in favor of the proposed chapter 11 plan, that this would not lead to the conclusion that the certificate holders must therefore be allowed to vote on the trusts' claims as the parties by contract have set out the rights and obligations of the servicers.

The court summarized its decision stating that "in a corporate bond issuance, the investor is a creditor of the corporation that issued the bonds or debentures, and has a right to payment from the corporation. In contrast, in an asset securitization, the investors' relationship is with the special purpose vehicle to which the originator of the assets...has transferred those assets, and the investors' right to payment come from the cash generated by the transferred assets, not from the originator of the assets itself.