What’s under dispute is whether the servicer is owed penalty interest for the time it managed the property in distressed conditions.

When news broke in October that New York’s Stuy Town was being sold, observers expected the $3 billion loan on the property to be paid off without a glitch.

Recent litigation might change that.

In a note today, Trepp said the resolution might be delayed by four funds that hold bonds backed by slices of the loan. Linked to billionaire investor David Tepper, these bondholders have gone to court to block the loan’s special servicer from collecting “penalty interest” once the sale goes through.

In play is about $566 million.

The loan, which helped finance the purchase of the building complex in 2006, became delinquent following the financial crisis.

Given the loan’s enormous size—it is sliced up into five commercial mortgage-backed securities—the pay off will further compress the delinquency rate in U.S. CMBS, according to Trepp. The rate is now at 5.13%, down 67 basis points from a year ago. 

The sale price should be more than enough to repay the loan. Private equity giant Blackstone and Ivanhoe Cambridge, the real estate unit of a major Canadian pension fund, have agreed to pay $5.3 billion. The deal was announced in October.

On Nov. 12, Appaloosa Investment and three associated equine-named vehicles—Palomino Fund, Thoroughbred Fund, and Thoroughbred Master—filed a motion in New York’s State Supreme Court for an injunction and restraining order against CWCapital.

What’s under dispute is whether the servicer is owed penalty interest for the time it managed the property in distressed conditions. CWCapital took control of the Stuyvesant Town Peter Cooper Village in 2010. In court documents, the servicer said they earned the penalty, given that the property was worth just $2.0 billion when they took it over, less than half of its current value. In addition, the property was at that time “subject to the largest rent control litigation in New York history.” Resolving those disputes and riding out other challenges in the past few years justifies the penalty interest, in CWCapital’s eyes.

The plaintiffs argue that the estimated $566 million should ultimately go to them as gain-on-sale proceeds. In court documents, the investors argue that the servicer’s main compensation—as spelled out in the prospectus for the CMBS trust with largest, $1.5-billion slice of the loan—consists of special servicing fee as well as fees for liquidating and working out the loan. Penalty interest, they contend, isn’t part of it.

Both parties say the pooling and servicing agreements in the CMBS trusts bolster their arguments.

In an Oct. 21 note, Barclays analysts said they expected CWCapital to collect the penalty interest, accruing a 3% a year since the loan first became delinquent.

Wachovia Bank Commercial Mortgage Trust, Commercial Mortgage Pass-Through Certificates, Series 2007-C30 (WBCMT 2007-C30) holds the $1.5 billion chunk of the loan. The rest of the loan is diced up into four other CMBS: COBALT CMBS Commercial Mortgage Trust 2007-C2 ($250 million); Wachovia Bank Commercial Mortgage Trust 2007-C31 ($248 million); ML-CFC Commercial Mortgage Trust 2007-5 ($800 million); and ML-CFC Commercial Mortgage Trust 2007-6 ($202 million).

Analysts have said that the CMBS investors stand to gain handsomely from the sale, which would cover more than the loan’s principal.

Stuyvesant Town-Peter Cooper Village consists of 11,232 rental units, nearly half of which are rent stabilized in some way. The sale earmarks 4,500 units reserved for middle-income tenants and 500 for low-income, according to the New York Times.

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