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STATE OF MICHIGAN COURT OF APPEALS

WELLS FARGO BANK, NA, Plaintiff-Appellee, v CHERRYLAND MALL LIMITED PARTNERSHIP and DAVID SCHOSTAK, Defendants-Appellants, and SCHOSTAK BROTHERS & CO., INC., Defendant.

FOR PUBLICATION December 27, 2011 9:00 a.m. No. 304682 Grand Traverse Circuit Court LC No. 2010-028149-CH

Advance Sheets Version

Before: CAVANAGH, P.J., and SAWYER and METER, JJ. PER CURIAM. In this mortgage deficiency action, defendants1 Cherryland Mall Limited Partnership and David Schostak (Schostak) appeal as of right the trial court's judgment awarding plaintiff, Wells Fargo Bank, N.A., $2,142,697.86 on the mortgage deficiency claim and $260,000 in stipulated attorney fees and costs, plus interest. We affirm. I. BASIC FACTS AND PROCEDURAL HISTORY At the heart of this case lies a commercial mortgage-backed securities (CMBS) loan. CMBS loans have a unique structure, as described by the Commercial Mortgage Securities Association and the Mortgage Bankers Association: Prior to the development of the CMBS market, commercial real estate was often financed on a recourse basis by banks, thrifts, specialty finance companies

Defendant Schostak Brothers & Co., Inc. is not involved in this appeal. references to "defendants" are only to Cherryland and Schostak.

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Accordingly,

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and other lenders. Such financing included a first mortgage lien on the real estate and a recourse note or guaranty allowing the lender to seek payment on the mortgage debt from the note obligor (customarily the property owner) or its constituent owner(s) as sureties. The holder of such a mortgage loan might hold the loan in its own portfolio as a whole loan or perhaps sell one or more pieces of it, often through traditional loan syndication or participation structures. With the advent of the CMBS market came the greater availability of non-recourse, asset specific financing for commercial real estate through the use of capital markets, an expansion that attracted new and varied sources of capital to this sector and permitted property owners to acquire and more easily finance real estate without putting their personal balance sheets at risk. In a simple CMBS structure, a lender would make a number of disparate mortgage loans to unrelated entities, then deposit each of the loans into a trust that would issue securities in the public or private markets backed by the cash flow and collateral from the pool of mortgage loans. These securities would be created in a senior/junior structure such that the more senior securities would have payment priority as to both interest and principal during the term as well as at liquidation (and hence a lower coupon rating reflecting the lower risk) over the more junior securities. . . . As many fixed income bond investors--that would otherwise not be active real estate lenders--could now participate in the commercial real estate market through the purchase of CMBS, the flow of capital to the commercial real estate mortgage markets increased significantly and played a major role in leading the country out of the nationwide real estate depression caused by the savings and loan crisis of the late 1980s. . . . One of the bedrock elements of a CMBS financing is the isolation of the asset to be financed. This is the essential bargain between borrower and lender that permits financing on a non-recourse basis: the lender agrees not to pursue recourse liability directly or indirectly against the borrower or its owners, provided that the lender can comfortably rely on the assurance that the financed asset will be "ring-fenced" from all other endeavors, creditors and liens related to the parent of the property owner or affiliates, and from the performance of any asset owned by such parent entity or affiliates. More specifically, it is not just the isolation of the real property asset, but the isolation of the cash flows coming from the operation of the real property, from which debt service is paid on the mortgage loan and subsequently distributed to the holders of the securities issued backed by such mortgages. . . . The twin components of asset isolation are (i) separateness covenants (the "Separateness Covenants") and (ii) narrow limitations on the lender's general agreement not to pursue recourse liability (the "Limited Recourse Provisions"). . . . The Separateness Covenants, while often referred to and discussed as a unitary concept, are really a package of separate and independent covenants made by a borrower to a CMBS lender. The following is a sample set of Separateness Covenants, taken from the form documents for a CMBS lender: -2-

The borrower has not and, for so long as the mortgage loan shall remain outstanding, shall not: * * * (xviii) fail to remain solvent or pay its own liabilities (including, without limitation, salaries of its own employees) only from its own funds . . . . * * * The Limited Recourse Provisions are the other key element of asset isolation in CMBS financing. It is important to note that the nature and purpose of this limited recourse is different from a financing that relies on recourse to the borrower, its parent or sponsor for additional credit enhancement beyond the security offered by the mortgaged property. In a CMBS financing, in the event of certain "bad acts" (the "Recourse Triggers") on the part of the borrower and/or its affiliates, the lender's basic agreement not to pursue recourse liability against a borrower or its owners or principals has limited application, allowing the lender to pursue recourse as part of its remedies. The Recourse Triggers would typically be divided into two categories, with differing recourse consequences. In the first category, the recourse would be limited to the amount of any losses incurred by the lender. In the first category, the recourse would be limited to the amount of any losses incurred by the lender. These Recourse Triggers include [fraud, intentional misrepresentation, misappropriation of rents if the loan were in default, misappropriation of insurance proceeds, actual waste or arson]. To pursue recourse under any of the foregoing Recourse Triggers, a lender would have to establish not only the existence of the Recourse Trigger, but also determine the magnitude of its resulting loss. For the second category of Recourse Triggers, the lender could seek recourse liability against the borrower in the amount of the total outstanding balance of the mortgage loan, plus any accrued and unpaid interest, regardless of whether the lender had actually suffered a loss. These Recourse Triggers are: (i) a material breach by borrower of its affiliates of the Separateness Covenants; (ii) any breach of the due-on-transfer or due-on-encumbrance provisions of the loan documents; or (iii) any voluntary or collusive involuntary bankruptcy or insolvency filing by or on behalf of the borrower. This list of Recourse Triggers, taken from the document template for a CMBS lender, is representative of the limitations found in most CMBS loans. Both with respect to the Recourse Triggers tied to actual losses and those triggering full recourse liability for the entire loan amount, the purpose is the same, namely to provide a credible and enforceable disincentive for the borrower -3-

to engage in any act that would constitute a Recourse Trigger. This is wholly different in concept as compared to a recourse-based financing that relies on a direct payment obligation by the borrower or a payment guaranty from its parent as credit support for the loan. [Amended brief of amici curiae Commercial Mortgage Securities Association and Mortgage Bankers Association, filed in In re Gen Growth Props, Inc, 409 BR 43 (SD NY, 2009), pp 4-14.] In October 2002, Cherryland obtained an $8.7 million CMBS loan from Archon Financial, LP, using the mall it owned located at 1712 S. Garfield Road, Garfield Township, Michigan, as collateral. Schostak was the guarantor on the loan. At closing, Cherryland executed the mortgage, note, and assignment, along with other documents, and Schostak signed the guaranty (collectively, the loan documents). Archon transferred the Cherryland loan and the attendant loan documents to plaintiff. The loan was then made a part of a real estate mortgage investment conduit (REMIC) trust, which is governed by a pooling and servicing agreement dated December 1, 2002. Plaintiff is the trustee of the REMIC trust, which contains the Cherryland loan as part of its $685 million, pool of CMBS loans. In 2009, Cherryland failed to make the August 1, 2009, mortgage payment. Plaintiff ultimately commenced foreclosure by advertisement, and the sheriff's sale was conducted on August 18, 2010. Plaintiff was the successful bidder with a bid of $6 million, leaving a deficiency of roughly $2.1 million. On August 19, 2010, the day after the foreclosure sale, plaintiff filed the instant action against Cherryland to enforce the loan documents. Plaintiff subsequently filed an amended complaint, adding Schostak as a defendant as the guarantor of the loan. Plaintiff asserted that it was entitled to recover damages in the amount of the loan deficiency from both Cherryland and Schostak because Cherryland's insolvency constituted a failure to maintain its single purpose entity (SPE) status. On January 31, 2011, after the close of discovery, plaintiff filed multiple summary disposition motions under MCR 2.116(C)(10) and a motion to disgorge attorney fees. Motion No. 1 sought a judgment against Schostak, as the guarantor, for the entire loan deficiency on the ground that Cherryland's insolvency constituted a failure to maintain its SPE status. Motion No. 2 also sought a judgment against Schostak as the guarantor for the entire loan deficiency, but on the additional ground that Cherryland had entered into unfair transactions with an affiliate, also an alleged failure to maintain its SPE status. Motion No. 42 also sought a judgment against Schostak, again as the guarantor, for $61,958 for a distribution Cherryland made to its owners in 2010. Motion No. 5 requested that defendants' attorneys disgorge $34,371 in attorney fees that they received from Cherryland. After hearing arguments from the parties, the trial court ruled from the bench and found in favor of plaintiff on Motion Nos. 1, 4, and 5, but in favor of defendants on Motion No. 2.

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Motion No. 3 related solely to Schostak Brothers & Co., Inc., and is accordingly not relevant to this appeal.

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After the trial court's ruling, the parties placed several stipulations on the record, one of which related to attorney fees. Subsequently, the parties disagreed about the order for Motion No. 4 (summary disposition for $61,958). Plaintiff demanded that the order for that claim also include a $260,000 attorney-fee award; defendants claimed that the stipulation was for $260,000 for the entire action related to the $2,142,697 mortgage deficiency, not just the $61,958 claim, particularly because the $61,958 claim had only been asserted in the second amended complaint, filed just one month before. After a hearing, the trial court determined that the $260,000 attorney-fee stipulation would also be included in the order for Motion No. 4. The final judgment was then entered. Defendants moved for reconsideration on March 28, 2011, which the trial court denied. Defendants appeal only two of the trial court's rulings: (1) On Motion No. 1, they challenge the finding that Schostak, as guarantor, was liable for the entire loan deficiency on the basis of the trial court's conclusion that insolvency was a violation of Cherryland's SPE status, and (2) on Motion No. 4 they challenge the attorney fee award of $260,000. II. STANDARD OF REVIEW We review de novo the trial court's decision to grant motions for summary disposition brought under MCR 2.116(C)(10). Dressel v Ameribank, 468 Mich 557, 561; 664 NW2d 151 (2003). The facts are considered in the light most favorable to the nonmoving party. Id. We review the record and the documentary evidence, but do not make findings of fact or weigh credibility. Taylor v Lenawee Co Bd of Co Rd Comm'rs, 216 Mich App 435, 437; 549 NW2d 80 (1996). We also review de novo issues involving the proper interpretation of a contract or the legal effect of a contractual clause. McDonald v Farm Bureau Ins Co, 480 Mich 191, 197; 747 NW2d 811 (2008). III. ANALYSIS A. SUIT ON THE MORTGAGE Defendants first contend that the mortgage was extinguished upon its foreclosure, thereby barring plaintiff's lawsuit because it was initiated after the foreclosure sale, at which time the mortgage and, thus its terms and conditions, no longer existed. Generally speaking, defendants are correct that foreclosure extinguishes a mortgage. See Senters v Ottawa Savings Bank, FSB, 443 Mich 45, 56; 503 NW2d 639 (1993) ("[P]laintiff and defendant were parties to a mortgage agreement that was extinguished by the foreclosure sale in August of 1989."); New York Life Ins Co v Erb, 276 Mich 610, 615; 268 NW 754 (1936) ("A mortgage is not extinguished by foreclosure until the sale."). In addition, MCL 565.6 provides that absent agreement to the contrary, mortgages are nonrecourse in Michigan: No mortgage shall be construed as implying a covenant for the payment of the sum thereby intended to be secured; and where there shall be no express covenant for such payment contained in the mortgage, and no bond or other separate instrument to secure such payment, shall have been given, the remedies of the mortgagee shall be confined to the lands mentioned in the mortgage. -5-

See, also, 1 Cameron, Michigan Real Property Law (3d ed),

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