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Bank Trustee Fiduciary Duties in Securities and Mortgage Litigation Cases

Expert Witness: Don Coker
An example and discussion of a report for a recent Bank Trustee fiduciary duty case involving complex mortgage and securities issues.

During the development and evolution of the current methods of financing various real estate and mortgage investments, it quickly became clear that there was a need for an independent entity to perform certain aspects of these sometimes complex financing scenarios. The obvious solution was to involve a bank or trust entity as the independent party that could make decisions and take actions specified in the agreements that were executed by all parties to each transaction.

Bank Trustee cases involve an unusually wide variety of roles a Bank Trustee can undertake including the following list and many others:

Trustee for Corporate Bonds.

● Trustee for Municipal Bonds.

● Trustee for Mortgage-Backed Securities.

● Registrar for Bonds.

● Transfer Agent for Corporate Stocks and other Securities.

● Trustee for any other financial situation where an independent party is needed to make decisions and take actions that comply with written instructions agreed to by all parties.

Whereas the universe of tasks for which a Trustee may be responsible can vary widely, it is important to note that the fiduciary duty responsibilities of a Trustee are the same regardless of the specified tasks.

Typical Bank Trustee Case Types

Opinions typically requested by an attorney handling Bank Trustee cases involve banking industry practices in general, and in specific, to provide a reasoned opinion as to whether the Trustee Bank’s conduct was prudent and appropriate and met the standard of care it owed to the parties involved in the legal action.

Source of Industry Standards

Industry standards for Bank Trustees are based upon the actions that a reasonable bank would take under the same or similar circumstances. There is no Big Book of Bank Trustee Industry Standards. In order to obtain credible information, you have to turn to a recognized professional with industry experience.

Bank Trustee cases usually are complex and involve high-dollar transactions. I find that generally there are significant individual nuances to each of these cases that make them rather unique.

Sample Redacted and Abbreviated Report on a Recent Bank Trustee Case

Here is an example of a heavily redacted and abbreviated report for a Bank Trustee case for which I was engaged in the last couple of years:

In order to refinance the construction and development of a new multi-family housing development, a state development finance agency issued First Mortgage Revenue Refunding Bonds. The state development finance agency issued the Bonds pursuant to the terms of a certain Loan and Trust Agreement, and loaned the proceeds to a corporation for the purpose of refinancing the multi-family housing development. Pursuant to the Agreement, the corporation agreed to repay the loan of the Bond proceeds from the state development finance agency through payments to a specified bank as Trustee under the Agreement.

To secure the corporation’s obligations under the Agreement, the corporation entered into a Leasehold Mortgage and Security Agreement (the “Mortgage”) which granted to the Trustee bank as Trustee a first mortgage on the leasehold estate created by a Ground Lease. To provide additional security for the corporation’s obligations under the Agreement, the corporation also entered into a Collateral Assignment of Residency Agreement (“Collateral Assignment”), which granted the Trustee Bank a lien on the corporation’s gross revenues including receipts, payments and other monies received on behalf of the corporation from any source, including without limitation any entrance fees and monthly service fees, and the corporation’s interests in all Residence Agreements. In addition, substantially all rights of the state development finance agency under the Agreement were assigned to the Trustee Bank, as Trustee, as further security for the repayment of the loan of the Bond proceeds.

The bank’s role as Trustee Bank was to actively look out for the interests of the Bondholders.

The multi-family housing development is located on a site that the Debtor ground leases from an institutional owner pursuant to the terms of the Ground Lease that includes an annual lease payment, which payments are subordinate to the Debtor’s payment obligations with respect to the Bonds (defined below). The Ground Lease had an original lease term of 75 years. By its terms, the property had to be used as a retirement or healthcare community, even in the event of a foreclosure.

The property consists of a mix of independent living units, assisted living units, a nursing care facility (the “Nursing Center”), and common facilities for the residents. The independent living units include mostly apartment units and several semi-detached, cottage-style cluster homes. The assisted living units are designed as apartment units, and some of the assisted living units were specially designed to care for the needs of memory-impaired adults. The Nursing Center is licensed as a Level II long-term care facility and is designed to meet the long-term care needs of residents who transfer to it on a temporary or permanent basis. Common facilities include a “Wellness Center” in which residents can receive routine medical examinations and assistance with minor health problems, rehabilitation services, occupational and physical therapy, and prevention and fitness programs. The Community’s facilities are staffed by over one hundred and fifty non-unionized employees.

At the time of the litigation, there were over one hundred and fifty residents living in the Community. Typically, residents entering the Community at the independent living and assisted living levels execute Residence and Care Agreements that give each resident the right to occupy a living unit in the Community and delineates the services to be provided. Residence and Care Agreements have differing payment structures depending on whether the resident arrives at the independent living level and seeks continuing care or whether the resident arrives at the assisted living level. Some residents enter the Community at the skilled nursing level and sign an Admission Agreement, which contains provisions required by state and federal law. Under the Admission Agreement, the resident pays a daily rate for his or her care.

Within two years after the execution of the Agreement and sale of the Bonds, the corporation was unable to meet its payment obligations under the Agreement. At a certain point in time, the Trustee Bank subordinated its first lienhold position on the collateral and provided that preference to the corporation and the institution in order for the corporation to obtain bridge loan financing from another financial source.

At the same time, the Trustee Bank also entered into a Forbearance Agreement with the corporation which, among other things, permitted the corporation to defer payment on the Bonds until a future date. Notwithstanding the Trustee Bank’s duty to look out for the interests of the Bondholders, the Trustee Bank agreed to the subordination of its first lienhold position and entered into the Forbearance Agreement without demanding or obtaining on behalf of the Bondholders any additional security on their investment, more favorable repayment terms, an increased interest rate on the Bonds, or any other consideration.

Clearly, this action by the Bank Trustee placed the Bondholders in a worse position than they were before the change in the loan terms.

A few days after the execution of the Forbearance Agreement, the borrower corporation filed Chapter 11 which constituted an Event of Default pursuant to the Agreement.

In the event of default by the borrower corporation, the Trustee Bank had broad discretion under the Agreement to protect the interests of the Bondholders without direction or instruction from the Bondholders, including:

(1) declaring an acceleration and exercising the remedies of a mortgagee and secured party;

(2) exercising the rights and remedies of a secured party under the UCC or otherwise with respect to the lien on gross revenues, including collecting the gross revenues;

(3) enforcing the Agreement by legal proceedings for any appropriate legal or equitable remedy;

(4) filing proofs of claim and take such other action, including participating as a member of any committee of creditors to have the claims of the trustee and the holders of bonds allowed; and

(5) pursuing any available remedy to enforce the payment of and interest on the Bonds.

As set forth in the Final Order Regarding Use of Cash Collateral and Adequate Protection (“Final Order”), the Trustee Bank had a first priority interest in the Ground Lease and the assets of the borrower corporation for payment of the loan; and the value of the assets exceeded the debt owed by a significant amount. The fact that the property was worth much more than the debt owed was supported by the fact that the corporation recently had purchased an insurance policy for an amount that far exceeded the debt amount.

It was my opinion that the Trustee Bank failed to undertake any meaningful actions to best protect the financial interests of the Bondholders in light of the bankruptcy petition, despite the Trustee Bank’s broad rights and Trustee responsibilities. In particular, the Trustee Bank failed to foreclose on the mortgaged property or take such actions in the corporation’s bankruptcy proceeding which would have protected and maximized the financial interests of the Bondholders. The Trustee Bank knew or should have known at the time that a sale of the Ground Lease with the buildings thereon, by foreclosure or otherwise, would have netted the Trustee Bank sufficient proceeds for the bondholders to recover approximately their initial investment with interest.

Rather than foreclose or take other actions to preserve and protect the Bondholders’ financial interests, the Trustee Bank instead consented to the terms of a sale of the development as a going concern to a real estate investment company whereby the purchaser agreed to pay the Trustee Bank a minimal amount and, among other things, assume the corporation’s obligations and liabilities to residents and former residents.

The terms of the sale to the real estate investment company were designed and intended to protect the interests of the residents and former residents to the detriment of the best financial interests of the Bondholders.

The Trustee Bank notified the Bondholders of the proposed sale of the multi-family housing project to the real estate investment firm at a price that would have a material adverse effect on the Bonds. The notice failed to disclose any possible alternative courses of action to preserve and protect the interests of the Bondholders, thereby apparently attempting to mislead the Bondholders into believing that there were other no alternatives to this sale more favorable to the interests of the Bondholders when, in my opinion, that was untrue.

It was my opinion to a high degree of professional certainty that the Trustee Bank failed to exercise the degree of care and skill required of a banking institution serving as the institutional trustee of a multi-million dollar bond issuance. The Trustee Bank had an obligation to act in the best financial interests of the Bondholders at all times. The Trustee Bank had many real, reasonable, meaningful and obvious opportunities to protect the Bondholders’ best financial interests, but it stumbled and failed at every turn in gross dereliction of its duties. It was my professional opinion that the Trustee Bank had at least the following obligations:

(1) to ensure that the Ground Lease provided proper security for the Bondholders, and if not, to promptly renegotiate it so that the security was not illusory;

(2) to advise the Bondholders that their security was largely illusory and that their investment was highly unsecure, which would have enabled the Bondholders to sell their bonds and find a more secure investment as was their goal in this investment;

(3) to monitor the property on an on-going basis so as to confirm and ensure that it was on a sound financial footing so that if there was a realistic indication of a risk that the community would default on its debt service, a meaningful restructuring could take place to protect the interests of the Bondholders;

(4) to advise the Bondholders that in the event of a default, the Trustee Bank would not look out for their best financial interests but instead would look out for the interests of the property as a whole, the residents, the majority Bondholders and others;

(5) to utilize its substantial leverage contained in the security documents as a major creditor, including its option to remove the residents in order to make the facility financially more attractive to a prospective purchaser, and in order to negotiate much better protections for the Bondholders;

(6) to argue against the proposed sale to the real estate investment company before the Bankruptcy Court, as was made clear in that Court’s transcripts that the plaintiffs were taking a “hit” in that case;

(7) to inform the management company that it wanted to entertain management offers and offers to finance a purchase price which could have improved the Bondholders’ financial interests;

(8) to enforce its liens because a foreclosure and “entry fee” sale was a better option and would have maximized the sales price;

(9) to advocate for a purchaser who would not undertake the residents’ entrance fee repayment as an integral part of the offer price;

(10) to argue to the Bankruptcy Court that it should be able to sell its rights under the ground lease without the restriction of having to market it as a healthcare or retirement facility, as that restrictive covenant should not be enforced so long as the bonds remain unpaid (or that the bankruptcy could or should invalidate that restrictive covenant);

(11) to fulfill its fiduciary obligations to the plaintiffs as minority Bondholders as the operative documents and the law require, and not to defer to the instructions of the majority Bondholders where those instructions were contrary to the Trustee Bank’s obligations.

The loan and trust agreement requires the property to provide a regular stream of financial records to the Trustee Bank. However, the bank did not review these records or take due notice of the continuing deterioration of the financial situation at the property until it was in dire financial straits. In fact, this is clearly supported by the fact that at the deposition of the Trustee Bank’s 30(b)(6) representative, he indicated that the Trustee Bank, when they received reports and disclosures from the property, instead of reviewing the documents in any meaningful way merely put them in a file.

Even in this dire financial situation, the bank could have shut down the facility and evicted the residents, and then sold the ground lease to another retirement community business without the burden of assuming the repayment obligations to the residents. The buildings and the facility was worth more than $20,000,000 just for the remaining usage under the 75-year ground lease. Indeed, it was insured for over $20,000,000 based on an independent valuation of the property for insurance purposes. This alternative, although perhaps drastic, nonetheless provided the bank substantial negotiating powers with the residents and the landlord which they never seriously considered or exercised. A middle ground could have been negotiated or considered.

Had the Trustee Bank discharged its duties appropriately, they most likely could have recovered upwards of $20,000,000 for the Bondholders.

The Trustee Bank assented to a sale which was squarely not in the best financial interests of the Bondholders. The Trustee Bank should have asserted its first priority interests in order to effectuate a sale by foreclosure or otherwise in order to maximize the Bondholders’ financial return. It does not save Trustee Bank that the sale was approved by the Majority Bondholders because their approval was unnecessary and did not excuse the Trustee Bank from its obligations under the Prudent Man Rule. The Trustee Bank consented to the sale, and the Bankruptcy Court never considered foreclosure or was presented with other alternatives which preserved the Trustee Bank’s liens.

Both the Offering Statement and the Loan and Trust Agreement (“Agreement”) establish that, in the event of the Borrower’s default and bankruptcy, the Trustee Bank had broad powers to protect the Bondholders’ interests without direction from the Bondholders and without regard to the interests of third parties, such as the residents of the property. The Trustee Bank was required to comply with the Prudent Man Rule in all its dealings. Only the Trustee Bank could act on behalf of the Bondholders, who were without authority to act on their own behalf unless the Trustee Bank failed to act; and that never happened.

At no time prior to the public offering of the Bonds did the Trustee Bank disclose that, in the event of default or bankruptcy by corporation, the Trustee Bank (1) would not protect and preserve the best financial interests of all Bondholders, and (2) would protect and preserve the interests of the residents and former residents of the property by, among other things, taking action to maintain the project as a going concern, even if such action might be adverse to the best financial interests of the Bondholders.

At no time prior to the public offering of the Bonds did the Trustee Bank disclose that, in the event of default or bankruptcy by the corporation, the Trustee Bank would protect and preserve the interests of the Bondholders holding in the aggregate a majority of the principal amount of the Bonds outstanding (“Majority Bondholders”), even though such interests might not best preserve and protect the Bondholders’ capital investment and even though such action might be adverse to the financial interests of the remaining Bondholders, namely the plaintiffs.

The Trustee Bank has conceded that it consented to the sale. The Trustee Bank never squarely presented to the Bankruptcy Court foreclosure in a meaningful way, or any other form of enforcement of the Trustee Bank’s liens, as alternatives to better maximize the return to Bondholders. What is in the best interests of the collective group does not equate to meaning that it is in the best interests of any separate group standing alone. There were better alternatives which were never considered by the Bankruptcy Court. Insofar as this bankruptcy case was a zero-sum situation, what benefitted the unsecured creditors was contrary to the interests of the secured creditors.

It was only as a result of the Trustee Bank’s wrongdoing that the Bankruptcy Court was able to enter its Order approving the sale of the property to the Buyer. The Trustee Bank held an enforceable mortgage and other security interests. Nevertheless, the Trustee Bank subordinated its security interests to the detriment of the Bondholders whose financial interests the Trustee Bank was contractually and duty bound to protect. If the Bondholders had the right to object, then the Trustee Bank was grossly negligent in failing to advise the Bondholders of their rights in that regard.

As indicated in the Buyer’s stalking horse bid, the Buyer agreed to assume the debt to the residents, but the Buyer also intended to continue to operate the property with no entrance fee. This decision necessarily results in a low appraised value because yearly cash flow would be reduced by entrance fee refunds paid out each year. Had the property been marketed instead as an “entrance fee” community, then the annual payment of entrance fees would have increased the annual cash flow and significantly increased the property’s present value, resulting in a significantly higher appraised value.

Had the Trustee Bank asserted its liens and insisted that the property be marketed as an “entrance fee” community, then the Trustee Bank would have recovered significantly more than the several million dollar sales price and potentially could have recovered the entire investment amount in continuing payments over time in accordance with the prior arrangement with the corporation.

The bidding terms also discouraged potential purchasers from bidding because potential bidders were essentially required to bid for a “no entrance fee” community, thereby significantly curtailing their ability to generate additional income for the project, as entrance fees are a significant source of income.

Instead, there was a distressed sale which resulted in the Bondholders receiving back only a fraction of their investment.

Although the corporation lost the ability to attract new residents once it went bankrupt, a respectable purchaser of the property would, in my opinion, not suffer the same fate. Demand for CCRC units remains high as baby boomers grow older.

After the corporation defaulted, the Trustee Bank sent several notices to the Bondholders to keep them apprised of efforts to sell the property and recover the Bondholders’ investments. However, nowhere in any of those notices did the Trustee Bank disclose or suggest that there were alternatives to the proposed sale which would have better protected the Bondholders’ financial interests, nor did the Trustee Bank advise the Bondholders to file objections in Bankruptcy Court if they were dissatisfied with the proposed sale. To the contrary, the Trustee Bank directed inquiries solely to the Trustee Bank and agreed with the Bankruptcy Court that notice of proceedings need not be served on the Bondholders since the Trustee Bank was their duly authorized representative.

The Trustee Bank relinquished its first lienhold interests and assented to the sale which gave the Bondholders only about 10% of their initial investment. The Trustee Bank placed the interests of the property residents ahead of the interests of its own Bondholders. The Bankruptcy Court found that the sale was in the best interests of the estate and creditors based entirely on the representations of counsel and without any evidence as to alternatives whereby the Trustee Bank could enforce its liens. Had the Trustee Bank enforced its liens, the Bondholders could have recovered their entire investment. The Bondholders were individual investors who lost in excess of $3,000,000.

The Prudent Man Rule required the Trustee Bank to enforce its liens because enforcement would have maximized the financial return to all Bondholders. Under this rule, contrary instructions from Majority Bondholders should not have been followed and even the interests of the property residents were not the Trustee Bank’s concern. The Prudent Man Rule of the Agreement, sometimes referred to as the Prudent Investor Rule is established by law.

The Majority Bondholders’ consent to the sale does not excuse the Trustee Bank from failing to act in the best financial interests of all Bondholders as required by the Prudent Man Rule. Nothing in the Agreement required the Trustee Bank to obtain the consent of the Majority Bondholders. In fact, it is established banking practice that a trustee may not favor the interests of one group of beneficiaries to the detriment of another group of beneficiaries. The fact that a trustee has the support of a majority of the beneficiaries does not relieve him of a duty to act in a careful and prudent manner to conserve the assets and protect the Bondholders. The majority’s instructions are irrelevant particularly where, as here, the trustee is a corporate trustee in business for that purpose and authorized to act without any consultation or urging from the Bondholders.

The possibility of detriments effects to third parties, such as the residents of the property, were simply not the Trustee Bank’s concern. The Trustee Bank’s concessions that its actions were intended to protect the interests of the residents of the property amounts to an admission that it was placing the interests of these residents, third parties, ahead of the interests of the Bondholders, and contrary to the requirements of the Prudent Man Rule.

Pursuant to the Loan and Trust Agreement, the Trustee Bank had no specific obligation to monitor the financial condition of the borrower and, other than as expressly provided therein, did not have any responsibility with respect to reports, notices or certificates filed with it except to make them available to the Bondholders. The Trustee Bank did, however, have an obligation to read and understand the reports, notices and certificates filed with it pursuant to the Agreement, because it had an obligation to give notice to the issuer and the borrower of any Event of Default by the borrower or upon receipt of actual knowledge of such Event of Default. It is not merely a failure to make payments that can constitute an Event of Default. Rather, an Event of Default occurs where the borrower makes a written admission of its inability to pay its debts generally as they become due. In addition, a failure by the borrower to observe or perform any covenant, condition or agreement on its part to be observed or performed pursuant to the Agreement, the Borrower Documents or the Bonds for a given period after notice of such failure is given to the Borrower by the Trustee also constitute an Event of Default. Without reading and understanding the reports, notices and certificates provided to it by the borrower, the Trustee Bank would be unable to determine if an Event of Default had occurred and/or give notice to the borrower and the issuer of an Event of Default. The Agreement provides for a raft of continuous and detailed disclosure obligations on the part of the borrower, each of which are for the benefit of the Bondholders and to ensure the protection of their financial interests. These disclosures include reports as to occupancy, audited financial statements, a calculation of the borrower’s compliance with the debt service coverage ratio and liquidity covenants, and, “a letter from such accountant to the effect that in the course of such audit nothing came to its attention to lead it to believe that any default had occurred under this Agreement, or specifying the nature of such default”.

In this case, the Trustee Bank failed to exercise due care because it did not read the notices provided by the borrower and instead ignored them. If it had properly discharged its duties by reading the reports provided by the borrower, it would have become actually aware that the financial condition of the borrower was steadily deteriorating with sufficient time so as to restructure the debt or undertake an orderly sale process. Further, as a general matter, the Trustee Bank would have been unable to be responsive to a Bondholder’s request for particular categories of reports, notices or certificates filed with it by the borrower unless the Trustee Bank had read and analyzed such reports, notices or certificates and understood their contents.


As you can see from this convoluted tale, Bank Trustee cases can be quite complicated with many moving parts and many documents involved. Regardless of the level of complexity, the objective in the analysis of a Bank Trustee case is to keep the focus on the basic fiduciary duty owed by the Bank Trustee to the party in whose interest the Bank Trustee is working.

© 2015 by Don Coker. Serving clients worldwide from his Atlanta metro area office.

Expert witness and consulting services. Over 600 cases for plaintiffs & defendants nationwide, 146 testimonies, 12 courthouse settlements, all areas of banking and finance. Listed in the databases of expert witnesses recommended to both DRI and AAJ.

Clients have included numerous individuals, over 100 banks, Forbes 400 members, and governmental clients such as the IRS, FDIC.

Employment experience includes Citicorp, Ford Credit, and entities that are now JPMorgan Chase Bank, BofA, Regions Financial, and a two-year term as a high-level governmental banking regulator.

B.A. degree from the University of Alabama. Completed postgraduate and executive education work at Alabama, the University of Houston, SMU, Spring Hill College, and the Harvard Business School.

Called on by clients in 36 countries for work involving 64 countries.

Widely published, often called on by the media.

Don Coker serves clients worldwide from his Atlanta metro area office.

Copyright Don Coker

Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.

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