CBRE Loan Servicing Ltd v Gemini (Eclipse 2006-3) Plc

Under a securitisation agreement, receipts should be classified as principal or interest by reference to their source and commercial function in the underlying loan and security structure. Rental income is revenue and therefore interest. Proceeds from selling secured property represent realised capital value and are principal. A surrender premium is likewise principal where it represents the capitalised value of the remaining lease term. The common-law rules governing appropriation of a debtor’s payment between interest and principal do not determine the prior characterisation of receipts in the hands of a servicer. The contractual documents must be construed as a whole, using commercial common sense, while giving effect to clear language.

The claimant was the master and special servicer of a securitised commercial property loan. Following default and acceleration of the loan, it received rental income, property sale proceeds and premiums paid on the surrender of leases. The notes issued by the defendant issuer had not been accelerated, and the classification of receipts affected whether they entered the revenue or principal payment waterfall.

The Cash Management Agreement required the master servicer to identify funds as principal, interest or other amounts, but did not define principal or interest. The court had to determine how the three categories of receipt were to be classified in the context of the loan, its security and the wider securitisation arrangements.

1. The court construed the Cash Management Agreement in the context of the loan and securitisation documents as a whole. The exercise was a unitary one, requiring consideration of the language, relevant background and commercial consequences. In complex interlocking documents, individual provisions should not be interpreted in isolation.

2. The enquiry under clause 13.1(j) concerned the character of receipts in the hands of the master servicer. It was distinct from the later question of how a creditor should appropriate a payment between outstanding interest and principal. The common-law appropriation rule therefore did not answer the issue.

3. The undefined terms principal and interest were intended to be applied using commercial common sense rather than close legal analysis of the type relevant to tax characterisation. The receipts were to be classified according to their source and the role they played in the loan and its security.

4. Rent from the properties was interest, revenue or income for these purposes. Proceeds of sale were principal because they represented the realised capital value of secured property. A surrender premium was principal where, as assumed, it represented the capitalised value of the landlord’s interest in the remaining lease term.

5. This construction was consistent with the treatment of property disposals as repayment of loan principal before default and with the subordination of the junior notes. Treating capital receipts as revenue would produce a lack of symmetry and would improperly divert them to payment of note interest.

6. The court therefore answered the claim form question by declaring that rent was to be classified as interest, while property sale proceeds and surrender premiums were to be classified as principal.