Judge: Mark H. Epstein, Case: 22SMCV01852, Date: 2023-02-10 Tentative Ruling

Case Number: 22SMCV01852    Hearing Date: February 10, 2023    Dept: R

The matter is here on two motions: a demurrer and a request for a preliminary injunction.  There is a lot to go through, and the court is likely to take the motions under advisement for a short time (assuming that the status quo can be maintained).  However, to help structure today’s argument, the court sets out some of its thoughts.

A bit of background first.  (The fact pattern is somewhat complicated.  Accordingly, it is possible that the court has some of these facts wrong.  Although the court believes it understands the gist, if there is an error, counsel should feel free to point it out.)  This case involves the redevelopment of the Century Plaza Hotel in Century City.  Originally one of the premier landmark hotels in Los Angeles, it fell upon hard times and eventually closed.  There is a project underway—now essentially completed—to renovate and rejuvenate the property.  Not surprisingly, projects of this sort cost money—and lots of it.  And that is where the financing comes in.

The project is owned by Next Century and the work is being financed with a multi-tiered stack of loans.  The senior lender was JPMorgan, and it held the Deed of Trust.  It made the loan to Next Century.  The senior loan was for $446.4 million.  The next level is the Mezzanine Level, and it consisted of two loans.  The senior mezzanine loan (Mezz 1) was made by CDCF.  It was for $120 million.  The junior mezzanine loan (Mezz 2) was made by plaintiff CMB.  The Mezz 1 loan was made to the entity that owns Next Century, and the Mezz 2 loan was made to the entity that owns the entity that owns Next Century (meaning each new loan is made to an entity up the food chain and one more step removed from the actual project owner).  The Mezz 2 loan was for $425 million.  Thus, the total debt was about $1 billion.  The goal of this stack of loans was to be sure that there would be enough money to start and finish the project.  The senior loan is designed to be the least risky and most secured, with the risk going up as the stack goes down (but, presumably, the potential return going up as well).  The loans had a maturity date, which was, presumably, to occur after the project was complete.  The court assumes that the intent was that the debt would then be refinanced with a long term mortgage sufficient to repay the construction lenders and that the mortgage would be serviced by the ongoing operations of the hotel.

Not surprisingly, this structure resulted in a lot of paper setting forth each party’s rights and obligations.  Among the contracts is an Inter-Creditor Agreement, or ICA.  The ICA was between the mezzanine lenders and set forth the rights of each.  Among those rights was CMB’s right to approve any new lender coming into the Mezzanine stack.  The ICA was amended from time to time, the most recent being the Fourth Amended ICA (or 4ICA).

Things were moving along apace until March 2020.  At that time, the senior lender declared its loan “out of balance.”  Upon that declaration, the senior lender apparently had the right—which it exercised—to refuse to make further advances.  And, not surprisingly, that caused a crisis in the project.  According to CMB, it offered to make more money available to bring the loan back into balance, but it wanted (not surprisingly or unusually) the new money to be senior to the Mezz 1 loan.  Plaintiff states that its willingness to put in new money was to insure that no “predatory lender” came into the deal.  According to plaintiff, though, CDCF, the Mezz 1 lender, objected, not wanting to see CMB “leapfrog” in the stack.  (Recall that CMB was junior to CDCF.  Under the new arrangement, presumably because it was putting new money in, CMB would become senior to CDCF, although still junior to the senior lender, JPMorgan.)  CMB also allegedly offered to buy out CDCF’s position (at a discount) but CDCF refused that as well.  And that is where defendants come in.  Defendants are the Reuban Brothers and their agent Motcomb.  According to plaintiff, defendants agreed to put in $275 million in new money at the Mezz 1 level and stated that all of that money would be available to finish the project. 

In order to be able to do that, however, CMB needed to approve.  That was one of its rights under the ICA.  Under the new transaction, the senior lender signed a new agreement and the maturity date was extended to July 2021.  CMB had the right to know the terms of the new senior lender agreement, and, of course, if CMB had a problem with those terms, it could refuse to approve defendants’ entry into the mezzanine level.  CMB ultimately did approve the 4ICA (which approved the inclusion of defendants’ new money).  So far, so good.  But this is where the alleged misconduct comes in.

Plaintiffs contend that in addition to the agreements about which it knew, there was another agreement—a Participation Agreement (PA)—between CDCF and defendants about which it did not know.  The PA does not change the terms of the senior loan—it is solely an agreement between the Mezz 1 lenders.  According to defendants, all the PA did was to allocate the waterfall as among the Mezz 1 lenders.  But plaintiffs sing a different song.  According to plaintiffs, as a direct result of the PA things started to go badly.

Plaintiffs contend that defendants—contrary to their promise—did not in fact make the full $275 million available for the project.  Rather, defendants only allegedly made $125 million available before the loans’ maturity date.  According to plaintiffs, but denied by defendants, everyone knew that the maturity date would not work because the project would not be completed by then, and thus would have to be extended.  (The project was finished, according to plaintiffs, in May 2022.)  Because the maturity date came and went, the loans went into default.  That, in turn, allegedly caused defendants to start making “Protective Advances.”  A protective advance is an advance that is made to protect the project, but it comes at a much higher interest rate and cost, which was the case here.  Specifically, the senior loan is allegedly accruing interest at 33% per year (presumably in default interest) and the protective advances are accruing interest at 20% per annum, for a total Mezz 1 interest rate of about 25%.  Such advances were made, and the project did go forward, but allegedly as a result of the high cost of that money the project is underwater.  Moreover, allegedly due to the PA, CMB was unable to provide alternative and cheaper sources of funds to complete the project. 

In the meantime, defendants have taken over JPMorgan’s position regarding the senior loan.  Recall that it, too, is in default because the loan has matured but not been repaid.  Defendants have declared a default and intend to hold a foreclosure sale.  Defendants note that CMB has the right to buy defendants out of the senior loan—that is, CMB has the right to pay off the debt in full (but not in part) and thereby forestall any foreclosure.  However, the senior debt all in now stands at over $900 million, and CMB has not, cannot, or will not, make that payment.  According to CMB, the “plan” is for defendants to make a credit bid at the foreclosure sale and thereby take the project free and clear, wiping everyone else out.  In particular, doing so will wipe out the Mezz 1 and Mezz 2 loans and will wipe out any equity as well.  CDCF is going along with this, according to plaintiffs, because defendants essentially have them under financial duress through the PA.  (Plaintiff T3B has an equity interest in one of the entities in the chain of ownership; it is not a lender.)  CMB also notes that it currently has the single largest investment in the project (measured in terms of actual dollars lent).  According to plaintiffs, by July 2022—a year after the default—the total owing on the senior loan and Mezz 1 loan was over $2.2 billion, of which about 25% is interest and fees.  Recall that the original amount of those loans was about $560 million plus defendants’ $275 million for a total of about $835 million.

According to plaintiffs, and defendants do not really dispute this, they were not told in advance of the PA’s terms.  And therein lies the purported fraud.  According to plaintiffs, defendants had a duty to disclose the critical terms of the PA before CMB signed on to the 4ICA.  CMB claims that had it known of the specific terms in the PA, it would not have approved the 4ICA because it would have seen the potential for mischief that ultimately came to pass.  What would have happened then is somewhat of a mystery.  Presumably, defendants would not have come into the deal absent the PA and 4ICA.  But CMB was not able to put in its own money because CDCF would not allow it.  How the project would have obtained funding is therefore somewhat unsaid at this stage.

Before the court is a motion for a preliminary injunction brought by plaintiffs to stop the foreclosure sale.  They contend that in taking the actions that it took, defendants committed fraud by concealment, breached their fiduciary duty, breached of the covenant of good faith and fair dealing, engaged in unfair competition, and interfered with contract and prospective economic advantage.

In reply, plaintiffs ask the court to take judicial notice of a related proceeding in New York.  That is a proceeding brought under the various contracts at issue.  Defendants object to taking judicial notice, and there is little confusion as to why.  The New York court apparently found that the PA imposed onerous terms on CDCF and its owners such that CDCF was forced (as a practical matter, akin to financial duress) to do whatever defendants told it to do.  As a result, the New York court was willing to reconsider its prior ruling denying an application to appoint a receiver.  That finding could have been because defendants made there an argument similar to the one they made here—defendants could not have been acting all that badly because CDCF is not complaining.

In deciding a motion for a preliminary injunction, the general standard is well settled.  The court looks at two inter-related factors: (1) the probability that the moving party will ultimately prevail and (2) the relative harms.  The stronger the moving party’s showing on one factor, the less strong it needs to be on the other.  The court also looks to preserving the status quo—that is, the court is more likely to issue a preliminary injunction if it maintains the status quo pending trial rather than if it changes the status quo.  (The court notes that the status quo inquiry fades away at the permanent injunction stage.)

As to the likelihood of success, the court is not sure that plaintiffs have made a compelling showing.  Every iteration of the ICA, including the 4ICA, disclaims any fiduciary relationship among the lenders.  And the court thus has trouble seeing from whence the fiduciary duty arises between a lender (like defendants) on the one hand and one of the members of one of the ownership entities in the ownership chain of the borrower (like T3B) on the other hand.  Neither California nor New York law imposes such a duty as a matter of course.  And to the best of the court’s knowledge reading the papers, T3B has no managerial control over any entity—its interest is as an equity holder (or profit participant) in one of the ownership entities. 

That determination also hurts plaintiffs’ arguments as to fraudulent concealment.  Generally, a person has no duty to speak absent some kind of fiduciary relationship.  Of course, there is always a duty not to speak falsely.  And if a statement is made that is technically true but misleading, the speaker has a duty to disclose information needed to make the statement not misleading.  Here, plaintiffs contend that defendants had a duty to disclose the PA’s terms when they were seeking to have CMB sign the 4ICA.  However, plaintiffs are a bit vague on the precise term that they claim was hidden and material.  Of course, to the extent that all the PA did was to define a waterfall in terms of who would get any money that ultimately came in to repay the Mezz 1 loan, it is hard to see what CMB’s interest is or would have been.  But if, as CMB seems to be implying, the PA also gave defendants effective control over CDCF’s approval rights such that CDCF was no longer in control of anything but rather defendants had control, that could be different.  The court is aware that defendants are foreclosing not as the Mezz 1 lender but rather the as the senior lender.  That used to be JPMorgan, but is now defendants because they bought JPMorgan out.  According to defendants, whatever things might or might not have been done at the Mezz 1 level, none of it affects the senior debt.  Further, defendants state, CMB was fully aware of the senior loan agreements.

Without getting too much into the weeds in this ruling, the court is not prepared to say that CMB cannot prevail.  After all, at least according to CMB, defendants set themselves up to obtain control over the project and further set the project up to fail by secret terms in the PA of which CMB was unaware and about which it could have done something had it timely known.  But so far, CMB has not made a compelling showing.  Some questions do arise.  For example, plaintiffs state that defendants acted wrongly by making only $125 million of their $275 million commitment available.  However, plaintiffs do not really point out where that is a breach.  To know whether that is a breach, the court would need to know the specific conditions for funding.  Most construction loans are doled out; the full amount of the loan is not just paid over into the borrower’s coffers on day 1.  If this loan was like that, to know whether the lesser availability has any meaning the court would need to know if defendants breached their contractual duties by not making money available when they should have done so and what effect that had on the project.  For example, if a significant amount of money was needed to pay the electrical subcontractor but was not funded, thereby causing the subcontractor to stop working pending payment, that could have had a cascading effect and delayed the project’s completion, leading to default.  Alternatively, plaintiffs argue that defendants were under an obligation to extend the loan’s maturity date.  Maybe, but the court did not see that requirement in the contract.  It is not enough for plaintiffs simply to say that such a duty existed, but the court is not prepared to say that it did not exist as a matter of law.  (That said, most lenders are in the business to loan money and have it repaid with interest, not to own luxury hotels.  The “loan to own” phenomenon is not a new one, but it is different from the traditional loan.)  Relatedly, if defendants took any action that would have made it more difficult for the borrower (or plaintiffs) to have found alternative funding to pay off the loan, that could be a breach of contract or a tort duty.  In other words, by July 2021, the court presumes the project was significantly under way.  It could well be that a new construction lender would have been willing to take over the senior loan (or the senior loan and the Mezz 1 loan) given the state of work, thereby avoiding default.  If defendants, through their actions, made that difficult or foreclosed the possibility, that would seem wrongful.  However, it is not enough just to spin out hypotheticals at the end of the day.  There must be evidence.  The record is painfully thin on evidence actually connecting the necessary dots to get from complaint to permanent injunction.  In short, the court sees lots of potential pathways to relief, but the court cannot say that plaintiffs have shown that they are more likely to prevail than not.  Their showing is weak on this record, although the court is not prepared to say it is non-existent.

On the other hand, the balance of hardships seems to tilt decidedly in CMB’s favor.  If the foreclosure goes forward, everyone (except defendants) will lose their investment completely.  True, CMB and T3B will not be “wiped out” in the sense that each will have its chose in action for damages, but their interest in the project and the ability to profit or be repaid from it will be lost.  True, business is all about risk, and that is why we write contracts: to allocate that risk.  If the risk comes to pass, then it does.  But the contracts here are voluminous enough, and the arguments are complex enough, so that the court remains concerned about whether plaintiffs will be forced to suffer a risk for which they did not contract, and the harm if that is in fact the case is significant and (at least absent some showing of a lot of defendant wealth) irreparable.  On the other hand, the court is hard pressed to see the harm to the defense if the injunction does issue.  True, interest and fees will continue to accrue, but if (as plaintiffs state and defendants do not really dispute) defendants intend to submit a credit bid, that is really of no moment.  Defendants will (if the sale ultimately goes forward) obtain the entirety of the project for the debt.  Presumably, any operating revenue not needed for ongoing purposes can easily be sequestered pending the case’s outcome.

And the status quo favors CMB.  Right now, the situation is what it is.  Defendants, not plaintiffs, are the parties that intend to work a change in the status quo.

The court does not view the preliminary injunction to be free from doubt.  However, on balance, the court is inclined to issue the preliminary injunction.  But, due to the relatively weak merits showing, the court will put this case on a rocket docket and will decide the equitable issues first.  The court will discuss with counsel how quickly the case can be brought to trial.  While in California the normal time to trial for a billion (or two billion) case like this might be two to five years, the court is aware that other jurisdictions measure the time to trial for similar or even more complex cases in months—and not many months at that.  This court is inclined to do the same.  The parties will need to work together to get discovery done, and quickly, so that the matter can be heard on its actual merits soon.  That may mean multi-tracking depositions; it may mean speedy document discovery without the normal extensions; it may mean an extra effort to minimize discovery disputes by operating in good faith; it may mean a Case Management Order that more speedily deals with experts and dispositive motions.  Plaintiffs have an incentive to do so because if the court concludes they are dragging their feet, it will be inclined to dissolve the preliminary injunction.  And defendants have an incentive to move quickly because the test for a permanent injunction is different—the merits are far and away the critical factor.  If defendants are as confident as they contend, then they will want to get to trial as soon as possible.  The court also believes that at least the first phase of the trial will be equitable.  Plaintiffs seek an injunction as their principal relief.  Injunctive relief is the hallmark of equity.  The court is confident that a bench trial can be had more quickly than a jury trial.  Of course, if any issues remain after the equitable phase, they will be tried to a jury.  But the equitable phase will resolve whether or not an injunction issues.  The court would urge both sides to minimize motion practice.  Energies should be directed to the trial rather than to motions.  The court’s thinking is something akin to 6 months or so.  The bond amount would be tied to the interest and fees that will accrue during that period.

On the demurrer, the court’s tentative view (with the notion that a more formal order will follow today’s hearing after the court has had the benefit of oral argument) is as follows: the demurrer is OVERRULED as to the first, fourth, and eighth causes of action.  (As to the eighth, it might well be that the declaratory relief action turns out to be duplicative, but it does no mischief and if it is not duplicative, better to leave it in for now).  The demurrer is SUSTAINED WITH LEAVE TO AMEND as to the second, third, fifth, sixth, and seventh causes of action, all of which are brought only by T3B.  the court has trouble seeing where the fiduciary duty might lie or where the covenant of good faith and fair dealing comes in as to T3B, which does not even have a contractual relationship with any of the defendants.  As to the interference with contract cause of action, the tort does not lie merely because a contract becomes less profitable.  The tort only lies if the contract was interfered with in the sense that one of the contracting parties breached or threatened to breach it, or compliance became more expensive or difficult.  T3B’s argument is not that its contract is being breached; it is that its contractual equity position in a risky venture will turn out to be of little value.  As to prospective economic advantage, the court still does not see it.  If defendants’ conduct is not otherwise barred, it is not a tort to enforce one’s own contractual rights.  If the wrongful act is defendants’ breach of their contractual duties as a lender, that might be sufficient (although the court is not so holding at this juncture), but it will need to be pled with greater granularity.  The demurrer is SUSTAINED WITHOUT LEAVE TO AMEND as to the ninth cause of action.  Injunction is not a cause of action.  However, in any amended complaint it can be added to the prayer or sought as relief for an underlying cause of action.  In other words, defendants do not demur on the theory that plaintiffs (should they otherwise prevail) cannot get injunctive relief as a matter of pleading; they object only to the technical framing of “injunction” as a cause of action rather than as a remedy for some other cause of action.  Plaintiffs will have 10 days leave to amend.