Servicing Transition: Mitigating the Trustee’s Discretion when Document Provisions Conflict

September 26, 2019

In typical structured finance transactions, the terms of indentures, servicing agreements, pooling and servicing agreements and other similar servicing arrangements (each an “Operative Agreement”) provide that under certain circumstances a “Servicer” may resign or otherwise be terminated during the lifecycle of the deal. In these instances, it is common for the terms of the Operative Agreement to provide that the “Trustee” appoint a successor Servicer.

Frequently, the Operative Agreement provides that in appointing a successor Servicer, the Trustee may make such arrangements for the reasonable compensation of such successor as it and the successor may agree. From a technical perspective, this discretion could seemingly permit the Trustee to modify the economic provisions of the deal and potentially reduce the amount of distributions available to investors.

In structured finance transactions, amendments to the economic provisions of the deal generally require the consent of a set threshold of investors. The discretion to agree to the compensation of a successor Servicer may impose a modification to the economic terms of the deal, which could contravene restrictions on document amendments. For example, increasing a servicing fee rate payable through transaction cash waterfall provisions could require a threshold of consenting investors not otherwise obtainable as a practical reality.

To address this potential conflict, Trustees and other transaction parties entering into Operative Agreements should consider as possible mechanisms: (1) defining “reasonable compensation” to provide for a range of acceptable modifications to the successor Servicer’s compensation; (2) incorporating a requirement that a set percentage of investors provide written consent to modify compensation outside of that range; and (3) contracting with a backup servicer at closing to have the successor Servicer’s fees agreed upon prior to the Servicer’s termination. In connection with such modifications in respect of existing transactions, Trustees should consider the possibility of utilizing judicial intervention to modify such terms in the absence of consent by the requisite investors.

For more information, please contact any member of the Global Banking and Institutional Finance Group at Seward & Kissel LLP.