Mortgage Break-Up Fees

New York Real Estate Journal recently published an article written by Olshan Real Estate partner Thomas Kearns entitled “Mortgage Break-Up Fees,” in which he cites a pending S.D.N.Y. case to explore the question “Is a $2 million break-up fee in a term sheet for a $250 million mortgage ‘grossly excessive’ and ‘not customary in the industry?’” The lawsuit was brought by Dreien Opportunity Partners LLC against real estate company Avison Young, whom Dreien hired to arrange $460 million in financing to purchase the former JC Penney headquarters in Plano, TX. Avison obtained term sheets from two lenders for the financing: from Och-Ziff for $250 million and from Cindat for $80 million. The Och-Ziff term sheet stipulated that, “In the event that [purchaser] obtains a loan for the property from anyone other than an affiliate of [Och-Ziff] prior to December 31^st, 2016, the [purchaser] must pay a break-up fee to [Och-Ziff] in the amount of $2 million.” After Cindat chose not to proceed with its share of the financing three weeks later and Dreien was forced to seek an alternative financing source, Och-Ziff contended that the break-up fee was payable even if it didn’t close due to Cindat’s withdrawal. Och-Ziff subsequently sued Dreien for the break-up fee and Dreien in turn sued Avison for professional negligence, alleging that Avison failed to advise Dreien that the break-up fee was “not customary in the industry,” “was grossly excessive,” and “should not have been included in the agreement.” “Surprisingly,” Mr. Kearns notes, “the opinion does not spend much time on why a sophisticated purchaser who signed a term sheet with a break-up fee should be relieved of the obligation.” According to the complaint, “Avison Young failed to provide Dreien with multiple options for each component of the capital stack…and did not, therefore, provide Dreien with any alternatives to Och-Ziff,” and the Court’s September 30^th opinion held that the complaint should not be dismissed at this early pleading stage. “A trial may ensue,” he concludes on what we can glean from this case, “and Avison Young may be reaching out to experts to testify as to the practice and reasonability of break-up fees in mortgage transactions and that in the circumstances of this case the break-up fee was appropriate.”