Carl Icahn's Suit Against Rialto Can Go Forward In Potential Blow To Special Servicers

A Nevada judge ruled Tuesday that billionaire investor Carl Icahn can proceed with a lawsuit against a special servicer who managed a $67M CMBS loan backed by a struggling mall that wound up as a total loss for its bondholders.

The case stems from a 2022 lawsuit Icahn filed against Rialto Capital Management, in which he accused the special servicer of dragging its feet over the disposition of the Prizm Outlets mall while collecting more than $12M in fees from bondholders. 

Clark County District Judge Mark Denton on Tuesday ruled against Rialto’s request for summary judgment. The Miami-based firm had argued that Icahn lacked standing to sue because it didn't represent enough of the bondholders to execute a clause that would give it the right to oust Rialto from its role.

Icahn claims Rialto’s actions, including ordering fraudulent appraisals, led to CMBS bondholders facing a total wipeout of more than $62M of the principal balance left on the loan while Rialto reaped nearly $13M in fees, advances and expenses at the property.

Distressed mall investor Kohan Retail Investment Group purchased Prizm Outlets for $400K in 2021. The loss on the loan was, at the time, the largest for CMBS investors since 2008, according to the suit.

For years, some investors have groused that special servicers delay selling struggling assets to reap fees for longer periods and have too much control over loan workouts. Rialto, in particular, has a history of being accused of ignoring bondholders’ and borrowers’ best interests in pursuit of profits.

Denton's decision could give bondholders more confidence to try to hold special servicers accountable, said Michael Hanin, the attorney representing Icahn.

“Hopefully, the illusion that servicers are beyond reproach, that there’s invincibility, is shattered here to some degree,” said Hanin, a partner with law firm Pallas Partners. 

Rialto downplayed the ruling’s potential ramifications.

“The recent rulings are just procedural motions in a frivolous lawsuit,” a Rialto spokesperson said in a statement to Bisnow. “We look forward to presenting the actual facts at trial.”

In 2017, Rialto was tapped as the special servicer of a $67M CMBS loan tied to what was then called Fashion Outlets of Las Vegas in Primm, Nevada. The loan was part of a $1.1B CMBS created in 2012, and Rialto was brought in after the mall struggled to repay its matured debt, Bloomberg reported. 

Icahn purchased his stake in the Nevada mall after it was already struggling, according to Bloomberg, citing previous case motions. The investing mogul said in the complaint that he did so to demonstrate how Rialto and other special servicers were hurting the “basic integrity” of the CMBS market, according to Bloomberg.

Icahn Partners commanded more than 80% of the Class E bondholders' shares in the CMBS, which it claims allowed it to act as the controlling class of bondholders and exercise a clause that would allow it to remove Rialto as the special servicer of the property.

It accused Rialto, which foreclosed on the property in 2018, of getting a series of three appraisals on the property that artificially inflated its value to a point that diluted Icahn’s controlling stake in the CMBS and pushed the firm below a level to oust Rialto as the special servicer.

Rialto's attorneys, in their bid to have a judge throw out the suit, claimed that the struggles with the mall affected more than just Icahn’s bondholder class and that he didn't control enough shares overall to lodge the complaint.

On Tuesday, Denton disagreed with Rialto, ruling that Icahn’s Class E holdings were “uniquely” harmed by Rialto’s actions compared to other bondholder classes in the CMBS.

“Plaintiffs have offered evidence, at least sufficient to raise questions of material fact, that Rialto’s alleged actions were undertaken for the purpose of denying controlling class rights to the Class E certificates,” Denton wrote in his decision. 

This is Rialto’s second effort to toss the lawsuit out of court. In October 2022, a judge rejected Rialto’s motion to dismiss the case. The servicer at the time argued that Icahn Partners strove for a loss on the property faster because Icahn had an “unrelated short play against malls via a CMBS derivatives index.”

Hanin said he hopes the ruling makes it easier for bondholders to pursue legal remedies against special servicers like Rialto, who have been accused over the years of delaying dispositions of struggling properties under the premise that they would continue to reap fees on struggling assets.

“It is notoriously difficult to bring lawsuits against special servicers,” Hanin said. “I think this decision affirming that this case can go forward and be a trial will make special servicers think twice.”

Special servicers enjoy widespread protection from lawsuits by bondholders in making their decisions with distressed properties. But Kons Law Firm principal Joshua Kons, who has worked on bondholder litigation cases but isn't involved in the Icahn-Rialto dispute, told Bisnow that this ruling has the potential to give bondholders more sway over the actions of special servicers. 

“This case provides a road map for future plaintiffs and bondholders that special servicers can be liable,” Kons said.

The fact that Icahn provided evidence of Rialto’s activity was likely “critical” to the ruling, he said.

“It may be the beginning of a new era where special servicers need to take note of their activities with regard to certificate holders who might have control rights.”