(Bloomberg) — Carl Icahn is suing a mortgage payment collector for being too slow to liquidate a struggling Nevada mall, a delay that boosted fee payments to the collector while hurting lenders to the shopping center.

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The delays in recognizing the mall’s troubles and writing down its debt are too common among mortgage payment collectors known as special servicers, according to Icahn Partners’s suit in Nevada state court. The shopping center in question, the Prizm Outlets outside Las Vegas, had loans that had been bundled into bonds through a trust.

“The Prizm Outlets saga is no isolated incident and reverberates far beyond the Trust at issue here,” the complaint said. Icahn owns some of these bonds, but has also famously bet on the downfall of malls through derivatives known as CMBX. The liquidation of Prizm Outlets resulted in a payout to those, including Icahn, who bet against the CMBX Series 6 index.

The mall had a more than $60 million mortgage when it was liquidated during the pandemic for just over $400,000. When fees were added, total losses were 120%. Investors would have ended up better off had the mall been sold sooner, according to the suit.

The lawsuit comes as prices for commercial real estate across the US and around the world have been hit first by the pandemic and now by rising interest rates. More such litigation is probably coming as parties fight over who should bear the losses, an issue that can get particularly thorny when mortgages are bundled into securities in the $670 billion commercial mortgage bond market.

Half Vacant

A division of Rialto Capital Management became servicer after the mall failed to repay its mortgage that matured in 2017, and should have seen signs of the mall’s decline, according to the complaint. The shopping center was half vacant by late 2017, according to Icahn’s complaint, when the gradual rise of e-commerce was triggering a wave of bankruptcies and cutbacks among mall stores. A representative for Rialto declined to comment.

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Rialto foreclosed in 2018, after the mall had defaulted on its mortgage. According to the complaint, the firm tried to turn the property around instead of selling it off immediately, then deliberately manipulated appraisals to prevent the loan from being written down too quickly. In the end, lenders had to pay around $13 million to Rialto for unnecessary fees and other expenses, the complaint said.

The loan had been chopped up into pieces and sold to investors in the form of bonds. Some buyers of the bonds received higher interest payments on their securities in exchange for being the first to suffer losses if the value of the property declined, and some received less interest and would be later to suffer any losses.

The first group of bondholders to take losses usually have control over the underlying property. But once an appraisal of the property creates enough losses to wipe out 75% of the value of their debt holdings, they lose control, and the next group in line gains that right. By delaying writedowns, Rialto could ensure that control didn’t pass to a new group of investors that might have sought to sell the property sooner, a shift that could have deprived the company of potential fees, according to the complaint.

‘Preventable Consequence’

Icahn bought class E notes in 2021. The class G notes were first in line to take losses, followed by class F. Losses to these two other classes were “assured by deteriorating market conditions before Rialto began servicing Prizm Outlets in 2018,” but losses to the class E notes were “the preventable consequence of Rialto’s actions,” according to the complaint.

Rialto, for example, instructed the appraiser to assume the mall was nearly 100% occupied when the half-vacant property was valued in April 2019, inflating the value and preventing the class E noteholders from taking over, the complaint said. The appraisal came in at $28.8 million, even as Kroll Bond Rating Agency, a ratings firm, said it was closer to $9.5 million, the complaint said.

Meanwhile, Rialto committed millions of dollars to repairs, renovations, and enhancements, such as a mural project, in an effort to bring in more customers, according to the complaint. By March 2020, it was clear that the class E noteholders were in charge, but by then, Covid-19 was becoming a pandemic, and valuations were depressed even further.

“Fair and transparent markets benefit everyone, including Mr. Icahn’s funds,” said Michael Hanin, a Kasowitz Benson Torres partner representing the investor.

Icahn’s legal team also took aim at investors that own shopping centers, highlighting mutual fund giant Putnam Investments. That firm recently threatened to take legal action against the special servicer of Crossgates Mall if the servicer moved to recognize losses associated with the property, according to the complaint.

“The known and suspected efforts by Putnam and others to influence the timing and extent of losses in CMBS trusts are wrongful and manipulative,” the complaint said.

A representative for Putnam said the assertion that the firm acted improperly is “baseless.”

The case is Icahn Partners LP, 22-854147, Nevada District Court Clark County.

(Updates comment line in sixth paragraph.)

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