On April 28, a Brooklyn appellate panel handed Eli Karp a second chance. The court revived his 2021 lawsuit against Madison Realty Capital, ruling that a lower court improperly dismissed claims that the lender orchestrated a loan-to-own scheme at the Hello Nostrand project in East Flatbush.
Karp, a developer who once bet big on luxury rentals in less-gentrified Brooklyn neighborhoods, now gets to pursue damages for fraud, breach of contract, and bad faith dealing. The decision clears the way for discovery into Madison’s conduct on a project that ended with a $70 million credit bid and a stalled apartment complex.
Madison ultimately acquired the site at 1580 Nostrand Avenue last year after Karp’s plans for a 200-unit complex stalled. Only one rental building was completed. The property had been mired in litigation for years.
Karp’s Hello Living bought the site for $13 million in 2014. Construction began, but financing quickly unraveled. According to Karp, Madison bought up the project’s mezzanine debt, raised the interest rate, and forced him to take on more debt—ultimately pushing the development into default.
Karp placed the property into bankruptcy in 2021, one day before Madison could initiate a UCC foreclosure. Madison then sold the $6 million mezzanine loan and $73 million senior loan to Arch Companies, which sued Karp to start a new foreclosure. Arch later ran into its own trouble, and Karp agreed to a bankruptcy sale. Madison eventually took back the senior loan.
The appellate court’s ruling does not decide the merits. It simply finds that Karp’s allegations—that Madison made false promises to fund the project and deliberately engineered a default to seize control—are sufficient to survive dismissal. An attorney for Madison did not respond to a request for comment. In court filings, the firm has argued the default stemmed from Karp’s failure to repay his original loan.
This is not Karp’s only fight with Madison. In January, he sued the lender on another foreclosed property, Hello Lenox, alleging a similar loan-to-own scheme. There, Karp claims Madison intentionally overvalued the Brooklyn property to trigger a default and take control.
The pattern is consistent: a developer secures financing, the lender acquires subordinate debt, restructures terms, and the project falters. The lender then forecloses and takes the asset at a credit bid. Karp alleges that is not coincidence—it is design.
Loan-to-own strategies are not new. Distressed debt investors have long used mezzanine positions to gain control of troubled assets. But the line between aggressive restructuring and bad faith is thin, and courts are increasingly willing to examine it.
For lenders, the Karp decision is a reminder that aggressive foreclosure tactics can invite years of litigation. Discovery will expose internal communications, underwriting decisions, and restructuring negotiations. That risk is priced into the cost of capital, but it is rarely modeled as a binary event.
For developers, the ruling offers a narrow but real avenue of recourse. A well-pleaded fraud claim can survive summary judgment and force a lender to defend its conduct. That changes the leverage dynamic in restructuring negotiations.
The broader implication is about capital discipline. In a rising rate environment, lenders are under pressure to manage non-performing loans. The temptation to use mezzanine debt as a control mechanism is strong. But the legal system is watching. Karp’s case will test how far a lender can go before a jury decides whether the strategy crossed into fraud.
Madison Realty Capital is one of the most active private lenders in New York. It has the balance sheet and legal resources to litigate. But the Karp case will consume management attention and legal fees. And if discovery reveals a pattern, it could invite additional claims from other borrowers.
The appellate court’s decision does not end the case. It begins it. Karp now gets to depose Madison executives, review loan files, and present evidence to a jury. That is a risk no lender can fully hedge.