InfoBytes Blog

2nd Circuit: Bank’s suit to recover RMBS losses is untimely

On February 6, the U.S. Court of Appeals for the 2nd Circuit affirmed the judgment of the district court dismissing, as untimely, a trustee’s breach of contract and indemnity claims related to losses resulting from alleged defects in mortgage loans. At issue are three pools of residential home mortgages that at the time of sale had an aggregate principal balance exceeding $3.4 billion. These loans were sold by a mortgage company to Lehman Brothers Holding Inc. and Lehman Brothers Bank FSB in 2006 and subsequently securitized into three trusts. In addition to the representations and warranties made and the remedies provided in the Mortgage Loan Purchase Agreements (MLPAs) and Trust Agreements, the mortgage company, Lehman, and the depositor entered into a separate Indemnification Agreement for each trust, which contained its own representations and warranties indemnification provision. Investors, including Freddie Mac, purchased certificates in the trusts.

According to the court, Freddie Mac conducted a forensic review of the trusts six years after the sale, which allegedly revealed that an “overwhelming percentage” of the loans in the trusts breached the mortgage company’s representations and warranties (R&W). Shortly after discovery, the trustee submitted breach notices to the mortgage company, which did not cure or repurchase the loans.

The Federal Housing Finance Agency (FHFA), as conservator for Freddie Mac, filed a complaint against the mortgage company asserting breach of contract and indemnification claims. After the FHFA dropped out of the litigation, the trustee filed an amended complaint that included two breach of contract counts and two indemnification counts—one seeking indemnification based on the MLPAs and Trust Agreements and another seeking indemnification based on the Indemnification Agreements.

The mortgage company moved for summary judgment on the first three claims and moved to dismiss the fourth claim. The district court granted the motion. It found that the breach of contract claims were time-barred because the FHFA filed the summons with notice more than six years after the limitations period at issue, which begins to run on the effective date of the R&Ws. The court also found the trustee’s indemnification claim based on the MLPAs and Trust Agreements to be time-barred because it was “merely a reformulation of its breach-of-contract claims.” The district court dismissed the other indemnification claim based on the Indemnification Agreements as time-barred because it involved a new set of operative facts and thus could not relate back to the original complaint filed by the FHFA.

On review, the 2nd Circuit affirmed the lower court’s decision. As to the breach of contract claims, the 2nd Circuit relied on two New York Court of Appeals cases: Ace Securities Corp. v. DB Structured Products, which held that the six year statute of limitations begins to run on the effective date of R&Ws, and Deutsche Bank National Trust v. Flagstar Capitals Market Corporation which held that an express accrual clause in a contract cannot delay the start of a limitations period under New York law. With respect to the third cause of action for indemnification under the MLPAs and Trust Agreements, the 2nd Circuit stated that absent unmistakably clear language in an indemnification agreement that demonstrates that the parties intended this clause to cover first-party claims as opposed to third-party claims, an agreement between two parties to indemnify each other does not mean that one party’s failure to perform gives rise to an indemnification claim. In reviewing the claim at issue in count three, the court found that the claim sought payment to the trustee arising from the mortgage company’s alleged breach of R&Ws, which is a breach of contract claim. The trustee argued that the indemnification section provided an independent remedy, but the 2nd Circuit rejected that argument stating that a claim is not independent if its success directly depends on the breach of the R&Ws in the MLPAs outlined in the contract claims. Finally, with respect to the fourth clause of action for indemnification, the 2nd Circuit held that this claim filed in 2016, would only be timely if it related back to the facts of the earlier claims, but since it arose out of different contracts it therefore could not relate back.

Courts RMBS Second Circuit Appellate Indemnification

Court opens door for CFPB to appeal constitutionality determination to 2nd Circuit

On August 23, the U.S. District Court for the Southern District of New York granted the CFPB’s request for entry of final judgment with respect to the court’s June decision to terminate the CFPB as a party to an action. The court has previously concluded that the CFPB could not proceed with its claims under the Consumer Financial Protection Act (CFPA). The entry of final judgment will allow the CFPB to appeal the court’s constitutionality determination to the U.S. Court of Appeals for the 2nd Circuit. As previously covered by InfoBytes, the CFPB brought the action with the New York Attorney’s General office (NYAG) against a New Jersey-based finance company and its affiliates (defendants). Although the court dismissed the CFPB’s claims, it determined that the NYAG had plausibly alleged claims under New York law and the CFPA and had the independent authority to pursue those claims.

The court also granted the defendants’ request to stay the NYAG case during the pendency of the CFPB’s appeal to the 2nd Circuit.

Courts CFPB CFPA State Attorney General Second Circuit Single-Director Structure

2nd Circuit holds NCUA lacks standing to bring derivative suit against two national banks regarding RMBS claims

On August 2, the U.S. Court of Appeals for the 2nd Circuit held that the National Credit Union Administration (NCUA) lacked standing to bring a suit against two national banks on behalf of trusts created by the agency that held residential mortgage-backed securities (RMBS). According to the opinion, in 2009 and 2010, NCUA took control of five failing credit unions, including ownership of certificates the credit unions held in RMBS trusts. NCUA then transferred the certificates into new trusts and a financial institution was appointed, pursuant to an Indenture Agreement, as Indenture Trustee. NCUA subsequently brought derivative claims on behalf of the trusts against two national banks, trustees of the original RMBS trusts. In affirming the lower court’s dismissal of the claims, the appellate panel found that the NCUA did not have derivative standing to sue on behalf of the trusts because the trusts had granted the right, title, and interest to their assets, including the RMBS trusts, to the Indenture Trustee. The 2nd Circuit reasoned that therefore only the Indenture Trustee possesses the claims, and the NCUA did not have the right to sue on behalf of the Indenture Trustee under the Indenture Agreement.

Courts Second Circuit Appellate RMBS Standing Securities

2nd Circuit reverses district court, holds fair debt collection claim can proceed when dispute notice is included

On July 27, the U.S. Court of Appeals for the 2nd Circuit held that a lower court erred when it concluded that a consumer was prevented from alleging violations of the Fair Debt Collection Practices Act where a debt collector sought payment on a previously settled debt because the debt collector had included a notice of the right to dispute the debt, which the consumer did not exercise. According to the 2nd Circuit panel, the consumer plausibly argued that consumers could be misled by collection notices that misstate debts whether or not there is an option to dispute the debt, especially because the debt collector told her it might report her account information to credit bureaus. “A least sophisticated consumer who was so advised might understand her right to dispute the misstated debt but, nevertheless, pay the debt out of fear that there was already an adverse effect on her credit that would continue as long as the obligation remained outstanding,” the panel opined. Moreover, a debt dispute notice does not preclude claims for misrepresenting the debt. The appellate court vacated the lower court’s judgment and remanded for further proceedings.

Courts Debt Collection FDCPA Appellate Second Circuit

2nd Circuit affirms no securities fraud in mortgage bundle sale

On July 24, the U.S. Court of Appeals for the 2nd Circuit affirmed a district court’s decision, holding that a group of securities investment firms (defendants-appellees) did not unlawfully hide concerns about a mortgage bundle it sold to a Luxemburg-based financial institution (plaintiff-appellant) when it marked down the value of certain junior securities within the bundle. The three judge panel affirmed the lower court’s decision to dismiss securities fraud and breach of contract claims, which alleged that the defendants-appellees’ undisclosed markdown concealed its view that the mortgage bundle would underperform. The defendants-appellees contended that the markdown was related to commonly-used accounting strategies designed to manage risk tied to the preference shares, to which the lower court agreed—ruling that the plaintiff-appellant had failed to show evidence proving its claims of fraud. The appellate court agreed, holding that the plaintiff-appellant “has thus failed to raise a material issue of fact as to [the defendants-appellees’] knowledge that there was anything wrong with the underlying assets, which is essential to establishing its theory of fraud.” The appellate court further upheld the breach of contract dismissal because the offering circular and marketing materials for the mortgage bundle did not specify the value of the preference shares.

Courts Appellate Second Circuit Securities Mortgages

Supreme Court upholds credit card company’s anti-steering provisions

On June 25, the U.S. Supreme Court in a 5-4 vote held that a credit card company did not unreasonably restrain trade in violation of the Sherman Act by preventing merchants from steering customers to other credit cards. As previously covered by InfoBytes, in September 2016, the U.S. Court of Appeals for the 2nd Circuit considered the non-steering protections included in the credit card company’s agreements with merchants and concluded that such provisions protect the card company’s rewards program and prestige and preserve the company’s market share based on cardholder satisfaction. Accordingly, the 2nd Circuit concluded that “there is no reason to intervene and disturb the present functioning of the payment‐card industry.” In June 2017, a coalition of states, led by Ohio, petitioned the Supreme Court to review the 2nd Circuit decision, arguing the credit card industry’s services to merchants and cardholders are not interchangeable and therefore, the credit card market should be viewed as a two-sided market, not a single market. The Supreme Court disagreed with the petitioners’ arguments, finding that the credit card industry is best viewed as one market. The court reasoned that while there are two sides to the credit card transaction, credit card platforms “cannot make a sale unless both sides of the platform simultaneously agree to use their services,” resulting in “more pronounced indirect network effects and interconnected pricing and demand.” Accordingly, the two-sided transaction should be viewed as a whole for purposes of assessing competition. The court further concluded that the higher merchant fees the credit card company charges result in a “robust rewards program” for cardholders, causing the company’s anti-steering provisions to not be inherently anticompetitive, but in fact to have “spurred robust interbrand competition and has increased the quality and quantity of credit-card transactions.”

Courts U.S. Supreme Court Credit Cards Antitrust Appellate Second Circuit

Supreme Court rejects review of $806 million RMBS judgment

On June 25, the Supreme Court denied without comment an international bank’s petition for writ of certiorari to challenge the $806 million in damages awarded by the Federal Housing Finance Agency (FHFA) for selling allegedly faulty mortgage-backed securities to Fannie Mae and Freddie Mac. As previously covered by InfoBytes, in September 2017, the U.S. Court of Appeals for the 2nd Circuit affirmed the New York District Court’s ruling requiring the $806 million payment. Both lower courts concluded that the marketing prospectus used to sell the mortgage securities to Fannie and Freddie between 2005 and 2007 contained “untrue statements of material fact,” including false statements regarding the underlying loans’ compliance with underwriting standards related to the creditworthiness of borrowers and appraisal value of the properties.  

Courts U.S. Supreme Court Writ of Certiorari RMBS FHFA Appellate Second Circuit Fannie Mae Freddie Mac

2nd Circuit affirms dismissal of class action against international bank for alleged AML control misrepresentations

On April 13, the U.S. Court of Appeals for the 2nd Circuit affirmed a district court’s dismissal of a proposed class action alleging an international bank misrepresented the effectiveness of internal controls to investors, during a time Russian traders were laundering more than $10 billion through the bank. In May 2016, investors filed a class action complaint against the bank alleging securities law violations for touting its compliance efforts while Russian clients were engaging in “mirror trades.” The district court dismissed the complaint for failing to sufficiently allege how the bank misled investors. Specifically, the district court noted that general statements about reputation and compliance amount to “puffery” and are regularly held to be non-actionable. In affirming the district court’s decision, the 2nd Circuit agreed that the plaintiffs failed to adequately allege scienter. The panel rejected the plaintiff’s reliance on, among other things, a consent order between the New York Department of Financial Services (NYDFS) and the bank (previously covered by InfoBytes here) as evidence the bank was aware of Russian wrongdoing during the time it made its alleged misrepresentations, stating “the consent order thus contradicts the plaintiffs’ argument that the individual defendants were aware of any wrongdoing at the time they made their alleged misrepresentations.”

Courts Anti-Money Laundering Financial Crimes NYDFS Second Circuit Appellate

2nd Circuit: debt collectors do not need to state interest is not accruing

On March 29, the U.S. Court of Appeals for the 2nd Circuit held that a debt collection letter, which does not disclose that the balance due is not accruing interest or fees is not misleading under the Fair Debt Collection Practices Act (FDCPA). The decision results from a 2016 lawsuit filed by two debtors who alleged that the debt collection notices they received from the defendants were “false, deceptive, or misleading” under Section 1692e of the FDCPA because the notices did not state whether the balances were accruing interest or fees. The district court awarded summary judgment in favor of the defendants after unrebutted evidence was produced to show that the debtor’s balances did not accrue interest or fees during the collection period.  In affirming the district court’s decision, the 2nd Circuit applied the “least sophisticated consumer” standard and found that even if a consumer interpreted the debt collection notice to believe the balance due was accruing interest or fees, the only harm that would exist is “being led to think that there is a financial benefit to making repayment sooner rather than later.” The panel also noted that the notice was consistent with Section 1692g of the FDCPA because interest and fees were not accruing, the balance due stated the accurate amount of the debt.

Courts Debt Collection Second Circuit FDCPA Appellate

2nd Circuit finds bankruptcy claim non-arbitrable

On March 7, the U.S. Court of Appeals for the 2nd Circuit denied a bank’s motion to compel arbitration, holding that arbitration of the debtor’s claims would present an inherent conflict with the intent of the Bankruptcy Code because the dispute concerns a core bankruptcy proceeding. The debtor’s claims against the bank relate to a purported refusal to remove a “charge-off” status on the debtor’s credit file after the debtor was released from all dischargeable debts through a Chapter 7 bankruptcy. The bankruptcy court allowed the debtor to reopen the proceeding in order to file a putative class action complaint against the bank alleging that the designation amounted to coercion to pay a discharged debt. The bank moved to compel arbitration, based on a clause in the debtor’s cardholder agreement, and the court denied the motion. On appeal, the district court affirmed the bankruptcy court’s decision. In affirming both lower courts’ decisions, the 2nd Circuit reasoned that a claim of coercion to pay a discharged debt is an attempt to undo the effect of the discharge order and, therefore, “strikes at the heart of the bankruptcy court’s unique powers to enforce its own orders.” The circuit court found the debtor’s complaint to be non-arbitrable based on a conclusion that it would create an inherent conflict with the intent of the bankruptcy code.

Courts Second Circuit Arbitration Bankruptcy Appellate