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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.
On December 4, the Illinois Attorney General announced a $17.25 million settlement with a national bank resolving allegations of misconduct in the marketing and sale of residential mortgage backed securities (RMBS) dating back to before the 2008 mortgage crisis. According to the announcement, the bank’s $17.25 million settlement will be distributed to the Teachers Retirement System of the State of Illinois, the State Universities Retirement System of Illinois, and the Illinois State Board of Investment. Additional details on the settlement have not been made available by the state.
On November 30, the U.S. District Court for the Southern District of New York agreed to stay proceedings covering an investment company’s challenge to a bank’s practice of billing the legal fees incurred in defending a residential mortgage-backed securities (RMBS) trusts lawsuit to the RMBS trusts. According to the opinion, in 2014, an investment company filed a lawsuit against the national bank alleging breach of contract and other common law duties in the bank’s role as trustee for multiple RMBS trusts. In 2017, the investment company filed a separate lawsuit in the same court, challenging the bank’s practice of billing the RMBS trusts for the legal fees incurred by defending the original lawsuit. The two lawsuits were consolidated and the bank moved to dismiss the second lawsuit or stay the proceedings during the pendency of the original lawsuit. Upon review, the court agreed to stay the proceedings, noting the “claims at issue in the fees complaint may well turn on determinations made in the underlying suit.” The investment company argued that while the trusts’ agreements contain fee indemnity clauses, the clauses are not applicable to the bank’s alleged “willful misfeasance, bad faith, or gross negligence.” The court noted that whether the bank acted grossly negligent in its duties as trustee for the RMBS trusts is a “central factual question” in the original lawsuit and therefore, staying the proceedings “could avoid a possible waste of both the parties’ and the court’s resources.”
Additionally, in the same order, the court denied NCUA’s request to intervene in the fees action, holding the agency did not establish it could meet the higher burden of demonstrating inadequate representation by the investment company, which shares the same interests as NCUA.
On November 8, the DOJ announced it filed a complaint in the U.S. District Court for the Eastern District of New York against an international bank and several of its U.S. affiliates for allegedly defrauding investors in connection with the sale of residential mortgage-backed securities (RMBS) from 2006 through 2007. Specifically, the DOJ alleges the bank violated the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) based on mail fraud, wire fraud, bank fraud, and other misconduct by “knowingly and repeatedly” making false and fraudulent representations to investors about the quality of the loans backing 40 RMBS deals. The DOJ is seeking an unspecified amount of civil money penalties under five FIRREA claims.
In response to the filing, the international bank issued a statement indicating that it intends to “contest the complaint vigorously,” arguing, among other things, that the risks of RMBS investments were clearly disclosed to investors and that the bank suffered its own losses from investing in the RMBS referred to in the DOJ complaint.
On November 8, a federal jury for the U.S. District Court for the District of Minnesota awarded the ResCap Liquidating Trust, the post-bankruptcy successor-in-interest to Residential Funding Company, LLC (RFC), a $27.8 million verdict in an indemnity case against a correspondent lender. Shortly after RFC’s bankruptcy plan was confirmed in 2013, the ResCap Liquidating Trust filed indemnity and breach of contract lawsuits against more than 80 correspondent lenders, alleging that the loans RFC purchased from the lenders did not comply with applicable representations and warranties, thereby causing RFC to incur liabilities in the form of bankruptcy-allowed claims.
Before trial, the court excluded certain of the lender’s expert witnesses and concluded that under the relevant contracts, the ResCap Liquidating Trust had sole discretion to determine whether a loan was in breach. Thus, the issues for the jury largely were limited to determining the applicability of certain contracts to the loans and assessing damages for the alleged breaches.
It has been reported that during a hearing on October 29, a judge for the U.S. Bankruptcy Court for the Southern District of New York approved Lehman Brothers Holdings, Inc.’s motion to amend and extend indemnification claims brought against mortgage sellers, allowing Lehman to include an additional $2.45 billion in residential mortgage-backed securities (RMBS) allowed claims from settlements reached earlier this year. As previously reported by InfoBytes, these claims had not yet accrued when the original order was entered pursuant to Federal Rule of Bankruptcy Procedure 9024. Lehman’s prior claims addressed indemnification claims held against roughly 3,000 counterparties involving more than 11,000 mortgage loans related to litigation settlements reached with Fannie Mae and Freddie Mac.
According to the report, the judge stated her decision to allow the amendments will not delay litigation, nor abridge defendants’ rights, as discovery has not yet commenced. The judge’s decision further requires the parties to reach an agreement concerning an alternative dispute resolution regarding the claims.
New York Court of Appeals holds that accrual clause does not delay commencement of six-year statute of limitations for RMBS repurchase claims
On October 16, the New York Court of Appeals affirmed a trial court’s dismissal of trustee RMBS repurchase claims against a mortgage originator on statute of limitations grounds, concluding that New York’s six-year statute of limitations for breaches of representations and warranties governed despite the inclusion of an accrual clause within the governing agreements.
In the underlying lawsuit, the plaintiff trustee claimed that the mortgage originator breached representations and warranties in loan purchase agreements relating to the characteristics and quality of the loans ultimately securitized into RMBS. However, because the originator sold the final set of loans conveyed into the RMBS in May 2007, and the trustee did not file suit until August 2013, the trial court held that the claims were time-barred under New York’s six-year statute of limitations for breach of contract suits. The trial court cited precedent set by the appeals court in ACE Securities Corp. v. DB Structured Products, which found that “a cause of action for breach of representations and warranties contained within a [RMBS] contract accrued when the contract was executed” because the representations and warranties were breached on that date.
On appeal, the trustee argued that the contractual language at issue was different from the language in ACE. Specifically, the trustee argued that the inclusion of an accrual clause stating that claims “shall accrue” upon an originator’s failure to repurchase a defective loan created a condition precedent to suit and operated to delay the commencement of the statute of limitations. The appeals court disagreed, concluding that “no substantive condition precedent was created, and that to the extent the parties otherwise intended to delay the commencement of the limitations period, their attempt to do so was inconsistent with New York law and public policy.” In reaching this conclusion, the appeals court explained that New York’s public policy “represented by the statute of limitations” and specific New York laws governing extensions thereof would effectively be abolished if contracting parties could circumvent it by mutually agreeing to postpone the date on which the period of limitation commences.
On October 16, the U.S. Attorney for the Eastern District of New York announced that the U.S. branch of a Japanese bank and several of its affiliates would settle claims related to the bank’s marketing, sale, and issuance of residential mortgage-backed securities (RMBS) in the lead-up to the 2008 financial crisis. In particular, the U.S. Attorney alleged that the bank, among other things, (i) misrepresented the effectiveness of its due diligence loan review procedures and the quality of the RMBS to investors; (ii) overruled due diligence warnings and allowed the securitization of loans that failed to comply with underwriting guidelines without investors’ knowledge; and (iii) continued to work with originators that “had ‘systemic’ underwriting issues and employed ‘questionable’ origination practices.” The bank disputes the allegations and does not admit to any liability or wrongdoing, but agreed to pay a $480 million civil money penalty pursuant to the Financial Institutions Reform, Recovery, and Enforcement Act to resolve the matter.
On October 9, the U.S. Attorney for the District of Colorado announced that an international bank would settle claims related to the bank’s packaging, securitizing, issuing, marketing and sale of residential mortgage-backed securities (RMBS) in the lead-up to the 2008 financial crisis. In particular, the U.S. alleged that (i) the bank’s due diligence loan review procedures disclosed to investors were not, in certain instances, followed; (ii) bank managers overruled due diligence vendors’ warnings regarding the quality of certain loans included in securitizations; and (iii) the bank misrepresented the quality of the RMBS to investors. The bank disputes the allegations and does not admit to any liability or wrongdoing, but agreed to pay a $765 million civil money penalty pursuant to the Financial Institutions Reform, Recovery, and Enforcement Act to resolve the matter.
On October 1, Lehman Brothers Holdings Inc., the firm’s plan administrator, and certain subsidiaries moved to increase the indemnification claims brought against mortgage sellers, seeking to include obligations resulting from more than $2.45 billion in residential mortgage-backed securities (RMBS) trust claims. Lehman’s prior claims addressed indemnification claims held against roughly 3,000 counterparties involving more than 11,000 mortgage loans related to litigation settlements reached with Fannie Mae and Freddie Mac. Lehman now seeks to increase the indemnification claims to include claims from additional settlements reached earlier this year for an additional $2.45 billion in RMBS allowed claims. The proposed amended order does not seek to materially change existing procedures, but only seeks to add claims which had not accrued when the original order was entered pursuant to Federal Rule of Bankruptcy Procedure 9024. Lehman asserts the amendment is appropriate under Bankruptcy Rule 7015 and would benefit the creditors by “expediting the resolution and recovery on account of such claims and by increasing distributions to creditors.”
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