As MBS trustee put-back suits mount, Minn. case sets bad precedent

October 4, 2012

I have a bold assertion: Breach of contract suits by mortgage-backed securities trustees are no longer a rarity. In my daily feed of new filings, I’m seeing a fairly regular trickle of cases asserting trustee claims that mortgage originators didn’t live up to their representations and warranties about the loans they sold to MBS trusts. The roster of firms filing cases for trustees has expanded as well. Kasowitz, Benson, Torres & Friedman still seems to be the likeliest to appear on the signature page of MBS trustee complaints, but last week MoloLamken filed a put-back suit in New York State Supreme Court for the trustee of a Morgan Stanley MBS trust, and Holwell Shuster & Goldberg brought a put-back claim in the same court for the trustee of a Deutsche Bank-backed trust.

So, now that put-back filings have become as relatively commonplace as Miguel Cabrera home runs, it’s time to start asking how successful the cases will be. Banks have been disposing of billions of dollars of put-back demands asserted by bond insurers and by Fannie Mae and Freddie Mac for years, but those claims haven’t been resolved through litigation. And Bank of America reached its proposed $8.5 billion global settlement with private investors in Countrywide mortgage-backed securities before the investors’ lawyers at Gibbs & Bruns filed a complaint claiming that Countrywide breached MBS representations and warranties. As far as I’m aware, there has been no publicly disclosed settlement of a put-back case filed by an MBS trustee acting at the behest of private certificate holders.

With that paucity of precedent, a ruling this week in one of the earliest put-back cases on the dockets is bad news for certificate holders. The suit, filed by Kasowitz Benson against the originators of loans in a $555 million Wells Fargo MBS offering, stemmed from an investigation that noteholders demanded back in April 2010. In a sample of 200 of the 3,000 loans in the underlying pool, investors identified material breaches in 150, or 75 percent, of the sample. When the originators EquiFirst and WMC Mortgage refused to accede to put-back demands based on breaches in the sample, the MBS trustee, U.S. Bank, sued on behalf of noteholders.

Senior U.S. District Judge Paul Magnuson took the guts out of the case in February, dismissing all of the trustee’s claims against EquiFirst because they weren’t asserted within 60 days of U.S. Bank’s knowledge of the alleged breaches, as is contractually required. Even more devastating was Magnuson’s ruling on the claims against WMC, which originated almost 60 percent of the loans in the trust. The judge said that under the purchase agreements between WMC and the trust, the trustee only had the right to demand that WMC repurchase the deficient mortgages — and, critically, not the right to demand monetary damages for loans that weren’t available for repurchase. (I wrote about the ruling at the time but didn’t give it as much attention as I now realize it deserved.)

On Monday, U.S. District Judge John Tunheim finished the job Magnuson started. (Magnuson recused himself in June, without explanation.) Ruling on WMC’s motion for summary judgment, Tunheim said that since the trustee’s only remedy was repurchase, it had no cause of action against WMC for mortgages that were extinguished through foreclosure. The judge’s 17-page opinion rejected the trustee’s argument that WMC could be compelled under the purchase agreement to buy back even foreclosed loans under one reading of the phrase “mortgage loans.” Tunheim said the argument had “superficial” appeal but continued, “It would be a tortured reading of the provision, however, to equate the loan’s constituent parts with the loan itself, and hold that merely because the trustee can produce certain parts of the ‘mortgage loan’ — the mortgage file, foreclosure proceeds, etc. — the mortgage loan as a whole remains to be repurchased.”

Given the volume of allegedly deficient loans in MBS trusts that have already gone into default, the one-two punch from Magnuson and Tunheim could be very consequential for noteholders. WMC has already cited the Magnuson ruling in parallel Minnesota cases Kasowitz brought on behalf of other Wells Fargo MBS trusts, and I would be very surprised if the decisions didn’t become standard references as these trustee cases begin to be litigated.

I left messages with Michael Fay of Kasowitz and WMC counsel Barbara Steiner of Jenner & Block but didn’t hear back.

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