N.Y. judges split on time bar for billion-dollar MBS put-back claims
It is no exaggeration to say that billions of dollars hang on the question of whether New York Supreme Court Justice Shirley Kornreich or her colleague Justice Peter Sherwood is correct about how long mortgage-backed securities trustees have to assert claims that MBS sponsors breached representations and warranties. There’s no disagreement that under New York law, which applies to most MBS deals, the statute of limitations for breach of contract suits is six years. But in dueling opinions issued Tuesday, Kornreich and Sherwood came to different conclusions about when the statute begins to run. Sherwood sided with the securitizer Nomura and its lawyers at Orrick, Herrington & Sutcliffe, ruling that the clock starts ticking on the securitization’s closing date. Kornreich explicitly rejected that theory in a trustee case filed by Kasowitz, Benson, Torres & Friedman against DB Structured Products, finding instead that DB’s refusal to repurchase supposedly defective underlying loans triggered the statute.
The statute of limitations for MBS trustee breach of contract suits, otherwise known as put-back claims, is an issue of first impression in New York state court, and given that these two judges have now reached opposite conclusions about the same federal-court precedent (Structured Mortgage Trust v. Daiwa Finance and Lehman Brothers v. Evergreen), we’ll have to wait to see what the state appeals court thinks. The question for the appeals court is stark: Is an MBS pooling and servicing agreement breached when underlying loans fall short of promises the sponsor makes on the day the deal is signed or does the breach occur only when the sponsor fails to meet a continuing obligation to repurchase deficient loans?
To get a sense of the magnitude of that question, consider Sherwood’s footnote that 14 MBS cases in his court alone will be affected by his interpretation of the statute of limitations. Joseph Frank of Orrick told me that four of those cases are against Nomura, asserting aggregate damages of $500 million. And that’s just a few cases before one judge. The statute issue is so momentous that the Association for Mortgage Investors, a trade group, submitted an amicus brief in the Nomura case Sherwood decided, asserting that MBS sponsors have a continuing obligation to repurchase defective mortgages.
If you’re wondering, as an initial matter, why trustees waited so long to assert claims based on mortgage pools whose dubious quality hasn’t exactly been a secret, it’s because the MBS investors that originally bought into trusts in 2005 and 2006 haven’t generally been the ones forcing trustees to sue. Instead, opportunistic hedge funds have been buying up mortgage-backed certificates expressly to bring put-back suits. (To do that, as you know, the hedge funds have had to amass the requisite voting rights in the trusts they bought into, an obstacle that has blocked many ordinary investors from directing trustees to make put-back demands.) The directing certificate holders in the cases before both Kornreich and Sherwood were hedge funds that acquired their interests just before asserting their claims of a breach.
That shouldn’t make a difference in how courts interpret the law, of course, and neither Kornreich nor Sherwood suggested that it did. Sherwood simply said that because MBS sponsors make representations and warranties about the underlying loan pools as of the deal’s execution date, that’s when any supposed breach occurs. The sponsor’s subsequent refusal to buy back a defective loan, in Sherwood’s reading, is a failure to cure the original breach but is not itself a breach of the pooling and servicing agreement.
Kornreich, on the other hand, added common-sense reasoning to her interpretation of the law. MBS pooling and servicing agreements spell out elaborate protocols for repurchase demands on underlying mortgages and home-equity loans that often have 30-year terms. If the contracts intended to cut off claims within six years of their execution, Kornreich said, they could have said so rather than including specific deadlines for demand and cure periods. “To contend … that the trustee’s claims accrued in 2006 because the trustee could have made a demand at that time utterly belies the parties’ relationship and turns the PSA on its head,” she wrote. Kornreich likened pooling and servicing agreements to reinsurance deals, in which a breach occurs when the reinsurer rejects a coverage demand by the primary insurer. Here, she said, “the breach is the failure to comply with the (put-back) demand.”
Both Sherwood and Kornreich rushed out their rulings within weeks of oral argument on the defendants’ dismissal motions. The date on Sherwood’s decision is May 10, though he didn’t actually issue the opinion until four days later. Kornreich issued hers soon thereafter. The dueling decisions, meanwhile, create all kinds of procedural complications. Will the Appellate Division, First Department, take the unusual step of consolidating appeals on the statute issue? (That might make sense since Kasowitz Benson represents the directing certificate holders in both cases.) Justice Sherwood has stayed discovery in 14 other trustee cases before him, but will DB’s lawyers at Simpson Thacher & Bartlett ask Kornreich to do the same? (Simpson partner David Woll declined to comment.) And how will other judges in state Supreme Court in Manhattan treat the split between their colleagues? (“If trial courts make a reasoned decision based on the law, they will deny dismissal motions,” said Marc Kasowitz.)
I said in a post last week that we’ve reached the beginning of the end of MBS litigation. But the Sherwood and Kornreich decisions prove that we’ve still got a long way to go.
(Reporting by Alison Frankel)
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