N.Y. appeals court to decide time limits on MBS put-back claims
On Wednesday, when most people are calculating how early they can slip out of work and begin their Thanksgiving festivities, an awful lot of high-priced New York lawyers will be fighting for seats at 27 Madison Avenue, where the New York Appellate Division, First Department, hears appeals. Billions of dollars of claims for breaches of representations and warranties on mortgage-backed securities hang on what the state appeals court decides about the time limits for these suits. Does the clock start ticking when the securities are issued and representations about underlying mortgage loans take effect? Or does New York’s six-year statute of limitations begin running only when the MBS seller refuses to repurchase loans that breach its contractual assurances? A five-judge appellate panel will confront the issue Wednesday in a case called Ace Securities v. Deutsche Bank Structured Products. The courtroom should be packed with lawyers and clients on both sides of New York’s sprawling MBS put-back litigation docket, who are hoping for clues about what the appeals court will decide.
Marc Kasowitz of Kasowitz, Benson, Torres & Friedman will argue (as he does in Ace’s appellate brief) that New York State Supreme Court Justice Shirley Kornreich of Manhattan got it right when she ruled last May that because certificate holders cannot direct an MBS trustee to sue for breach of contract until the MBS seller has refused to buy back deficient loans, time limits date from that refusal. Deutsche Bank’s lawyer, David Woll of Simpson Thacher & Bartlett, will argue, per the bank’s appeals brief, that under well-established New York law, claims for breaches of representations and warranties accrue on the date the representations are made, not when breaches are discovered or demands for a cure are refused. You may recall that one of Kornreich’s colleagues in the Manhattan commercial division, Justice Peter Sherwood, agreed with the bank-advocated interpretation when he dismissed MBS put-back claims against Nomura in a decision that came out only a few days before the Kornreich decision now before the First Department. (Kasowitz Benson, which was on the losing side of Sherwood’s Nomura ruling, filed its notice of appeal in that case after Simpson Thacher had already appealed Kornreich’s Deutsche Bank decision, which is why the appeal of the later ruling will be heard first.)
The start date for MBS put-back claims is an issue of first impression for New York appellate courts, though there’s plenty of case law on the statute of limitations in the context of other sorts of contracts. Both sides in the Deutsche Bank appeal seem to agree that the most important precedent from New York’s highest court is a 2012 ruling in Hahn Automotive v. American Zurich, which held that the six-year statute can’t be extended unless the contract clearly conditions the right to a claim, and the 1979 opinion in Bulova Watch v. Celotex, in which the Court of Appeals said that the statute of limitations resets for distinct breaches within a contract.
That’s the law at issue. How about the stakes? If you look at the calendar, you’ll see that we’re more than six years past the date of the last securities backed by mortgages issued in the housing bubble. So if the appeals court sides with Deutsche Bank and MBS issuers, time has run out for New York suits by any investor that hasn’t already filed a breach of contract claim. (New York state court isn’t the only venue for MBS put-back claims, but it probably has a plurality of the cases already under way.) Banks will almost surely manage to boot some already filed suits if they win the appellate fight on the statute of limitations, but it’s more important to them to cap their potential exposure to put-back claims. A favorable ruling from the appeals court would do that. If the First Department agrees with Justice Kornreich, on the other hand, MBS issuers would face the prospect of 20 or more years of new repurchase suits. Whenever an MBS issuer refuses to buy back a supposedly deficient mortgage – even if that mortgage dates back to 2005 or 2006 – certificate holders would have six years to sue, under Kornreich’s interpretation. Some MBS trusts have 30-year lives, so that would give MBS litigation an awfully long tail.
You don’t have to take my word about how much is riding on the appeal to be argued Wednesday: Three trade groups filed amicus briefs with the First Department warning of the dire consequences that will ensue if the appeals court decides this case the wrong way. You probably won’t be surprised to hear that the amicus brief filed by the Association of Mortgage Investors strongly supports Ace and Kasowitz. If the appeals court requires investors to sue within six years, according to the group’s lawyers at McCool Smith, it will be undermining the repurchase protocols both sides agreed to in MBS pooling contracts and will be granting a windfall to issuers like Deutsche Bank that have refused to live up to their repurchase obligations. (As Ace noted in its brief, Deutsche Bank has refused to buy back any loans from the $500 million trust in the case, even though as many as 99 percent of the 1,600 mortgages in the sample Ace examined contained breaches.)
In contrast, briefs from the Securities Industry and Financial Markets Association and the Mortgage Bankers Association insist that if the appeals court agrees with Kornreich, it will not only inspire a flood of new put-back suits that will continue for the next 30 years but will also wreak havoc with New York contract law. “This court’s resolution of this issue will likely have far-reaching, multibillion-dollar implications for the securities and financial industries and SIFMA’s members, and more generally, will affect the drafting and enforcement of all manner of complex business contracts under New York law,” predicted SIFMA’s lawyers at Wachtell, Lipton, Rosen & Katz. The Mortgage Bankers’ counsel at Jenner & Block offered an even more dire scenario, predicting that a misstep by the state appeals court could impact the entire housing market. “If the statute of limitations is essentially limitless, entities like (Deutsche Bank) will be deterred from making broad representations and warranties in future RMBS agreements,” the brief said. “And because they will need to keep more capital on hand to address potential lawsuits, they will have less to lend to consumers. Affirming a limitless statute of limitations will only make it more difficult for consumers, particularly first-time and middle income borrowers, to get the credit they need to purchase a home.”
It’s notable that Deutsche Bank and its friends all promulgate two different extra-legal arguments for cutting off MBS litigation. The first is that if the court sides with Kornreich, overburdened state court dockets will be bogged down in MBS litigation for decades to come. The AMI brief argues that the flooded-dockets fear-mongering is unjustified. For one thing, MBS issuers like Bank of America and JPMorgan Chase are making global deals to resolve put-back claims across hundreds of trusts, which would certainly limit suits by individual trusts. And for another, the appeals court shouldn’t curtail a valid cause of action just because defendants engaged in egregious conduct that gave rise to a lot of claims.
The second tangential argument for cutting off MBS put-back suits is that late-vintage claims are being filed by distressed-debt investors. These hedge funds, according to defendants, didn’t own the securities when they were issued but bought them later, near the six-year deadline, specifically in order to pursue put-back litigation. This case’s history, according to Deutsche Bank and its amici, bears out this trend. The investors that originally sued Deutsche Bank were formed only in 2011, years after the 2006 securities were issued, as vehicles for hedge funds specializing in distressed debt. The funds first tried to persuade the MBS trustee to sue, and when they couldn’t, filed a put-back suit in March 2016, just before the six-year anniversary of the issue. Only later, after Deutsche Bank had exhausted its contractual buy-back review period and refused to repurchase the supposedly flawed underlying mortgages did the MBS trustee, HSBC, bring claims.(The trustee didn’t weigh in until the six-year anniversary had passed; Kasowitz has argued that HSBC’s claims are still within a six-year time frame because the trustee case relates back to the investor suit but Deutsche Bank says there’s no relation back to a case in which plaintiffs lacked standing.)
Deutsche Bank and SIFMA, in particular, argue that the state appeals court shouldn’t make new law on the statute of limitations for contract claims to accommodate opportunistic arbitrageurs. The “vulture fund” argument has become a theme of MBS put-back defense, as you can see from this ALM report on recent hearings before New York State Supreme Court Justice Marcy Friedman on a cluster of suits against Nomura.
I doubt that New York judges are likely to be swayed by the invocation of the dreaded words “hedge funds.” There are brisk secondary markets for all kinds of securities, after all. Why shouldn’t smart investors who purchase valid claims be permitted to assert them? Moreover, the MBS trustees that sue at the direction of certificate holders with sufficient voting rights are supposed to act on behalf of all investors in the trust. So even if claims are initiated by hedge funds that bought up certificates on the secondary market, once the trustee files a suit the claims belong to every certificate holder in the trust.
Of course, I’m not a judge in the First Department, so my opinion doesn’t count. We’ll find out more about the views that matter on Wednesday.
(Reporting by Alison Frankel)