Too late for MBS investors to sue in N.Y. state? Try federal court!

January 9, 2014

We are just beginning to witness the impact of the ruling last month by the New York State Appellate Division, First Department, that the six-year statute of limitations for breach-of-contract claims based on mortgage-backed securities begins to run on the securities’ closing date. As you surely recall, a unanimous state appeals court flatly rejected contrary reasoning by State Supreme Court Justice Shirley Kornreich, who had ruled that the breach in MBS contracts occurs not at the moment the deal closes but when the issuer refuses an MBS trustee’s demand for the repurchase of underlying mortgages that don’t live up to the issuer’s representations and warranties. Kornreich’s interpretation would have permitted MBS mortgage repurchase, or put-back, claims to be filed throughout the life of the securities. Instead, the appeals court essentially capped put-back exposure for MBS issuers. It’s only been a couple of weeks since the appellate ruling, but as the New York Commercial Litigation Insider reported Wednesday, state-court judges have already begun tossing mortgage repurchase cases filed more than six years after the MBS closing date.

That’s why a one-paragraph, handwritten order Tuesday by U.S. District Judge Alvin Hellerstein of Manhattan raises such intriguing possibilities.

Judge Hellerstein is presiding over a breach-of-contract suit by MBS trustee Deutsche Bank against MBS issuer WMC Mortgage, a now-defunct General Electric mortgage originator. On Dec. 17 – two days before the New York state appellate ruling on the statute of limitations – Hellerstein denied a motion by WMC’s lawyers at Jenner & Block to dismiss the case on timeliness grounds. The federal judge agreed with his state-court colleague Kornreich that the breach of an MBS contract occurs when the issuer refuses to cure false representations and warranties by repurchasing deficient underlying mortgages. After the state court held otherwise on Dec. 19, the trustee’s counsel, Ropes & Gray, sent Hellerstein a letter asserting that he need not reconsider his Dec. 17 finding because he’s not bound by the decision of an intermediate state appeals court.

WMC, as you would expect, argued to the contrary in a brief submitted just before the end of the year. The circumstances of the case before the state appeals court exactly parallel those of the trustee’s case against WMC, Jenner & Block argued, and the state court’s unanimous decision “reversed the primary authority on which this court relied, and it constitutes a definitive ruling from the highest New York court to have considered the issue.” Hellerstein must reconsider his statute-of-limitations ruling, WMC said. At the very least, he must stay the trustee’s case until the New York Court of Appeals (the state’s highest court) opines on the start date for the statute of limitations for MBS contract claims.

Hellerstein denied WMC’s motion. “I’ve read the Appellate Division’s decision,” he wrote, “and it does not change my views that the contract was breached not at the time of closing, but at the time of failure to cure.” Pretty interesting, right? Hellerstein’s summary rejection of the state court ruling means that MBS investors (via trustees, of course) may still have live claims in federal court even though the exact same complaint – same basic facts, same cause of action – would be deemed untimely in state court.

So should every MBS investor call on trustees to start filing (or refiling) put-back suits in federal court? If only! The only reason Deutsche Bank, as trustee, was able to litigate against WMC in federal court is diversity jurisdiction: The bank’s trust company, according to a memo on jurisdiction by Ropes & Gray, is based in California, not New York. Trustees based in New York (and thus investors in the MBS trusts they oversee) can’t claim diversity jurisdiction so they are still stuck in state court, where their claims are barred if they’re filed more than six years after the issue date. Trustees based elsewhere can try their luck in federal court, citing diversity jurisdiction and Judge Hellerstein’s expansive view of the statute of limitations for put-back claims.

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