When mortgage-related litigation, including residential mortgage-backed securities (RMBS) lawsuits, erupted after the last financial crisis (the Great Recession of 2008), the litigants recognized that some of their disputes presented issues of “first impression.” That is, the parties’ arguments required judicial analysis and interpretation of contractual provisions and other issues that had not been litigated in a mortgage industry context. Even now, more than a decade later, some key issues remain subject to contradictory legal rulings or still lack definitive rulings from appellate courts.
Other key issues, though, were vigorously litigated by the parties and resolved (to one degree or another) by some courts. This post will examine some of those subjects, which might prove critical to future litigation involving other securitized assets, such as commercial mortgage-backed securities (CMBS).
When does the statute of limitations start to run?
One hot-button issue in mortgage litigation has been when the applicable statute of limitations starts to run. In several cases litigated in Colorado federal court under New York law in the last decade, defendants successfully argued that the limitations period began running at the moment the loans changed hands, because the applicable representations and warranties were made only through the sale date. [1] The district court judges in those cases—subsequently affirmed on appeal by the Tenth Circuit Court of Appeals—rejected the plaintiffs’ argument that the statute did not begin running until the plaintiffs decided to seek a remedy (repurchase or indemnification) against the sellers, usually many years after the sale of the loan.
Some further guidance on the statute of limitations relating to some RMBS-related claims arrived about a decade after the market crash in 2008. In late 2018, the New York State high court definitively ruled that contractual repurchase claims accrue on the date of the contract, with rare exceptions. [2] Then in early 2019, the appellate court overseeing New York (the Second Circuit Court of Appeals) found that a plaintiff’s “indemnification” claims were indistinguishable from a breach of contract claim and should receive similar treatment for purposes of the statute of limitations—in other words, the claims were time-barred. [3] However, several other courts have concluded that contractual indemnification claims did not begin to accrue until the plaintiff had incurred liability to a third party.
If a wave of CMBS litigation ensues, the statute of limitations defense might be relevant to CMBS trusts created many years ago or claims focused on particular loans originated many years ago. In such circumstances, any alleged breaches of the trust formation agreements, or as to the loans themselves, may be deemed to have occurred (if at all) at that much earlier time, and thus a defendant may be able to contend that a statute of limitations defense applies to bar the claim. Conversely, plaintiffs seeking the remedy of contractual indemnification may find courts less receptive to a defendant’s statute of limitations argument.
What constitutes compensable loss/damage?
Another hot topic of dispute in RMBS litigation has been what constitutes a compensable “loss.” No one disputed that RMBS investors suffered losses, but the question became what amount of those losses were actually “damages” for which a defendant (either the aggregator/depositor of loans into the trust or, in subsequent cases brought by those entities, the loan originator or broker) should pay. Again, contractual language was often key: most, if not all, contracts required investors/trustees to prove that any breach “materially and adversely affected” the interests of the investor. What constituted a “material and adverse effect” often hinged on the type of plaintiff and the governing law under the contract.
If the contract was governed by New York law and the plaintiff was an insurer (in this context, a “monoline” insurer or financial guaranty company), the insurer benefitted from New York statutory insurance law. New York trial courts found that an insurer did not have to prove actual loss under the statute, but instead only an increased risk of loss. In contrast, if the plaintiff was not an insurer (usually an investor or trustee), the plaintiff typically had to prove actual loss.
In the CMBS context, parties should first determine whether the “material adverse effect” language (or similar language) is present in their contracts, which might determine what constitutes a compensable loss for the plaintiff. Likewise, many representations and warranties in the RMBS world are qualified, such that only “material” breaches trigger liability. Parties should pay similarly close attention to the representations and warranties in CMBS agreements because many technical breaches might not have been material, and even many non-technical breaches may not have caused any real damage or otherwise triggered liability.
What remedies are available to a plaintiff?
One of the two most sought-after remedies in RMBS litigation has been repurchase, also known as put-back claims. This remedy is a form of specific performance resembling rescission, whereby the conveyance of the loan is unwound. Whether a plaintiff can seek a “monetary” form of repurchase has been the subject of conflicting opinions, with the result again often depending on the language of the particular contract. At least one federal Circuit Court of Appeals has found that a plaintiff cannot obtain repurchase when the loan has been extinguished, but there are also several conflicting opinions. [4]
The other remedy frequently pursued by plaintiffs has been indemnification. Courts have split on the question of whether that remedy is any different from the remedy of repurchase. [5] Whether indemnification provides any additional value to a plaintiff—including but not limited to the question presented above concerning when the statute of limitations starts running—can depend upon whether the contract treats indemnification as a “mere remedy” or as a “standalone cause of action.”
Plaintiffs in the CMBS space will need to review their contracts carefully to determine what remedies are available. One particular point to pay attention to in the contract is whether it includes a plaintiff-friendly catch-all clause (e.g., “and all other remedies available at law or in equity”), or instead, a defendant-friendly limitation of remedies to only those expressly listed (typically cure, repurchase, and indemnification).
Is sampling an appropriate means of proof?
Any given RMBS trust contained thousands of residential mortgage loans, presenting a potential problem for plaintiffs: how could they prove their case in a way that was both cost-efficient and tolerable for a court (and jury)? Many plaintiffs attempted to solve this problem by using statistical sampling, which had previously been used in other types of cases, such as mass torts and Federal Tort Claims Act cases. But some courts refused to allow sampling, instead requiring plaintiffs to prove their cases loan-by-loan.
Whether a court allowed sampling often depended on the language of the particular contract(s) at issue. Some courts read certain contracts to require proof as to each loan under a “sole remedy” clause or due to the wording of indemnification provisions, while other courts interpreted contracts, particularly those lacking such language, to permit proof by sampling.
In the CMBS space, the number of loans pooled into trusts is typically much smaller, which might create less of an imperative for plaintiffs to invoke sampling. Plaintiffs pursuing claims relating to a large number of trusts might still seek to use sampling to expedite the litigation.
Conclusion
If and when CMBS litigation picks up in earnest in the aftermath of the pandemic, and the effects it has wrought on loan and property values begin to emerge, the parties may find that their cases present seemingly new questions of law and contract interpretation that courts must confront for the first time. Lessons gleaned from over a decade of RMBS litigation could pay dividends in looming CMBS cases.
[1] https://www.financialserviceswatchblog.com/2016/01/4296/
[2] https://www.financialserviceswatchblog.com/2018/12/new-york-high-court-rules-on-statute-of-limitations/
[3] https://www.financialserviceswatchblog.com/2019/02/new-second-circuit-statute-of-limitations-ruling-a-benefit-to-loan-originators-brokers/
[4] https://www.financialserviceswatchblog.com/2019/11/appellate-court-tells-citimortgage-it-cant-force-repurchase-of-what-no-longer-exists/
[5] https://www.financialserviceswatchblog.com/2019/02/new-second-circuit-statute-of-limitations-ruling-a-benefit-to-loan-originators-brokers/
