Publications

(Article from Securities Law Alert, June 2015)

For more information, please visit the Securities Law Alert Resource Center

On June 11, 2015, the New York Court of Appeals held that a cause of action “for breach of representations and warranties” in connection with the sale of residential mortgage-backed securities “accrued at the point of contract execution.” ACE Sec. Corp. v. DB Structured Products, Inc., 2015 WL 3616244 (N.Y. Ct. App. 2015)(Read, J.).[1] The court further held that the seller’s “refusal to repurchase the allegedly defective mortgages” pursuant to a contractual cure or repurchase obligation “did not give rise to a separate cause of action” for purposes of determining whether the statute of limitations had run. The court ruled that the “cure or repurchase obligation was not a separate and continuing promise of future performance,” nor was it an “independently enforceable right” that “continue[d] for the life of the investment.”

Background

On March 28, 2006, ACE Securities Corp. executed a Mortgage Loan Purchase Agreement (the “MLPA”) with DB Structured Products, Inc. (“DBSP”) for the purchase of certain residential mortgage-backed securities (“RMBS”). That same day, ACE “transferred the loans and its rights under the MLPA” to the ACE Securities Corp. Home Equity Loan Trust, Series 2006-SL2 (the “Trust”) pursuant to a Pooling and Servicing Agreement (the “PSA”). DBSP made numerous representations and warranties in the MLPA “regarding the credit quality and characteristics of the pooled loans ‘as of the Closing date.’” The MLPA provided that “the Trust’s ‘sole remedy’ in the event DBSP ‘breach[ed] any of the representations and warranties contained in’ the MLPA was for DBSP to cure or repurchase a non-conforming loan.”

Six years after the execution of the MLPA, two investment funds that held certificates in the Trust brought suit, alleging “breaches of representations and warranties” in connection with the RMBS and that DBSP had “refus[ed] to comply with its repurchase obligation.” Several months later, on September 13, 2012, the Trustee of the Trust substituted itself for the funds as plaintiff.  The Trustee claimed that “it had promptly notified DBSP of the breaches of representations and warranties on” various dates beginning on February 8, 2012, and asserted that “each of these notices specified the defective or non-conforming loans, detailed specific breaches for each loan and supplied supporting documentation.” In response, “DBSP moved to dismiss the Trust’s complaint as untimely” in light of the six-year statute of limitations applicable to contract causes of action in New York. See N.Y. CPLR § 213(2). DBSP argued that the Trust’s “claims accrued as of March 28, 2006, more than six years before the Trust filed its complaint.” DBSP also argued that the complaint filed by the Trustee on behalf of the Trust could not be deemed timely by virtue of the funds’ earlier filing, since the funds lacked standing to sue under the PSA’s “no action” clause, and had not afforded DBSP a 90-day pre-suit notice period, as required under the PSA. 

On May 13, 2013, the New York Supreme Court denied DBSP’s motion to dismiss. The court “reasoned that DBSP could not have breached its repurchase obligations until it ‘fail[ed] to timely cure or repurchase a loan following discovery or receipt of notice of a breach of a representation or warranty’” (quoting ACE Sec. Corp. v. DB Structured Products, Inc., 40 Misc. 3d 562 (N.Y. Sup. Ct. 2013) (Kornreich, J.)). The court found that “DBSP’s cure or repurchase obligation was recurring and that DBSP committed an independent breach of the PSA each time it failed to cure or repurchase a defective loan.” DBSP appealed.

On December 19, 2013, the New York Appellate Division, First Department, reversed the Supreme Court’s decision. The First Department “held that ‘the [Trust’s] claims accrued on the closing date of the MLPA, March 28, 2006, when any breach of the representations and warranties contained therein occurred,’” and also sided with DBSP on its standing and pre-suit notice arguments (quoting ACE Sec. Corp. v. DB Structured Products, Inc., 112 A.D.3d 522 (N.Y. App. Div. 2013) (Tom, J.P., Andrias, DeGrasse, Richter, JJ.)). The Trust appealed.

New York Court of Appeals Holds That DBSP’s Cure or Repurchase Obligation Was Not “Independently Enforceable” as a “Separate and Continuing Promise of Future Performance”

On appeal, the Trust contended that “its claim did not arise until DBSP refused to cure or repurchase, at which point the Trust . . . had six years to bring suit.” The Trust argued that “the repurchase obligation [was] a distinct and continuing obligation that DBSP breached each time it refused to cure or repurchase a non-conforming loan.” In essence, the Trust claimed that “the cure or repurchase obligation [was] a separate promise of future performance that continued for the life of the investment (i.e., the mortgage loans).”

The New York Court of Appeals found that “DBSP’s cure or repurchase obligation could not reasonably be viewed as a distinct promise of future performance.” The court underscored that DBSP “never guaranteed the future performance of the mortgage loans.” Rather, DBSP “represented and warranted certain facts about the loans’ characteristics as of March 28, 2006, when the MLPA and PSA were executed.” The court explained that “DBSP’s cure or repurchase obligation was the Trust’s remedy for a breach of those representations and warranties, not a promise of the loans’ future performance.” The court emphasized that “nothing in the contract specified that the cure or repurchase obligation would continue for the life of the loans.”

From a practical perspective, the court explained that “it makes sense that DBSP, as sponsor and seller, would not guarantee future performance of the mortgage loans.” The court observed that “[a] sponsor does not guarantee payment for the life of the transaction because loans may default 10 or 20 years after they have been issued for reasons entirely unrelated to the sponsor’s representations and warranties.” In view of this possibility, “[t]he sponsor merely warrants certain characteristics of the loans, and promises that if those warranties and representations are materially false, it will cure or repurchase the non-conforming loans within the same statutory period in which remedies for breach of contract (i.e., rescission and expectation damages) could have been sought.”

Had DBSP not agreed to a cure or repurchase obligation, the court explained that “the Trust’s only recourse would have been to bring an action against DBSP for breach of the representations and warranties . . . within six years of the date of contract execution.” The court determined that DBSP’s cure or repurchase obligation simply provided the Trust with an “alternative remedy” for alleged breaches of representations and warranties, not an entirely separate cause of action. The court found no basis for the Trust’s contention that “the cure or repurchase obligation transformed a standard breach of contract remedy, i.e. damages, into one that lasted for the life of the investment ― decades past the statutory period.” The court determined that “nothing in the parties’ agreement evidences such an intent.”

New York Court of Appeals Rejects the Trust’s Contention That the Cure or Repurchase Obligation Was a Substantive Condition Precedent to the Trust’s Claim for Breach of DBSP’s Representations and Warranties

The Trust also contended that “the cure or repurchase obligation was a substantive condition precedent to suit that delayed accrual of [its] cause of action” against DBSP. According to the Trust, “it had no right at law to sue DBSP until DBSP refused to cure or repurchase the loans within the requisite time period.”

Rejecting this argument, the New York Court of Appeals found that “[t]he Trust suffered a legal wrong at the moment DBSP allegedly breached the representations and warranties.” From that point forward, “a cause of action existed for breach of a representation and warranty.” The court explained that “[i]f DBSP’s purchase obligation were truly the separate undertaking the Trust alleges, DBSP would not have breached the agreement until after the Trust had demanded cure and repurchase.” But in the case at hand, the court determined that “DBSP breached the representations and warranties in the parties’ agreement, if at all, the moment the MLPA was executed.” The court found that “[t]he Trust simply failed to pursue its contractual remedy within six years of the alleged breach.”