Commercial Division Blog

Posted: February 25, 2017 / Categories Commercial, Fraud/Misrepresentation

Insurer Adequately Pleads Reliance on RMBS Issuer's Representations

On December 19, 2016, Justice Friedman of the New York County Commercial Division issued a decision in Ambac Assurance Corp. v. Countrywide Home Loans, Inc., 2016 NY Slip Op. 51864(U), holding that an insurer had adequately pled reliance on an RMBS issuer's misrepresentations, explaining:

The general standards for pleading and proof of justifiable reliance have repeatedly been addressed by the Court of Appeals. In New York, sophisticated parties have an affirmative duty to protect themselves from misrepresentations made in arm's length business transactions by undertaking a reasonable investigation of the details of the transactions. As the Court of Appeals has repeatedly reaffirmed:

If the facts represented are not matters peculiarly within the defendant's knowledge, and the plaintiff has the means available to it of knowing, by the exercise of ordinary intelligence, the truth or the real quality of the subject of the representation, the plaintiff must make use of those means, or it will not be heard to complain that it was induced to enter into the transaction by misrepresentations.

Moreover, when the party to whom a misrepresentation is made has hints of its falsity, a heightened degree of diligence is required of it. It cannot reasonably rely on such representations without making additional inquiry to determine their accuracy. Thus, where a plaintiff is aware that it has not been provided with financial information to which it is entitled, its duty to perform a heightened degree of diligence is triggered. Absent hints of falsity, however, where a misrepresentation has been made on a matter as to which the plaintiff has inquired, the plaintiff may be entitled to rely on the representation without making further inquiry or obtaining a prophylactic provision.

As the Court of Appeals has emphasized, the question of what constitutes reasonable reliance is not generally a question to be resolved as a matter of law on a motion to dismiss.

As a threshold matter, the court rejects Countrywide's contention that the disclosures in the Offering Documents bar Ambac's claim of justifiable reliance as a matter of law. The disclosures on which Countrywide relies were set forth in the Prospectuses and Prospectus Supplements for the Transactions. They included, among other things, representations that mortgage loans will generally be originated in accordance with underwriting guidelines but that exceptions will be made from time to time and in the ordinary course of business, or that exceptions to Countrywide's underwriting guidelines may be made if compensating factors are demonstrated by a prospective borrower. Additional disclosures were made that a substantial percentage of the mortgage loans provided by Countrywide had been originated or reviewed pursuant to underwriting programs under which certain documentation requirements concerning income/employment and asset verification are reduced or excluded. The Offering Documents also warned of the possibility of inaccurate or inflated appraisals, borrower fraud, and inaccuracies in other data about the loans, including data about owner occupancy.

Consistent with the weight of authority, this court has held that substantially similar disclosures are ineffective to notify investors in RMBS securitizations of the systematic or wholesale abandonment of underwriting standards. The court holds—and Countrywide does not argue otherwise—that this authority is equally applicable in the monoline insurer context. The disclosures at issue do not bar Ambac's claim that Countrywide completely abandoned its underwriting standards.
Countrywide's disclosures as to the underwriting of the negative amortization loans, in particular, do not bar Ambac's claim of justifiable reliance based on alleged misrepresentations with respect to such loans, because the disclosures do not relate with sufficient specificity to the misrepresented matters. For example, Countrywide disclosed in the Offering Documents that special features of such loans may or will affect the rate at which principal on these mortgage loans is paid or create a greater risk of default if the borrowers are unable to pay the monthly payments on the related increased principal balances. In the case of the Lehman Transactions, Countrywide also disclosed that the loans may have been originated according to underwriting guidelines that do not comply with Fannie Mae or Freddie Mac guidelines, and that a significant portion of the mortgage loans in the trust fund may have been classified in relatively low credit categories, such as subprime, with borrowers that may have imperfect credit histories.

These disclosures fall far short of informing Ambac of the extent of the risk associated with Countrywide's negative amortization product, or that Countrywide purposefully off-loaded the negative amortization loans into RMBS securitizations in order to keep these "toxic" loans off its own books, as Ambac alleges here.

(Internal quotations and citations omitted).