Blogs

Commercial Division Blog

Current Developments in the Commercial Divisions of the
New York State Courts by Schlam Stone & Dolan LLP
Posted: March 11, 2019

Court Clarifies Rules Regarding Accrual of RMBS “Failure to Notify” Put-Back Claims

On February 15, 2019, Justice Friedman of the New York County Commercial Division issued a decision inĀ HSBC Bank USA, N.A. v. Merrill Lynch Mtge. Lending, Inc., 2019 NY Slip Op. 30358(U), clarifying the rules for the accrual of RMBS failure-to-notify put-back claims, explaining:

The court adheres to its holding that accrual of a failure to notify cause of action requires both the defendants discovery of breaches and its failure to give prompt written notice of the breaches to the trustee.

On the prior motion to dismiss, Countrywide argued that HSBC’s failure to notify cause of action accrued at the latest on October 1, 2007, prior to the limitations period, at the time it allegedly made its last sale of loans to the sponsor. In support of this contention, Countrywide cited the allegation of the complaint that Countrywide had knowledge by that date of the falsity of the representations and warranties it made to the sponsor about the loans, as a result of its origination of the loans. In opposition to the motion to dismiss, HSBC disputed not only that October 1, 2007 was the date of the last sale of the loans, but also that October 1, 2007 was the date as of which Countrywide made its representations knowledge that such representations and warranties had been breached. HSBC also argued that notice within two months of discovery of a breach is prompt as a matter of law and that, even assuming that Countrywide made representations and warranties and had knowledge of breaches by October 1, 2007 (i.e., more than six years before the assertion of the failure to notify claim), notice given two months later (i.e., within the six-year limitations period) would still have been prompt.

The prior decision held that Countrywide failed to submit evidence sufficient to show that Countrywide did not discover breaches of representations and warranties between October 1, 2007 and the closing date of the securitization on October 31, 2007, and therefore that there wen.: no discoveries after October 1 that may benefit from the Tolling Agreement in effect between October 16, 2013 and May 18, 2016. Further, the prior decision held that the complaint pleaded that Countrywide discovered breaches of representations and warranties through post-closing internal quality control and review processes, and that the trustee’s failure to notify cause of action against Countrywide was maintainable based on these allegations as to post-dosing discovery. It was in this context that the court found that the complaint pleaded a timely cause of action against Countrywide to the extent that it was based on Countrywide’s discovery of such breaches, and failure to provide prompt written notice thereof- within the six-year limitations period preceding the assertion of the failure to notify cause of action, accounting for the tolling period.

It was not the court’s intention to suggest that discovery and provision of notice of the breaches must both occur within the limitations period. Rather, having found that the complaint pleaded timely failure to notify claims based on discovery within the limitations period, the court did not reach HSBC’s argument that the complaint also pleaded timely failure to notify claims based on discovery prior to the limitations period and failure to give notice within the limitations period, provided that notice within the limitations period would still have been prompt In particular, the court did not reach HSBC’s argument that even if Countrywide discovered breaches on an October 1, 2007 loan sale date, prior to the closing and prior to the limitations period, the failure to notify claims were also timely to the extent that they were based on Countrywide’s failure to give notice up to two months later, within the limitations period.

Nor could the court have determined the timeliness of this claim on the record of the motion to dismiss. The record of the prior motion did not identify the specific dates of the loan sales, and there were factual and legal disputes as to the dates on which Countrywide made its representations and warranties and therefore as to when the breaches of the representations and warranties occurred and Countrywide could have known of such breaches. (See supra, at 3.) In addition, HSBC failed to offer any explanation as to how, if Countrywide made representations on or before October 1 and had know ledge of breaches as of October 1, notice up to two months later could have been considered prompt.

The authority on which HSBC relied on the prior motion, and on which it continues to rely, does not support its contention that notice is prompt as a matter of law if given within two months of the knowledge of the breach. The two cases cited by HSBC in its opposition to the motion addressed the promptness of notice given by a trustee as a condition precedent to suit against a defendant securitizer or loan seller for repurchase of loans, and not, as here, the notice to be provided by the defendant to the trustee. HSBC has not discussed the differing purposes for which trustees and the various other parties involved in a securitization are obligated to give notice. Nor has HSBC discussed, or submitted legal authority that addresses, the impact of these differing purposes on the time by which notice must be given in order to be considered prompt and, in the case of a securitizer’s or originator’s obligation, the time by which the trustee’s failure to notify cause of action will accrue if notice is not given.

In the interest of avoiding confusion, however, the court modifies the prior decision to state explicitly that the prior decision did not reach HSBC’s argument that the complaint pleaded timely failure to notify claims based on the defendant securitizer’s or originator’s discovery of breaches of representations and warranties prior to the limitations period and failure to give notice within the limitations period, provided that notice within the limitations period would still have been prompt. The prior decision therefore does not preclude such a claim in future on a fully developed supporting factual record and on supporting legal authority as to the promptness of such notice.

Also in the interest of avoiding confusion, the court notes that this claim was not at issue in its bellwether decision in the coordinated Part 60 RMBS litigation on the standard for accrual of a failure to notify cause of action. The prior decision in the instant action held that the accrual rule for a failure to notify claim set forth by this court in FHFA/Morgan Stanley applied to HSBC’s failure to notify claims in this action. The FHFA/Morgan Stanley decision held that, like other breach of contract claims, the failure to notify claim does not accrue until the time of the breach, and that a defendant does not breach its notification obligation until it discovers a breach of representations and warranties and fails to give prompt written notice to the Trustee.

The defendant-securitizer in each of the actions decided by FHFA/Morgan Stanley argued that failure to notify claims are subject to the same statute of limitations as claims forĀ breaches of representations and warranties, and accrue on the date on which the underlying representations and warranties are made. The Trustee contended that the earliest the breach of a notification obligation could have occurred–and the earliest the statute of limitations could have begun to run–is after the defendant discovered the defective loans but failed to notify the Trustee. The Trustee further contended that under the continuing obligation doctrine, it may assert claims for persistent failures to notify, regardless of when the defendant initially discovered the breaches, because the defendant continued to breach its duty to notify by continuing to fail to provide notice.

In FHFA/Morgan Stanley, the parties did not address the meaning of prompt notice or its proper interpretation in the RMBS context The court thus did not consider whether, or to what extent, the time of discovery differed from the time by which prompt notice must be provided, In holding that the Trustee had misconstrued the continuing obligation doctrine, the court stated that the Trustee’s claim for a breach of the notification obligation will be timely only if the defendant’s discovery occurred within the six-year period before the assertion of the failure to notify causes of action and that claims based on defendants’ discovery of breaches prior to this six-year period will not be timely. Such statements were made in the context of rejecting the Trustee’s apparent contention that, under the continuing obligation doctrine, its failure to notify claims would be timely regardless of when discovery occurred, based on the defendant’s ongoing failure to give notice of the discovery. Although these statements appear to equate the time of discovery with accrual of the fail me to notify claim, they were not intended to alter the accrual rule articulated earlier in the opinion. Nor should they be read to imply that a claim for failure to notify can accrue before the obligation to provide prompt notice is breached.

(Internal quotations and citations omitted).

Schlam Stone & Dolan represents investors in RMBS actions against underwriters and trustees and in related proceedings, such as trust instruction proceedings where an RMBS trustee seeks court guidance regarding the management of an RMBS trust. If you or a client are RMBS investors and have questions regarding potential claims against a trustee or how to influence the trustee’s prosecution of a put back action like the one at issue here, contact Schlam Stone & Dolan partner John Lundin at jlundin@schlamstone.com.

Click here to subscribe to this or another of Schlam Stone & Dolan’s blogs.

View posts