The global financial crisis that began over a decade ago has shaped how market participants, the government, and the public at large conceptualize and respond to risk. The crisis has also shaped the law in the most prominent financial center in the country, if not the world – New York.
Historically, in the days before securitization – i.e., the bundling of debt instruments such as residential mortgage loans – the primary risk accompanying a mortgage loan inured to the lending bank. The lending bank therefore had a vested interest in the borrower’s creditworthiness and the value of her collateral. If the borrower defaulted, then the bank suffered the loss. Structured products coupled with derivatives exponentially multiplied and expanded the risk accompanying residential mortgage loans. In the modern financial system, individual borrowers’ defaults crippled not only banks, but pension funds and their investors, insurance companies and their stakeholders, sovereign wealth funds and their citizens, down the line.
Now, more than a decade after the crisis began, the litigation brought in its wake has ambled its way through the courts, resulting in binding precedent – stare decisis – that will resonate for decades. A number of legal issues that reached the highest courts in New York have wide-ranging impact beyond the structured products space, including issues of contract interpretation, statutes of limitations, and privilege.
This article addresses several issues decided in the wake of the crisis, all of which arose from cases involving securitized mortgage loans, and all of which have applications that extend well beyond those particular financial products and the crisis.
Defenses – Statute of Limitations
Perhaps the most impactful decisions in New York emanating from the crisis are those involving New York’s statute of limitations.
In 2015, the New York Court of Appeals harmonized two cases with different outcomes that it decided in the late nineteenth century, over a hundred years earlier, by holding that even where a demand with a cure period is contractually required to invoke a remedy for breach of representations and warranties, the cause of action accrues not when the demand is made and refused, but when the initial representations and warranties were made. This is so, the Court added, irrespective of whether, when, and how the claimant became aware that the representations and warranties were false. Emphasizing the importance of certainty and predictability, the Court concluded that the defendant’s breach of contract occurred, if at all, on the closing date and not when it subsequently refused to repurchase breaching mortgages and New York’s six-year statute of limitations for breach of contract ran from that date. The case is ACE Securities Corp. v. DB Structured Products, Inc., 25 N.Y.3d 581 (2015).
Then in late 2018, the New York Court of Appeals in a split decision went a step further when it addressed whether parties can contractually define when a cause of action for breach of representations and warranties accrues. The Court affirmed the lower courts’ rulings dismissing the case as time-barred, even though the parties had an “Accrual Clause” in their agreement conditioning the accrual of a cause of action on demand for compliance with the parties’ agreement. Although the case would have been timely had that provision been enforced, the Court of Appeals held that to the extent the parties intended to delay the commencement of the statute of limitations by agreeing when a cause of action “shall accrue,” their attempt to do so was prohibited by New York law and its public policy. In a biting dissent, Judge Rowan D. Wilson wrote:
Both here and in our prior decision in ACE we have fundamentally misinterpreted the structure of RMBS agreements and, as a result, have created bad law: bad because it neither hews to the intent of the contracting parties nor of the investors in securities issued thereby; bad because it serves no public policy; bad because it disserves a very important public policy—the preservation of New York’s role as the commercial center of the nation.
Judge Wilson concluded, “were I advising a party to a prospective RMBS agreement today, I would tell my client that the law of Delaware is clear . . . , and the law of New York is not.” The case is Deutsche Bank National Trust Co. v. Flagstar Capital Markets Corp., 32 N.Y.3d 139 (2018).
Separately, in 2018, the New York Court of Appeals decided that the statute of limitations for non-scienter based enforcement actions brought by the New York Attorney General pursuant to the Martin Act (N.Y. GBL § 23-A) is three years, not six as argued by the government. The Court thus dismissed as time-barred the government’s non-scienter based claims. The case is People v. Credit Suisse Sec., 31 N.Y.3d 622 (2018). On August 26, 2019 Governor Cuomo signed into law a bill passed by the New York legislature in June amending the C.P.L.R. to codify that the statute of limitations for Martin Act claims is six years. In effect, this law reverses the Court of Appeals’ decision in People v. Credit Suisse.
Finally, the New York Court of Appeals is presently considering a case that will define the bounds of New York’s borrowing statute, N.Y. C.P.L.R. 202. The borrowing statute requires, in the case of a non-resident plaintiff suing in New York, that the court apply the shorter of New York’s statute of limitations or that of the place where the claim arose. And generally, under New York law, a claim arises where the plaintiff is injured, which is typically the plaintiff’s place of residence. Here, the trial court applied an exception to that general rule, finding that in the case of a securitization trustee suing for the benefit of investors concerning a New York common law trust that was created in New York, the place of injury if not New York is fact intensive and could not be decided on a pleadings motion. The Appellate Division, First Department disagreed and found that the claim arose in California where the trustee maintained its principal place of business and where a number of the securitized mortgage loans were issued. The Court of Appeals granted certification of the issue and is expected to hear the case in the fall of 2019. The case is entitled Deutsche Bank National Trust Company, solely in its capacity as Trustee of Securitized Asset Backed Receivables LLC Trust 2007-BR1 v. Barclays Bank PLC, Index No. 651338/2013 (N.Y. Sup Ct.)).
Contractual Interpretation - Reimbursement of Attorneys’ Fees
Three recent New York appellate decisions have upheld trustees’ rights to recover their attorneys’ fees and litigation expenses from the defendants, who are securitization sponsors and mortgage originators. These decisions add clarity to New York’s application of the “American Rule” under which, absent a statutory or contractual mandate, parties bear their own attorneys’ fees. In these cases, the Appellate Division, First Department concluded that the operative contractual language was sufficiently clear to evidence intent that defendants reimburse plaintiff trustees for their litigation fees and expenses. The cases are U.S. Bank National Association v. DLJ Mortgage Capital, Inc., 34 N.Y.S.3d 428, 429 (1st Dep’t 2016) (“HEAT”), Wilmington Trust Co. v. Morgan Stanley Mortgage Capital Holdings LLC, 152 A.D.3d 421 (1st Dep’t 2017) (“MSM”), and Deutsche Bank National Trust Co. v. EquiFirst Corp., 154 A.D.3d 605 (1st Dep’t 2017) (“EQLS”), and have not been appealed to New York’s Court of Appeals. As such, they are binding law in New York County – i.e., in Manhattan.
The Common Interest Privilege
In 2016, the New York Court of Appeals was called upon to consider whether the common interest privilege extended to protect communications between parties with a common business interest, even if there were no litigation pending or anticipated. This trend has evolved in the recent developments in the Second, Third, Seventh and Federal Circuits, where litigation is not required to establish the application of common interest. The Court declined to expand the privilege, holding that litigation must be reasonably anticipated in order to invoke the privilege. The case is Ambac Assur. Corp. v. Countrywide Home Loans, Inc., 27 N.Y.3d 616 (2016).
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A distinguished panel of New York practitioners will discuss these binding decisions and other important case law that shaped New York law in the wake of the financial crisis. The program is part of the ABA Business Law Section Annual Meeting, and is called How the Global Financial Crisis Has Shaped New York Law. The program is scheduled for 8:30 a.m. on Thursday, September 12, 2019.