OVERVIEW OF CONTRACT CLAIMS: RESIDENTIAL MORTGAGE BACKED SECURITIZATIONS

Transcription

1 OVERVIEW OF CONTRACT CLAIMS: RESIDENTIAL MORTGAGE BACKED SECURITIZATIONS KATHY PATRICK Partner Gibbs & Bruns LLP State Bar of Texas SUING, DEFENDING AND NEGOTIATING WITH FINANCIAL INSTITUTIONS February 9-10, 2012 Houston CHAPTER 17

2

3 KATHY D. PATRICK Gibbs & Bruns, LLP Partner Kathy Patrick focuses her practice on complex commercial litigation, with an emphasis on securities law, creditor recovery litigation, and institutional investor litigation. Kathy s representative clients include: Huntsman Corporation, PIMCO, Trust Company of the West, Invesco, Western Asset Management, Ambac Assurance, the former outside directors of Enron Corporation and the State of Arizona. After graduating from Harvard Law School, Kathy was a law clerk to Judge John R. Brown, United States Court of Appeals for the Fifth Circuit, from 1985 to 1986.

4

5 TABLE OF CONTENTS I. TYPICAL RMBS STRUCTURE... 1 II. TYPICAL PSA TERMS THAT AFFECT INVESTORS RIGHTS... 1 III. CONTRACT REMEDIES UNDER PSAS... 2 APPENDIX A: TEMPLATE PSA PROVISIONS... 5 i

6

7 OVERVIEW OF CONTRACT CLAIMS: RESIDENTIAL MORTGAGE-BACKED SECURITIZATIONS I. TYPICAL RMBS STRUCTURE 1 A. Mortgages are pooled as collateral for a trust B. The trust issues securities called certificates that are similar to notes C. As a result of the REMIC 2 structure of most RMBS trusts, holders of certificates receive pass through payments of the principal and interest on underlying mortgages. These function like payments of principal and interest on the notes, but have technical differences from them. D. Trust is administered by a Trustee, pursuant to either an Indenture of Trust or a Pooling and Servicing Agreement (PSA). 1. PSAs and Trust Indentures are functionally the same form of agreement See e.g. E.F. Hutton S.W. Prop. II, Ltd. v. Union Planters Nat l. Bank, 953 F.2d 963 (5 th Cir. 1992); Sterling Fed. Bank F.S.B. v. DLJ Mortg. Capital, Inc., 2010 WL (N.D. Ill. 2010); and, Greenwich Fin. Servs. Distressed Mortgage Fund 3 LLC v. Countrywide Fin. Corp., 603 f.3d 23 (2d Cir. 2010) (explaining that PSAs are trust agreements similar to bond indentures in many respects). 1 Most residential mortgage backed securities are structured pursuant to a standard set of agreements and terms. Appendix A to this outline contains a summary of the more common standard terms. 2 REMIC is an acronym for Real Estate Mortgage Investment Conduit. These vehicles, which were created by the Tax Reform Act of 1986, eliminated the double taxation of income at the corporate level and dividends to security holders, thus allowing REMICS to obtain tax-exempt pass through treatment of distributions to investors from underlying collateral pooled in a trust. 3 We use the term PSA for convenience in this outline, as that is the more typical form of agreement in a first-lien RMBS. Home equity RMBS are more typically created through an indenture structure. 1 E. Collection of principal and interest, investor reporting, pursuit of foreclosure or collateral remedies, and the maintenance and sale of foreclosed properties is the responsibility of the Master Servicer F. Sellers of mortgages pooled in the trusts provide representations and warranties that each Mortgage Loan conforms to specific credit quality, property and other characteristics. These are commonly known as reps and warranties. G. Sellers agree to repurchase mortgages that do not conform to representations and warranties, subject to certain conditions. II. TYPICAL PSA TERMS THAT AFFECT INVESTORS RIGHTS A. All collateral, claims and contract rights belong to the Trustee, which holds and exercises them for the benefit of the certificateholders in the Trusts. B. In the absence of an Event of Default, the Trustee s duties are typically confined to and limited by the express language of the contract. See generally Beck v. Manufacturers Hanover Trust Co., 218 A.D.2d 1, 632 N.Y.S.2d 520 (1 st Dept 1995). 1. The Trustee also has two common law duties under New York law 4 : a. to avoid conflicts of interest; See Elliot Assoc. v. J. Henry Schroder Bank & Trust Co., 838 F.2d 66 (2d Cir. 1988) b. to perform its non-discretionary, ministerial functions with due care. See also AG Capital Funding Partn., L.P. v. State Street Bank and Trust Co., 11 N.Y.3d 146 (2008). 2. The Trustee, despite its name, is not generally considered to be a fiduciary to the Certificateholders in the absence of an Event of Default. C. After an Event of Default, the Trustee is subject to a fiduciary obligation to exercise 4 Most PSAs and Indentures of Trust are governed by New York law.

8 the rights granted to it under the PSA in a prudent manner. Beck, supra. D. The Trustee is indemnified by the Master Servicer for all actions taken pursuant to the duties imposed on it under the Agreement. E. Certificateholders rights to act are limited. 1. PSAs require collective action by certificateholders 2. PSAs usually require large voting thresholds as a condition precedent to certificateholder actions to enforce the PSAs; 3. If the Trustee acts, Certificateholders typically cannot act unless they instruct the trustee to desist from the action; and, 4. If Certificateholders instruct the Trustee to take action, they must provide the Trustee with a reasonably satisfactory indemnity. III. CONTRACT REMEDIES UNDER PSAS A. Repurchase and Cure Remedies for Violations of Reps and Warranties. 1. What does materially and adversely affects the interest of the Certificateholders in that Mortgage Loan mean? 2. At what date is adversity determined? a. Wells Fargo Bank, N.A. v. LaSalle Bank N.A., 643 F. Supp. 2d 1014 (S.D. Ohio 2009) (denying summary judgment where there was strong evidence that the [loan] never would have been made if Defendant had been aware of the second mortgage); b. Wells Fargo Bank, N.A. v. LaSalle Bank N.A. (II), 2009 WL (S.D. Ohio Oct. 27, 2009) (excluding evidence of subsequent underwriting guidelines, suggesting that relevant date for determination of adversity is at the time of the securitization); c. LaSalle Bank N.A. v. Merrill Lynch Mortg. Lending, Inc., 2007 WL (S.D.N.Y. Aug. 13, 2007) (appearing to consider post-closing events in analysis of adversity); 2 3. What constitutes a material and adverse effect? a. Lehman Bros Holdings, Inc. v. Laureate Realty Svcs, Inc., 2007 WL (S.D. Ind. Sept. 28, 2007) (citing loss on loan as evidence of adversity) b. LaSalle Bank N.A. ex rel. Lewnnar Partners, Inc. v. Capco Am. Securitization Corp., 2005 WL (S.D.N.Y. Nov. 14, 2005) (default on loan supports summary judgment on the issue of adversity). c. LaSalle Bank N.S. v. Lehman Bros. Holdings, Inc., 237 F.Supp.2d 618 (D. Md. 2002) (evidence of environmental contamination at the time of securitization is sufficient to demonstrate adversity) d. LaSalle Bank N.A. v. Citicorp Real Estate, Inc., 2002 WL (S.D.N.Y. Feb. 5, 2002) (defaulted loan demonstrates adversity) 4. What is the significance of drafting history? a. Earlier versions of PSAs provided for repurchase if the defect materially and adversely affects the value of the Mortgage Loan. b. The value of language was deleted in later issuances. 1. See Wells Fargo I, supra 2. See Merrill Lynch Mortg. Lending, supra 5. What is the significance of intervening declines in the housing market, the job market, or individual issues that affect borrowers ability to pay? a. Pending motions for summary judgment in MBIA litigation against Countrywide may address this issue. b. Relevant cases: 1. Wells Fargo Bank, N.A. v. LaSalle Bank, N.A., 2011 WL (D. Nev. Feb. 23, 2011 (refusing to exclude evidence that decline in the housing and real estate

9 markets caused material adverse effects, not a breach of any representation ) 2. Wells Fargo Bank N.A. v. LaSalle Bank, N.A., 2011 WL (W. D. Okla. Apr. 1, 2011) ( So long as Plaintiff asserts material and adverse effects as of the closing date, evidence regarding the postsecuritization market conditions is inadmissible. 3. Wells Fargo v. LaSalle Bank (II), supra ( To put it another way, the fact that an investor might have made a different decision had he or she had different information may make that information material to the investor s decision, but it does not make the omission of hat information cause a material and adverse effect on the loan. Material information and material effect are not the same thing. ) B. Remedies for Missing Collateral Documentation 1. Robo-signing scandal has raised concerns regarding whether the chain of title necessary to pursue collateral remedies exists for some loans. 2. Most securitizations impose a three stage closing certification process to ensure all required collateral documents are conveyed. a. See e.g. Countrywide PSAs at 2.01 b. Step One: Mortgage files must be delivered; c. Step Two: Trustee prepares an initial certification confirming that it holds all required collateral documents, and noting any exceptions. This triggers a cure obligation on the part of the mortgage seller; d. Step Three: Following a cure period, Trustee delivers a Final Certificate confirming it has all required loan documentation, and noting any exceptions. The seller 3 is then required to cure or repurchase the affected loans that are missing documents. 3. Most securitizations also include a requirement that notes be endorsed in blank, without recourse, for the benefit of the Trustee. a. This form of endorsement is permissible under the UCC b. This form of endorsement, if actually performed, is also sufficient to support the right to foreclose on collateral. See U.S. Bank, N.A. v. Ibanez, 458 Mass. 637, 941 N.E.2d 40 (Mass. 2011). ( Where a pool of mortgages is assigned to a securitized trust, the executed agreement that assigns the pool of mortgages, with a schedule of the pooled mortgage loans that clearly and specifically identifies the mortgage at issue as among those assigned, may suffice to establish eh trustee as the mortgage holder. However, there must be proof that the assignment was made by a party that itself held the mortgage. ) 4. In general, in UCC states, statutes permit the Trustee to compel the execution or completion of missing collateral documentation. a. UCC permitting holder to compel completion of blank endorsements by person to whom note is made payable; b. UCC permitting a transferee for value to compel an unqualified endorsement by the holder; c. UCC permitting proof of existence through a valid lost note affidavit 5. The Trustee s requirement to provide closing certificates is a nondiscretionary duty it must perform with due care. See supra, Part II (B) (2). C. Remedies for Poor Mortgage Servicing

10 1. The Master Servicer has a contractual obligation to service the mortgage loans prudently. 2. If all conditions precedent are met, the breach of this duty may permit the Trustee to remove the Master Servicer. Certificateholders, subject to voting requirements and conditions precedent, may also direct the Trustee to remove the Master Servicer. a. See e.g. Countrywide PSA 7.01 b. If the Master Servicer is removed, the Trustee is to function as the Master Servicer. 3. What is the appropriate measure of damage for breach of this duty? a. In Beck, supra, the court reinstated a post-default claim for damages against a trustee that failed to act with reasonable care in disposing of collateral. [T]he Trustee s failure to obtain a competent, independent valuation of the sold collateral constituted a breach of the fiduciary duty owed by the Trustee to the trust beneficiaries; this breach is alleged to have resulted in the undervaluation of the auctioned trust assets, a circumstance from which consequential economic harm to the plaintiff trust beneficiaries may be readily perceived. b. Bowes v. City National Bank, 169 Misc. 78, 6 N.Y.S.2d 803 (N.Y. Sup. 1938) (a pledge cannot so deal with the trust property as to destroy or even impair its value ). c. In other contexts, which may not be applicable to PSAs, courts have described a roughly similar measure of damages for the breach of a duty of care with regard to assets held in trust: v. Catalino, 88 A.D.2d 780, 451 N.Y.S.2d 523 (4 th Dep t 1982) 2. Matter of Janes, 223 A.D.2d 20, 643 N.Y.S.2d 972 (4 th Dep t 1996) ( The proper measure of damages for a fiduciary s negligent retention of assets is the value of the capital that was lost. ). 3. Estate of Rothko, 84 Misc.2d 830, 379 N.Y.S.2d 923 (N.Y. Sur. 1975) ( It is clear that where a fiduciary breaches his duty to the beneficiaries any loss to the estate must fall upon his shoulders and any profit derived from the breach, or profit which would have accrued to the estate if there had been no breach, will inure to the benefit of the estate). 1. The appropriate measure of damages for breach of an escrow agent s obligation to maintain collateral requires placing plaintiff in the same condition it would have been had the wrong not occurred. See generally Town of Evans 4

11 APPENDIX A: TEMPLATE PSA PROVISIONS In order to facilitate the marketing of RMBS, issuers created and sold RMBS pursuant to a largely template deal structure. While particular provisions may vary depending upon collateral type and issuer, the terms described below are present in most RMBS structures. Trustee Ownership of Collateral See e.g. Countrywide PSA at 2.01(b) the Depositor sells, transfers, assigns, sets over and otherwise conveys to the Trustee for the benefit of the Certificateholders, without recourse, all the right title and interest of the Depositor in and to the Trust Fund together with the Depositor s right to require each Seller to cure any breach of a representation or warranty made herein by such Seller, or to repurchase or substitute for any affected Mortgage Loan in accordance herewith. Sellers Obligation to Cure or Repurchase Ineligible Mortgage Loans See e.g. Countrywide PSA at 2.03 Upon discovery by any of the parties hereto 5 of a breach of a representation or warranty with respect to a Mortgage Loan that materially and adversely affects the interests of the Certificateholders in that Mortgage Loan, the party discovery such breach shall give prompt notice thereof to the other parties. Each Seller hereby covenants that within 90 days of the earlier of its discovery or its receipt of written notice from any party of a breach of any representation or warranty with respect to a Mortgage Loan sold by it which materially and adversely affects the interests of the Certificateholders in that Mortgage Loan, it shall cure such breach in all material respects, and if such breach is not so cured, shall repurchase the affected Mortgage Loan from the Trustee at the Purchase Price. Prudent Servicing Obligation See e.g. Countrywide PSA at 3.01 For and on behalf of the Certificateholders, the Master Servicer shall service and administer the Mortgage Loans in accordance with the terms of this Agreement and customary and usual standards of practice of prudent mortgage servicers. The Master Servicer shall have full power and authority, subject to the terms of this agreement, to [sign documents, consent to transfers and assumptions of mortgages, collect insurance proceeds, and effectuate foreclosure]; provided that the Master Servicer shall not take any action that is 5 The parties are: the Trustee, the Master Servicer, the Depositor and the Mortgage Sellers. Certificateholders are not typically parties to the agreements, but they are beneficiaries of them with limited rights of enforcement. 5

12 inconsistent with or prejudices the interests of the Trust Fund or the Certificateholders in any Mortgage Loan or the rights and interests of the Trust Fund, the Trustee and the Certificateholders under this Agreement. The Master Servicer shall represent and protect the interests of the Trust Fund in the same manner as it protects its own interest in mortgage loans in its own portfolio in any claim, proceeding or litigation regarding a Mortgage Loan ) Trustee Obligations in Event of Default and in Absence of Default See e.g. Countrywide PSA at 8.01 The Trustee, prior to the occurrence of an Event of Default and after the curing of all Events of Default that may have occurred, shall undertake to perform such duties and only such duties as are specifically set forth in the agreement. In case an Event of Default has occurred and remains uncured, the Trustee shall exercise such of the rights and powers vested in it by this Agreement, and use the same degree of care and skill in their exercise as a prudent person would exercise or use under the circumstances in the conduct of such person s own affairs. ) Trustee Limitation of Liability See e.g. Countrywide PSA at 8.01 No provision of this Agreement shall be contrasted to relieve the Trustee from liability for its own negligent action, its own negligent failure to act or its own willful misconduct; provided, however, that: (i) Unless an Event of Default known to the Trustee shall have occurred and be continuing, the Trustee shall not be liable except for ht performance of such duties and obligations as are specifically set forth in this Agreement, no implied covenants and obligations shall be read into this Agreement against the trustee and the Trustee may conclusively rely, as to the truth of the statements and the correctness of the opinions expressed therein, upon any certificates furnished to the Trustee and conforming to the requirements of this Agreement which it believed in good faith to be genuine (ii) The Trustee shall not be liable for an error of judgment made in good faith (iii) The Trustee shall not be liable with respect to any action, taken, suffered or omitted to be taken by it in good faith in accordance with the direction of Holders of Certificates evidencing not less than 25% of the Voting Rights of Certificates relating to the time, method and place of conducting any proceeding for any remedy available to the Trustee, or exercising any power conferred upon the Trustee 6

13 Trustee Not Bound to Investigate or Expend Funds; Certificateholders Right to Instruct See e.g. Countrywide PSA 8.02 Except as otherwise provided in 8.01, (iv) the Trustee shall not be bound to make any investigation into the facts or matters stated in any [document related to the PSA], unless requested in writing so to do by Holders of Certificates evidencing not less than 25% of the Voting Rights of Certificates. 6 (vi) the Trustee shall not be required to risk or expend its own funds or otherwise incur any financial liability in the performance of any of its duties or in the exercise of any of its rights or powers hereunder if it shall have reasonable grounds for believing that repayment of such funds or adequate indemnity against such risk or liability is not assured to it. (vii) the Trustee shall not be deemed to have knowledge of an Event of Default until a Responsible Officer of the Trustee shall have received written notice thereof; (ix) the Trustee shall be under no obligation to exercise any of the trusts, rights or powers vested in it by this Agreement or to institute, conduct or defend any litigation at the request of Certificateholders, pursuant to the provision of this Agreement, unless such Certificateholders shall have offered to the Trustee reasonable security or indemnity satisfactory to the Trustee against the costs, expenses and liabilities which may be incurred Trustee Indemnity Provisions Most PSAs and Indentures contain two or more indemnity provisions. The first indemnity runs from the Master Servicer to the Trustee and is embedded in the agreements themselves. The second is an indemnity that is required of Certificateholders if Certificateholders exercise their rights to instruct the Trustee to take (or refrain from taking) action to enforce rights under the Agreement. See e.g. Countrywide PSA 8.05 Master Servicer Indemnity The Trustee and any director, officer, employee or agent of the Trustee shall be indemnified by the Master Servicer and held harmless against any loss, liability or expense (including reasonable attorney s fees and expenses) (i) incurred in connection with any claim or legal action relating to (a) this Agreement, (b) the Certificates or (c) in connection with the performance of any of the Trustee s duties hereunder, other than any loss, liability or expense incurred by reason of willful misfeasance, bad faith or negligence in the performance of any of the Trustee s duties hereunder or incurred by reason of any action of the Trustee taken at the direction of the Certificateholders Note that this indemnity typically includes: reasonable expenses of counsel and reasonable expenses of outside consultants and experts employed by the Trustee to the extent the Trustee needs to employ them to discharge duties under the agreement. See supra Countrywide PSA 8.02(ix) Certificateholder Indemnity 6 Voting Rights provisions in PSAs and Indentures vary widely, both as to total percentage requirements and to classes required to consent to action. As an example, some PSAs required 25% of all Voting Rights to take certain actions; others require 25% of the Voting Rights of each outstanding class of certificates to take action. Others require higher thresholds for certain actions than for other actions taken at the direction of certificateholders. 7

14 Event of Default Requirement of Notice and Opportunity to Cure See e.g. Countrywide PSA 7.01 Event of Default means (ii) any failure by the Master Servicer to observe or perform in any material respect any other of the covenants or agreements on the part of the Master Servicer contained in this agreement which failure materially affects the rights of Certificateholders, that failure continues unremedied for a period of 60 days after the date on which written notice of such failure shall have been given to the Master Servicer by the Trustee or by the Holders of Certificates evidencing not less than 25% of the Voting Rights evidenced by the Certificates. Limitation on Certificateholders Right to Act Requirement of Certificateholder Indemnity See e.g. Countrywide PSA No Certificateholder shall have any right to institute any suit, action or proceeding in equity or at law upon or with respect to this Agreement, unless such Holder previously shall have given to the Trustee a written notice of an Event of Default as provided in this Agreement, and unless the Holders of Certificates evidencing not less than 25% of the Voting Rights evidenced by the Certificates shall also have made written request to the Trustee to institute such action, suit, or proceeding in its own name as Trustee hereunder and shall have offered to the Trustee such reasonable indemnity as it may require against the costs, expenses and liabilities to be incurred therein or thereby, and the Trustee, for 60 days after its receipt of such notice, request and offer of indemnity shall have neglected or refused to instate any such action, suit or proceeding Requirement that Certificateholders Act for the Benefit of All Holders Prohibition on Invocation of Rights to Obtain Individual Benefit See e.g. PSA Section [Certificateholders may take action pursuant to required notices and indemnity] [I]t being expressly understood and intended, and being expressly covenanted by each Certificateholder with every other Certificateholder and the Trustee, that no one or more Holders of the Certificates shall have any right in any manner whatever by virtue of or by availing itself or themselves of any provisions of this Agreement to affect, disturb or prejudice the rights of the Holders of any other of the Certificates, or to obtain or seek priority over or preference to any other such Holder or to enforce any right under this Agreement, except in the manner provided in this Agreement and for the common benefit of all Certificateholders. For the protection and enforcement of the provisions of this Section 10.08, each and every Certificateholder and the Trustee shall be entitled to such relief as can be given either at law or in equity. 8