As we described in a prior client alert, the New York Court of Appeals issued in March of this year issued a significant decision affecting residential mortgage-backed securities (RMBS) putback litigation governed by New York law. The decision, US Bank National Association v. DLJ Mortgage Capital2022 WL 801440 (NY March 17, 2022), substantially tightened the pre-suit notice requirements in RMBS putback litigation, holding that the notice requirements of typical RMBS repurchase protocols can only be satisfied by loan-by-loan notice of material breaches, given prior to the commencement of suit.
In a significant follow-up ruling, a trial court in New York County has now addressed a crucial issue raised by the US Bank decision: whether, as an alternative to providing the required loan-by-loan notice, an RMBS plaintiff can instead show that the defendant had constructive knowledge of the loans’ defects. In a pre-trial ruling in Ambac Assurance Corp. v. Countrywide Home Loans, the New York State Supreme Court answered in the affirmative. Specifically, the court held that, to satisfy the “notice or discovery” requirement of the repurchase protocol, it is sufficient to show that the defendant knew or should have known of the loans’ defects – a showing that potentially can be made as to all loans in the aggregate, rather than having to be made on a loan-by-loan basis.
Ambac’s suit against Countrywide, commenced in 2010, arose out of 17 Countrywide-sponsored RMBS transactions that closed between 2004 and 2006, involving over 375,000 pooled residential mortgage loans with an original principal balance of approximately 25 billion. As the insurer of the securitizations, Ambac agreed to insure the payments of principal and interest due to the RMBS certificateholders for each securitization.
In the governing insurance agreements, Countrywide made a variety of loan-level representations and warranties about the quality of the mortgage loans and Countrywide’s policies for loan origination, as well as transaction-level representations and warranties concerning the accuracy of all information it provided to Ambac. . As in the US Bank case, the sole remedy against Countrywide for breaches of representations and warranties was the repurchase protocol, triggered by breaches of representations and warranties that materially and adversely affected the interests of Ambac.
In anticipation of a trial scheduled to commence this September, Countrywide moved to exclude evidence that it had constructive knowledge of breaches of representations and warranties so as to trigger the repurchase protocol. Following the Court of Appeals’ US Bank ruling, the parties filed letter-briefs seeking rulings addressing the effect of that decision on the proof to be admitted at trial.
Countrywide contended that, in light of US Bank, Ambac should not be permitted to offer evidence to show that Countrywide “discovered” breaching loans on a global basis, as opposed to an individual loan-by-loan basis. Ambac responded that the Court of Appeals in US Bankexplicitly stated that the issue of discovery was not before the Court. Accordingly, Ambac asserted, US Bank addressed only the notice prong of the repurchase protocol and not the separate and independent issue of discovery.
The May 18, 2022 Hearing
In a pre-trial hearing on Countrywide’s motion, the court declined to find that loan-by-loan discovery of breaches is required. Justice Reed agreed with Ambac that, because the US Bank The decision did not address the issue of when discovery triggers the repurchase protocol, the trial court was bound by controlling precedent of the First Department, which holds that (1) the issue of discovery is a triable issue of fact, and (2) the appropriate legal standard is constructive knowledge, ie, whether Countrywide “knew or should have known” of the breaching loans. The court further held that evidence of Countrywide’s policies and practices is relevant to whether Countrywide discovered breaching loans. In keeping with prior First Department rulings in other cases holding that the standard for discovery is constructive notice, Justice Reed held that, if Ambac can establish that Countrywide, as originator, knew or should have known of the breaches globally, it will not need to prove Countrywide’s knowledge on a loan-by-loan basis.
This decision has significant implications for the Ambac case, as well as for RMBS putback litigation generally. In this case, Ambac provided pre-suit notice of breach for only about 7,000 loans, whereas Ambac’s experts have opined that close to 80% of the 375,000 pooled residential mortgage loans were materially defective. Justice Reed’s ruling potentially enables Ambac to prove that Countrywide breached 300,000 loans, rather than just the 7,000 loans as to which Ambac had given specific notice. Moreover, Justice Reed’s ruling potentially enables Ambac to prove Countrywide’s constructive knowledge of breaches on a global, rather than loan-by-loan, basis. Given that Countrywide was the originator, servicer and sponsor of the loans in question, evidence of Countrywide’s policies and practices may go far to satisfy this evidentiary burden.
Should other judges follow Justice Reed’s ruling, other RMBS cases could be significantly impacted in similar fashion.
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