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The Essential Resource for Today’s Busy Insolvency Professional

Practice & Procedure By John D. Giampolo

ResCap Liquidating Trust Can Proceed Against Several Mortgage Loan Originators

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John D. Giampolo Wollmuth Maher & Deutsch LLP New York John Giampolo is a partner and co-chair of the Bankruptcy and Restructuring Group at Wollmuth Maher & Deutsch LLP in New York.

n Feb. 3, 2015, the U.S. Bankruptcy Court for the Southern District of New York filed a lengthy opinion in the chapter 11 case of In re Residential Capital LLC, et al. largely denying motions that sought to dismiss adversary proceedings brought by the ResCap Liquidating Trust against mortgage loan originators.1 Those adversary proceedings2 are among the numerous lawsuits commenced in the bankruptcy court, as well as in the U.S. District Court in the District of Minnesota by Residential Funding Co. LLC, f/k/a Residential Funding Corp. (RFC), or by the ResCap Liquidating Trust (the “trust”), as successor to RFC, alleging that mortgage loan originators sold billions of dollars in defective loans to RFC, which resulted in liability to RFC. In sum, the bankruptcy court’s ResCap opinion3 granted the motions to dismiss to the extent of dismissing the breach-of-contract claims arising from loans acquired by RFC before May 14, 2006, but denied the motions on all other grounds.4

Background

RFC was in the business of acquiring and securitizing mortgage loans.5 It would purchase loans from lenders and then either sell them to whole loan purchasers, or pool the loans and sell them to residential mortgage-backed securitization (RMBS) trusts, which would subsequently sell certificates to investors. RFC and its affiliates faced lawsuits 1 Case No. 12-12020 (MG) (Bankr. S.D.N.Y. May 14, 2012). 2 Adv. Proc. No. 13-01820 (MG); Adv. Proc. No. 14-01915 (MG); Adv. Proc. No. 14-01916 (MG); Adv. Proc. No. 14-01926 (MG); Adv. Proc. No. 14-01996 (MG); Adv. Proc. No. 14-02004 (MG); and Adv. Proc. No. 14-07900 (MG). 3 ResCap Liquidating Trust Mortg. Purchase Litig. v. HSBC Mortg. Corp. (USA) (In re Residential Capital LLC), 524 B.R. 563 (Bankr. S.D.N.Y. Feb. 3, 2015). 4 Id. at 597. 5 Id. at 572.

alleging that the loans that RFC had sold or securitized were defective. RFC and its debtor/affiliates subsequently filed their chapter 11 cases on May 14, 2012. Hundreds of proofs of claim were filed against RFC and its debtor/affiliates, alleging billions of dollars of damages arising from the allegedly defective loans. RFC and its debtor/affiliates settled much of this RMBS-related liability, granting allowed claims totaling billions of dollars and incurring millions of dollars in attorneys’ fees in connection with a global bankruptcy settlement under the debtors’ confirmed chapter 11 plan.6 When the plan became effective on Dec. 17, 2013, the trust became the successor-in-interest to RFC and the assignee of RFC’s claims.7 The original lawsuits that became the adversary proceedings were filed on the Dec. 17, 2013, plan effective date or on later dates by either RFC or the trust, as RFC’s successor,8 against the defendants, GreenPoint Mortgage Funding Inc., Summit Financial Mortgage LLC, Summit Community Bank Inc., Suntrust Mortgage Inc., HSBC Mortgage Corp. (USA), UBS Real Estate Securities Inc. and Mortgage Investors Group Inc.9 The complaints in the adversary proceedings allege that the loans that the defendants sold to RFC were defective, that the defendants breached representations and warranties made in various agreements governing the defendants’ sale of loans to RFC, and that such breaches caused much of the liabilities that RFC was forced to resolve under the bankruptcy settlement. Each complaint asserted two claims against each defendant, one breach-of-con6 7 8 9

Id. at 574. Id. Id. Id.

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tract claim for breaches of the representations and warranties, and one indemnification claim for liabilities and losses that RFC incurred as a result of those breaches.10 Since 2013, RFC or the trust has filed more than 80 lawsuits similar to the adversary proceedings against other defendant loan originators in Minnesota District Court seeking to recover on the billions of dollars of liability that RFC incurred.11

The ResCap Opinion

The ResCap opinion addressed four motions to dismiss, three that were filed by individual defendants and one that was filed collectively on behalf of all defendants.12 In sum, the motions asserted the following arguments: (1) the plaintiff lacked standing; (2) the complaints did not sufficiently plead satisfaction of all required conditions precedent to bringing the suit; (3) “sole remedy” provisions in the loan sale agreements precluded seeking monetary damages and only permitted the plaintiff to seek the repurchase of the loans as the exclusive remedy; (4) the plaintiff’s breach-of-contract claims were subject to collateral estoppel as they were untimely and insufficiently pled; and (5) the plaintiff’s indemnification claims should have been dismissed as a matter of law.13 The bankruptcy court ultimately denied the motions on all grounds except that the bankruptcy court found that the statute of limitations barred those breach-of-contract claims that related to loans acquired by RFC before May 14, 2006 (more than six years before RFC filed for bankruptcy).14 Standing Suntrust and UBS argued that when RFC filed the complaints against them on the Dec. 17, 2013, plan effective date, RFC had already assigned its rights to the trust, and therefore, the trust lacked standing to maintain RFC’s defectively commenced actions.15 The bankruptcy court held that even if a standing deficiency existed, such would constitute an honest mistake, and therefore “substitution of the Trust as the real party in interest to pursue these Adversary Proceedings [wa]‌s appropriate.”16 GreenPoint, Summit Community, Summit Financial and Suntrust asserted that the plaintiff lacked standing to bring claims based on the securitized loans at issue because RFC had assigned all of its rights in those loans to securitization trusts or to other third parties.17 The bankruptcy court considered how the Minnesota District Court rejected this same challenge in a similar Minnesota action.18 The court similarly concluded that the plaintiff had adequately alleged standing to assert its rights with respect to the securitized loans and that the alleged assignment documents cited by these defendants were not part of or embraced by the plaintiff’s pleadings and thus could not be considered on a motion to dismiss.19 The court also found that the lan10 Id. at 574. 11 Id. at 571, fn.3; see also rescapliquidatingtrust.com/RMBSCases.aspx for a list of RMBS cases (last visited Feb. 27, 2015). 12 ResCap Opinion, 524 B.R. at 574, fn.7-8. 13 Id. at 570, 571-72. 14 Id. at 571-72. 15 Id. at 576-77. 16 Id. at 579 (internal citations omitted). 17 Id. at 581. 18 Id. at 581-82 (citing Residential Funding Co. v. Cmty. W. Bank NA, 2014 WL 5207485, *11-12 (D. Minn. Oct. 14, 2014)). 19 ResCap Opinion, 524 B.R. at 582.

guage of the assignment documents that were cited did “not unambiguously establish RFC’s assignment of its claims relating to securitized loans,” and therefore, determining whether RFC assigned its rights in such loans to third parties would require factual findings that were not appropriate for a motion to dismiss.20 Sufficiency of Pleadings for Satisfaction of Conditions Precedent Citing certain agreements, Suntrust and UBS argued that the complaints did not sufficiently plead that RFC satisfied all conditions required in order to bring the claims against them, including alleged requirements that RFC provide written notice and opportunity to cure breaches before commencing suit.21 Relying on the plain language of Rule 9‌(c) of the Federal Rules of Civil Procedure, the bankruptcy court ruled that in pleading conditions precedent, it sufficed that the complaints generally alleged that all conditions precedent had occurred or been performed.22 Sole Remedy Provisions GreenPoint argued that the plaintiff was barred from suing to recover monetary damages because a provision in its agreements provided that the sole remedy for any breach is the repurchase of the allegedly defective loans.23 The bankruptcy court denied GreenPoint’s motion on this basis.24 and relying on case law from other courts in the Second Circuit, it ruled that the sole remedy provision does not bar monetary damages where specific performance of the sole remedy is impossible, and whether it is possible to repurchase the GreenPoint loans requires a factual determination not appropriate for a motion to dismiss.25 Plaintiff’s Breach-of-Contract Claims The defendants argued that collateral estoppel precluded the plaintiff’s breach-of-contract claims for loans sold before May 14, 2006, because the Minnesota District Court decided that similar breach-of-contract claims were time-barred in two similar Minnesota actions.26 The bankruptcy court rejected this argument because those two decisions were not final judgments.27 The defendants also argued that the breachof-contract claims accrued at the time that the allegedly defective loans were sold to RFC, and that such claims are time-barred because the three-year statute of limitations in Delaware (RFC’s state of organization) should apply under New York’s borrowing statute.28 The defendants argued that virtually all loans subject to the complaints were sold before May 14, 2009, and thus all breach-of-contract claims relating to those loans are time-barred under Delaware’s three-year statute of limitations, even though it was tolled for two years by RFC’s May 14, 2012, bankruptcy filing.29 The defendants alternatively argued that the plaintiff’s breach-of-contract claims for loans sold before May 14, 2006, were time-barred 20 Id. (internal citations omitted). 21 Id. at 583-84. 22 Id. at 584-85. 23 Id. at 585. 24 Id. at 586. 25 Id. at 585 (citing Ace Securities Corp. Home Equity Loan Trust, Series 2007-HE3 ex rel. HSBC Bank USA NA v. DB Structured Prods., 5 F. Supp. 3d 543, 555-56 (S.D.N.Y. 2014)). 26 Id. at 589, fn.19 (citations omitted). 27 Id. 28 Id. at 586-87 (internal citations omitted). 29 Id. at 588-89

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because the agreements contained choice-of-law provisions requiring application of the six-year statutes of limitations under either Minnesota or New York law.30 The bankruptcy court found that the cited choice-of-law provisions were not dispositive here because “[a] choice-oflaw provision in a contract generally does not govern the applicable statute of limitations to a cause of action arising out of that contract.”31 The court also found that the New York borrowing statute requires application of New York’s statute of limitations, unless the state where the claim accrued has a shorter statute of limitations.32 Applying New York law, the bankruptcy court reasoned that a corporation’s claim accrues where the corresponding economic injury occurs, which is either its state of incorporation or principal place of business,33 but when those are different states with conflicting statutes of limitations, the claim accrues “where the economic injury is suffered to a greater extent.”34 Here, it was not alleged that RFC had any financial base, other than its principal place of business in Minnesota, where RFC could have suffered its economic injury.35 Thus, the bankruptcy court found that the plaintiff’s breach-of-contract claims accrued in Minnesota and that New York’s six-year statute of limitations applied to them because Minnesota’s statute of limitations is no shorter than New York’s.36 In determining whether the plaintiff’s breach-of-contract claims were timely under the six-year statute of limitations, the bankruptcy court noted that under New York and Minnesota law, the claim accrues at the time of breach.37 The court found that “[a]‌s alleged in the Complaints, the Plaintiff’s breach-of-contract claims all relate to loan defects that occur at origination, and therefore these claims accrued on the closing date of these loans — the date [that] the Defendants’ false representations and warranties concerning these loans were made.”38 The bankruptcy court found that the time of accrual was not altered by the defendants’ alleged continuation of the breaches by failing to report or cure the breaches.39 Nor did that create separate or subsequent breachof-contract claims with later accrual dates.40 Ultimately, the court concluded that the plaintiff’s breach-of-contract claims relating to loans sold to RFC before May 14, 2006 (more than six years before RFC’s bankruptcy filing), are untimely and granted the motions to that extent.41 However, the bankruptcy court held that the plaintiff’s breach-of-contract claims for loans sold to RFC on or after May 14, 2006, were timely under the applicable statute of limitations.42 The defendants also argued that the plaintiff failed to plead its breach-of-contract claims with required specificity because the complaints make broad conclusory allegations of widespread loan defects, but only a small fraction of those allegedly defective loans were identified as loans sold from the defendants, and specific defects were only alleged with 30 Id. 31 Id. at 586 (citing Portfolio Recovery Ass’n. v. King, 927 N.E.2d 1059, 1061 (N.Y. 2010)). 32 ResCap Opinion, 524 B.R. at 586-87 (internal citations omitted). 33 Id. at 589. 34 Id. 35 Id. at 588. 36 Id., citing Minn. Stat. § 541.05‌(1); N.Y.C.P.L.R. § 213‌(2); and Stuart v. Am. Cyanamid Co., 158 F.3d 622, 627 (2d Cir. 1998). 37 ResCap Opinion, 524 B.R. at 588 (citing Guilbert v. Gardner, 480 F.3d 140, 149 (2d Cir. 2007)). 38 ResCap Opinion, 524 B.R. at 592. 39 Id., fn.21 (internal citations omitted). 40 Id. 41 Id. at 592. 42 Id.

respect to “a sample of each universe of loans.”43 Considering how Minnesota courts ruled on this issue, the bankruptcy court held that the plaintiff adequately pled its claims and was “not require‌[d] to plead ‘loan-by-loan specificity’ at the motion to dismiss stage.”44

[I]f a contract provided that representations and warranties survive the loan sale closing and impose a continuing disclosure obligation “to protect against some post-sale defect,” then a claim for the breach of that continuing disclosure obligation could survive.... Indemnification Claims The defendants argued that the plaintiff’s indemnification claims should be dismissed because they sought indemnification for a liability that was incurred by RFC for securities law, fraud or other intentional tort claims brought against RFC, and indemnification of such claims is barred as a matter of law.45 The bankruptcy court denied the motions on this basis.46 Analyzing cases within the Second Circuit and cases interpreting both New York law and Minnesota law, the bankruptcy court noted that other courts have refused to bar indemnification on claims for securities law violations or other intentional wrongdoing where the party seeking indemnification had not yet admitted liability or been found liable for the underlying claims.47 In this case, RFC’s exposure to RMBS-related losses had been fixed by the bankruptcy settlement, but RFC had not admitted liability and had not been adjudicated as liable on the claims for which the plaintiff sought indemnification.48

Analysis

Examination of the ResCap opinion in comparison with some decisions from the Minnesota actions provides some interesting takeaways. Notably, in its analysis the bankruptcy court often considered how the Minnesota courts had ruled on the same issues and at times reached conclusions similar to that of the Minnesota courts. Yet, the bankruptcy court was not particularly guided by decisions from similar Minnesota actions that found similar breach-of-contract claims to be untimely. Instead, the bankruptcy court performed its own analysis but reached a similar conclusion in finding that the breach-of-contract claims in the adversary proceedings could not have accrued later than the date that the corresponding loans were sold to RFC; therefore, the claims must be timebarred if they relate to loans purchased before May 14, 2006. 43 Id. at 593. 44 Id., quoting Residential Funding Co. LLC v. Broadview Mortg. Corp., 2014 WL 4104819, at *5 (D. Minn. Aug. 19, 2014). 45 ResCap Opinion, 524 B.R. at 594. 46 Id. 47 Id. at 594-95, citing Greenwald v. Am. Medcare Corp., 666 F. Supp. 489, 493 (S.D.N.Y. 1987) (internal citations omitted). 48 ResCap Opinion, 524 B.R. at 595.

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By contrast, Minnesota Court Judge Susan Nelson’s joint opinion filed Nov. 12, 2014, in other Minnesota actions, left open the possibility that a breach-of-contract claim for loans sold prior to May 14, 2006, could survive because it was “plausible from the face of th‌[os]e Complaints that one of the allegedly breached warranties related to an event that occurred, if at all, after the sale of a loan [and] [i]‌n that case, the statute of limitations would not begin to run until some later date.”49 Similarly, in another Minnesota action, Minnesota Court Judge David Doty refused to dismiss a breach-of-contract claim for loans sold prior to May 14, 2006, because it was specifically pled in that case that the defendant breached a continuing obligation that it had under the sale contract to promptly inform RFC of any defects in the loans that had been sold, and such a pleading was “sufficient to allege a continuing breach.”50 The ResCap opinion provided a hypothetical scenario in which a breach-of-contract claim for loans sold before May 14, 2006, could survive. The bankruptcy court remarked that if a contract provided that representations and warranties survive the loan sale closing and impose a continuing disclosure obligation “to protect against some post-sale defect,” then a claim for the breach of that continuing disclosure obligation could survive even if the sale occurred before May 14, 2006.51 However, the bankruptcy court found that allegation absent among the complaints in the adversary proceedings.52 abi Editor’s Note: For more insight on this topic, purchase A Practitioner’s Guide to Liquidation and Litigation Trusts, now available in the ABI Bookstore (abi.org/bookstore). Members must log in first to obtain reduced pricing. Reprinted with permission from the ABI Journal, Vol. XXXIV, No. 4, April 2015. The American Bankruptcy Institute is a multi-disciplinary, nonpartisan organization devoted to bankruptcy issues. ABI has more than 12,000 members, representing all facets of the insolvency field. For more information, visit abi.org.

49 Residential Funding Co. LLC v. Academy Mortgage Corp., Civil No. 13-3451 (SRN/JSM), ECF Doc. No. 42 (D. Minn. Nov. 12, 2014). 50 Residential Funding Co. v. CTX Mortg. Co., Civil No. 14-1710 (DSD), ECF Doc. No. 64 (D. Minn. Jan. 23, 2015). 51 ResCap Opinion, 524 B.R. at 592. 52 Id.

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