Is Loan-by-Loan Proof of Breaches Really Required for all RMBS Claims?

Is Loan-by-Loan Proof of Breaches Really Required for all RMBS Claims?

Does the “sole remedy” provision set forth in PSAs require loan-by-loan proof of breaches and preclude the use of loan sampling for all RMBS claims? While case law has for some time been pointing in that direction, a recent holding from the United States District Court for Connecticut signals that the tide may be turning on the use of loan sampling, at least in the case of breach claims separate from strict repurchase claims.

In Law Debenture Trust Co. of New York v. WMC Mort., LLC, No. 3:12-cv-1538 (CSH), 2017 WL 3401254 (D. Conn. Aug. 8, 2017), an RMBS Trustee, Law Debenture Trust Company of New York (“Law Debenture”), sued the loan originator, WMC Mortgage, LLC (“WMC”), claiming that: (1) WMC breached its contractual obligation to cure or repurchase defective loans; and (2) “WMC knew or should have known” of the breaches of reps and warranties but failed to notify the parties to the PSA. Id. at *9. Law Debenture planned to use loan sampling to prove its claims that, at the time of loan origination, WMC failed to exercise due diligence “to so grossly negligent and reckless a degree that the pool of loans in the Trust is afflicted by a pervasive number of loans whose material breaches of representations and warranties destroy or reduce the loans’ value.” Id. at *20. In what the court treated as a motion in limine, WMC argued that the “sole remedy” provision of the PSA “provides that WMC’s obligation to repurchase a materially defective breaching loan is not triggered unless WMC receives notice of the alleged breach, or itself discovers the breach” and that sampling, even if allowed, must be limited to loans for which WMC was given notice or discovered a breach. In a lengthy analysis, the district court denied WMC’s attemp to preclude the use of loan sampling, stating, “I decline to hold in limine that Law Debenture could prove every aspect of its worst-possible-scenario of WMC’s conduct, and still be precluded from establishing loan pool-wide liability and damages by means of statistical sampling.” Id. at 39.

The Law Debenture court distinguished the “strongly persuasive” ruling on summary judgment of Judge Castel in U.S. Bank, NA v. UBS Real Estate Secs., 205 F. Supp. 3d 386 (S.D.N.Y. 2016), that trusts could not recover under a “pervasive breach” theory because “the PSAs expressly provide that cure or repurchase are the ‘sole remedies’ and thus they foreclose the ‘pervasive breach’ theory.” U.S. Bank, NA v. UBS Real Estate Secs., 2015 WL 764665, at *10 (S.D.N.Y. Jan. 9, 2015). The court in Law Debenture noted that, among other differences, Judge Castel was dealing only with a repurchase claim and did not address the effect of the sole remedies provision upon a trustee’s claim of an originator’s failure to notify other PSA parties of multiple and pervasive breaches of reps and warranties. Law Debenture, 2017 WL 3401254, at *15.

In allowing the use of loan sampling, the Law Debenture court reasoned that the PSA’s “sole remedy clause was the linchpin of WMC’s loan-by-loan repurchase protocol,” but that New York’s First Department had stated that “the contractual obligation to notify was independent of the warranty obligations and that the claims for failure to notify were not claims respecting a warranty breach subject to the sole remedy clause.” Id. at *20 (quoting Bank of N.Y. Mellon v. WMC Mort., LLC, 151 A.D.3d 72, 81 (1st Dept. 2017) (emphasis in original)). The court thus found it unlikely that the New York appellate division would bar the use of statistical sampling to prove a claim for failure to notify. In support of its ruling, the court reviewed prior holdings of the New York courts favoring loan sampling and rejecting the contention that the “sole remedy” provision requires “loan-specific inquiries, which are incompatible with sampling as a method of proof.” Id. at 21, n.15. The court noted the limited nature of its in limine ruling which “allows Law Debenture to try to prove its case at trial by statistical sampling, and rejects WMC’s efforts to prevent Law Debenture from making that effort or limiting the number of loans that may be sampled.” Id. at 21.

The ruling in Law Debenture is significant in that it bucks the trend established in Ret. Bd. of the Policemen’s Annuity & Ben. Fund of the City of Chi. v. Bank of N.Y. Mellon, 775 F.3d 154, 162 (2d Cir. 2014), and other rulings that appeared to require loan-by-loan proof in breach of contract claims in RMBS cases. Following their reasoning, courts have continued to state, largely in dicta in ruling on motions to dismiss that, while it “is not a pleading requirement,” “[t]o prevail ultimately on the breach of contract claim, a plaintiff does have to demonstrate breach on a ‘loan-by-loan and trust-by-trust basis.’” Phoenix Light SF Ltd. v. Deutsche Bank Nat’l Tr. Co., 172 F. Supp. 3d 700, 713 (S.D.N.Y. 2016); Royal Park Inv., SA/NV v. Deutsche Bank Nat’l Tr. Co., 14-CV-4394 (AJN), 2016 WL 439020, at *6 (S.D.N.Y. Feb. 3, 2016)(quoting Ret. Bd. of the Policemen’s Annuity, 775 F.3d at 162). Indeed, an Ohio state court, in ruling in favor of an RMBS trustee following trial, recently expressly extended the prohibition on loan sampling to trial, stating, “[b]ecause plaintiffs must prove their case ‘loan by loan,’ the use of sampling to prove breaches in this case is impermissible: a breach in one loan says nothing about a breach in another, much less whether that breach has a ‘material and adverse effect’ on Certificateholders.” W. and S. Life Ins. Co. v. Bank of N. Y. Mellon, No. A1302490, 2017 WL 3392855, *10 (Ohio Com. Pl., Aug. 4, 2017) (citing BlackRock Allocation Target Shares v. Wells Fargo Bank, NA, 2017 WL 953550, at *5 (S.D.N.Y. Mar.10, 2017)). This reasoning was echoed in the District Court’s opinion in BlackRock Allocation Target Shares v. Wells Fargo Bank, NA, 14 Civ. 9371 (S.D.N.Y. Aug. 21, 2017), affirming the denial of a loan sampling motion and the reasoning of the Magistrate Judge “that sampling could not help the Consolidated Plaintiffs identify the loans in breach, demonstrate that any breaches materially adversely affected particular loans, or ascertain the loan-specific cure and repurchase remedy.” (Opinion and Order, at 27)

While the circumstances in which loan sampling is allowed may be an open question, the holding of the Connecticut District Court in Law Debenture indicates that the question may, at least for certain claims, be answered in the affirmative.

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