New York’s highest court may have shut the door to many future lawsuits against sellers and sponsors of flawed mortgage bonds, ruling investors have six years from the day the deal closed to pursue remedies.
The state Court of Appeals in Albany Thursday upheld the dismissal of a 2012 suit by investors seeking to force a Deutsche Bank AG unit to buy back more than $330 million of bad mortgages that were packaged into bonds before the financial crisis.
The ruling, eagerly awaited by the industry, may stop investors seeking to recoup mortgage-bond losses from filing new suits. The bank won a dismissal in 2013 when a lower-level appeals court threw out the mortgage-bond investors’ suit, citing the time limit. Thursday’s decision affirmed that ruling.
“It’s an extremely important decision both to the pre-existing mortgage-backed securities market and to the future of housing finance,” said Isaac Gradman, a partner at Perry Johnson Anderson Miller & Moskowitz LLP in Santa Rosa, California, a firm representing mortgage-bond investors. “It creates a detriment to investment in U.S. housing via the mortgage-finance market.”
While bond buyers may be more reluctant to invest after the ruling, potential issuers may gain confidence.
The decision increases the likelihood new mortgage-backed securities will be issued as it clarifies that claims for violations of representations and warranties about underlying loans are subject to a six-year “sunset,” Nomura Securities analysts Paul Nikodem, Pratik K. Gupta and Shawn Lim said in a note to investors.
The ruling also raises the possibility of settlements on individual deals already in litigation, along with agreements to extend the time that investors have to sue, the Nomura analysts said.
“Most of the banks now have a limited and defined set of mortgage repurchase liabilities and may look to settle as they look to resolve their legacy mortgage liability,” they said.
Investors sued DB Structured in March 2012 seeking more than $250 million in damages. According to the complaint, the company breached its obligations to repurchase loans in a pool of more than 8,000 that didn’t conform with statements about their characteristics and quality. A trustee, HSBC Bank USA, later replaced the investors in the suit.
Investors have been increasingly seeking to hold servicers and trustees responsible for their roles in later overseeing the loans made in the run-up to the financial crisis, and Gradman said the ruling is likely to lead to an increase in such suits.
“It puts the trustee squarely in the sights of any future litigation, particularly in cases where certificate holders asked them to act but even more broadly,” Gradman said.
The decision may be a Pyrrhic victory for Deutsche Bank, as a win for trustee HSBC in the case may have weakened claims that investors including BlackRock Inc. and others have brought against banks, including Deutsche Bank, over their roles as trustees, said Elliott Stein, an analyst for Bloomberg Intelligence.
The Deutsche Bank unit’s obligation to cure or buy back loans that didn’t conform with statements about their quality was the only remedy for investors, who didn’t pursue those options and are therefore blocked from suing by the state’s six-year statute of limitations, the Court of Appeals said.
Such statements “concern the characteristics of their subject as of the date they are made,” and Deutsche Bank’s refusal to buy back the allegedly defective loans didn’t allow the investors to sue, the court ruled. The investors also didn’t give Deutsche Bank enough time to fix the quality of the defective loans or to buy them back, the court said.
It makes sense that Deutsche Bank wouldn’t guarantee future performance of the loans as sponsor and seller, the court said.
“A sponsor does not guarantee payment for the life of the transaction because loans may default 10 or 20 years after they have been issued for reasons entirely unrelated to the sponsor’s representations and warranties,” the court said.
Deutsche Bank is pleased with the court’s decision, Amanda Williams, a spokeswoman for the company, said in an e-mail. Paul Clement, an attorney representing the investors, didn’t immediately respond to an e-mail and a voice-mail message seeking comment on the ruling.
The case is Ace Securities Corp. v. DB Structured Products Inc., 650980/2012, New York State Supreme Court, New York County (Manhattan).