Deutsche Bank N.T. Co. vs. Flagstar Capital Markets Corp.  – The New York Court of Appeals has held that an “accrual clause” contained in a residential mortgage-backed securities agreement was not a condition precedent

The following is a case update prepared by Professor Dan Schechter, Loyola Law School, Los Angeles, analyzing a recent decision of interest:

SUMMARY:

The New York Court of Appeals has held that an “accrual clause” contained in a residential mortgage-backed securities agreement was not a condition precedent to the accrual of the purchaser’s warranty claim against the originator; therefore, the plaintiff’s claim was time-barred. Further, any contractual attempt by the parties to delay the commencement of the statute of limitations was void as against public policy. [Deutsche Bank N.T. Co. vs. Flagstar Capital Markets Corp., 2018 Westlaw 4976777 (N.Y.).]

FACTS: A residential lender originated a portfolio of mortgage loans that were sold as residential mortgage-backed securities. As part of that transaction, the originator issued a series of representations and warranties regarding the quality of the underlying loans. The purchaser’s sole remedy was to demand cure or repurchase by the originator.

Slightly more than six years after the loans were sold, the trustee holding the loans brought suit against the originator, claiming that the loans were substandard. The defendants moved to dismiss the complaint on the ground that it was time-barred under the applicable New York six-year statute of limitations.

After the action was dismissed, the case eventually made its way through the New York court system to the state’s highest court, the Court of Appeals. In essence, the dismissal was affirmed.

REASONING: On appeal, the plaintiff cited the “accrual clause” contained in the governing agreement:

“Any cause of action against the Seller relating to or arising out of the breach of any representations and warranties . . . shall accrue as to any Mortgage Loan upon (i) discovery of such breach by the Purchaser . . . , (ii) failure by the Seller to cure such breach, . . . and (iii) demand upon the Seller by the Purchaser for compliance with this Agreement.”

The plaintiff argued that this language created a condition precedent to the accrual of the cause of action; therefore, the statute of limitations did not begin to run until all of those preconditions have been satisfied.

The court placed primary reliance on ACE Securities Corp. v. DB Structured Products, Inc., 25 N.Y.3d 581, 15 N.Y.S.3d 716, 36 N.E.3d 623 (N.Y. 2015), for the proposition that the plaintiff’s cause of action accrued when the misrepresentations were first made. The plaintiff argued, however, that ACE was distinguishable because the documents in that case did not contain an accrual clause comparable to the one at bar.

The court was unmoved, reasoning that the “accrual clause” was not a condition precedent to the accrual of the plaintiff’s claim because it related to the plaintiff’s pursuit of a remedy, not the defendant’s performance:

The accrual clause does not create a substantive condition precedent because no provision of the accrual clause creates a condition to defendant’s performance under the contract: delivery of mortgage loans that comply with the representations and warranties. Defendant was obligated to deliver loans that complied with the representations and warranties at the moment the [agreement] was executed. Defendant therefore breached the representations and warranties, “if at all,” on the closing date for each group of loans, because the representations and warranties with respect to each loan were either true or false on that date . . . . Nothing in the accrual clause created a condition to defendant’s obligation to comply with the representations and warranties, and therefore nothing in the accrual clause created a substantive condition precedent to the relevant performance that plaintiff alleges was breached . . . .

As a fallback to its primary holding, the court construed the “accrual clause” as a waiver of the statute of limitations and then held that it violated public policy:

It is possible, however, that the language in the accrual clause expressed the contracting parties’ intent to delay commencement of the limitations period notwithstanding that the clause does not create a substantive condition precedent. We therefore must examine whether the parties may postpone accrual in this way consistent with New York law and public policy.

The court then reasoned that because a New York statute permitted the contractual waiver of statutes of limitation after the accrual of a cause of action, it implicitly forbade a contractual waiver prior to the accrual of a cause of action. The plaintiff argued that the parties to this agreement were highly sophisticated and that freedom of contract should be upheld, but the court disagreed:

To the extent plaintiff asserts that sophisticated commercial entities should be allowed to enforce clear contract language choosing a later accrual date than the date that would otherwise apply by law, plaintiff’s remedy lies with the legislature . . . .

There were strong dissents; in particular, Judge Wilson was concerned about the commercial effects of this ruling:

[T]he parties chose New York law—the common choice of sophisticated commercial parties—based on the expectation that New York courts are commercially sophisticated and will enforce their bargained-for agreements . . . . By contradicting the parties’ unambiguous agreement for amorphous public policy reasons whose sweep is unknown, today’s decision undermines a public policy whose sweep undergirds our economy.

AUTHOR’S COMMENT: Strictly from a technical standpoint, the majority’s opinion makes some very thin distinctions. Is there really a difference between the accrual of a remedy and the accrual of a cause of action for breach of a duty?

From the standpoint of policy, the majority’s opinion is even worse. Does it make sense to thwart the obvious contractual intent of two highly sophisticated parties? What kind of a message does this send to parties planning large commercial transactions?

As the dissenting judges observed, if transactional lawyers cannot rely on the courts of New York to construe their contracts as written, they will tend to draft choice of forum and choice of law clauses that designate other jurisdictions. This case actually presents a business opportunity for states like Delaware and California: their legislatures could enact statutes that expressly authorize what New York has now forbidden.

For discussion of the intermediate appellate opinion in this case, see 2016-37 Comm. Fin. News. NL 73, “Delayed Accrual” Clause in Mortgage-Backed Securities Agreement is Unenforceable As Against Public Policy, and Purchaser’s Contractual Claims are Time-Barred.

For discussions of other cases involving disputes over the triggering of the statute of limitations, see:

• 2018-35 Comm. Fin. News. NL 70, Creditor’s Cause of Action on Credit Card Debt Accrues as Soon as Optional Acceleration is Available, Even If No Acceleration Occurs.
• 2018-26 Comm. Fin. News. NL 51, Acceleration of Note Was Not Self-Executing, and Statute of Limitations for Enforcement of Deed of Trust Was Never Triggered by Notices of Sale.
• 2018-7 Comm. Fin. News. NL 14, Lender’s Deficiency Claim Against Guarantor on Construction Loan is Time-Barred, and Claim on Mezzanine Guarantee May Be Barred Due to Accrual at Time of Default.
• 2017-47 Comm. Fin. News. NL 91, Guarantor’s Broad Waiver of All Rights and Defenses Arising under Anti-Deficiency Statutes Encompasses Waiver of Statute of Limitations Following Foreclosure.
• 2016-29 Comm. Fin. News. NL 57, Time Limit Contained in Uniform Fraudulent Transfer Act is Statute of Limitations, Not a Statute of Repose, Validating Tolling Agreement Between Plaintiff and Defendant.
• 2016-39 Comm. Fin. News. NL 78, Since Guaranty Stated That Guarantor’s Liability Did Not Depend on Creditor’s Exhaustion of Security, Creditor’s Claim Accrued upon Borrower’s Pre-Foreclosure Default and Was Thus Time-Barred.

Thank you for your continued support of the Committee.

These materials were written by Dan Schechter, Professor Emeritus, Loyola Law School, Los Angeles, for his Commercial Finance Newsletter, published weekly on Westlaw. Westlaw holds the copyright on these materials and has permitted the Insolvency Law Committee to reprint them.