Franklin American Mortgage Co. vs. University National Bank of Lawrence (6th Cir.) – Although Statute of Limitations Applicable to Repurchase Obligation Had Run, Mortgage Reseller’s Claim for Indemnification Was Not Time-Barred

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

SUMMARY:

The Sixth Circuit has held that even though the statute of limitations applicable to a mortgage reseller’s repurchase claim against the seller had run, the reseller’s claim for indemnification was not time-barred. [Franklin American Mortgage Co. vs. University National Bank of Lawrence, 2018 Westlaw 6377719 (6th Cir.).]

Facts: A mortgage originator sold two loans to a reseller. The agreement between the parties contained representations and warranties regarding the quality of the loans. The seller agreed to repurchase defective loans and to indemnify the reseller for any losses.

The reseller then assigned the loans to a bank. Several years later, that bank discovered defects in the seller’s underwriting practices; there were missing documents, and false representations had been made concerning the borrowers’ income. The bank sought and obtained indemnification from the reseller. The reseller then brought suit against the original lender, invoking both the repurchase and indemnification provisions. After the district court granted summary judgment in favor of the reseller, the seller appealed.

Reasoning: The Sixth Circuit affirmed. The seller argued that the statute of limitations governing the reseller’s complaint had run because the reseller’s causes of action had accrued at the moment that the loans were first purchased. The court distinguished between the repurchase claim (which did accrue at the moment of purchase) and the indemnification claim (which did not accrue until the reseller had incurred losses in favor of the ultimate purchaser).

The court noted that although the transaction was governed by the law of Tennessee, the same result would have been obtained if the transaction had been governed by the law of New York. The court held that under the controlling New York line of cases beginning with ACE Securities Corp. v. DB Structured Products, Inc., 25 N.Y.3d 581, 15 N.Y.S.3d 716, 36 N.E.3d 623 (2015), the cause of action for indemnification would not have accrued until losses were actually incurred. The court distinguished the facts of ACE Securities and its progeny, on the theory that the plaintiffs in those cases had not incurred losses to a third party:

The New York cases themselves do not discuss indemnification claims; the plaintiffs there had not asserted any. Nor could they have done so. The New York plaintiffs were trusts that had purchased and then pooled thousands of mortgage loans in order to sell residential mortgage-backed securities. When the mortgage borrowers defaulted or the trusts themselves discovered defects, the trusts sought repurchase to cut their losses. But since the trusts had not re-sold the actual loans to any third parties, there would have been no viable indemnification claims—just claims for breaches of the mortgages’ warranties and representations.

Author’s Comment: I am not sure that the Sixth Circuit is correctly reading the New York cases. The New York courts have dealt very harshly with “delayed accrual” clauses, on the theory that they are void as against public policy. Although no New York opinion has yet addressed the distinction between the accrual of claims based on repurchase obligations and indemnification provisions, one could easily imagine a New York court holding that an indemnification provision is nothing more than a “delayed accrual” clause in disguise, since the relief requested by the plaintiff is identical to the relief that would have been available under the time-barred repurchase obligation.

Having said that, I believe that the result in this case is desirable from the standpoint of public policy. If the cause of action for breach of warranty accrues immediately upon sale but is not discoverable until many years later, what good is the seller’s repurchase obligation: is it an illusory promise?

I also think that the New York cases interfere with freedom of contract: why not let sophisticated parties delay the accrual of specified claims until the fact and amount of loss becomes certain? If New York will not let parties tailor their documents to their own needs, will transactional lawyers opt for more laissez-faire jurisdictions?

For discussions of cases dealing with related issues, see:

• 2018-45 Comm. Fin. News. NL 89, “Accrual Clause” in RMBS Agreement is Not a Condition Precedent to Accrual of Purchaser’s Warranty Claim, and Parties’ Attempt to Delay Commencement of Limitations is Void as Against Public Policy.
• 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.

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.