The following is a case update prepared by Dan Schechter, Professor Emeritus, Loyola Law School, Los Angeles, analyzing a recent decision of interest:
The Second Circuit has held that despite an express “delayed accrual” clause, claims stemming from breach of warranties by a seller of residential mortgage-backed securities began to run at the moment of the sale, not upon discovery; therefore, the buyer’s claims against the seller were therefore time-barred. [Lehman XS Trust, Series 2006-GP2 by U.S. Bank N.A. vs. GreenPoint Mortgage Funding, Inc., 2019 Westlaw 452888 (2nd Cir.).]
Facts: A mortgage originator sold residential mortgage-backed securities. The purchase agreement contained representations and warranties (“R&Ws”) concerning the quality and credit worthiness of the underlying mortgages. It also contained an express “delayed accrual” provision:
Any cause of action against [the seller] relating to or arising out of the Breach of any [R&Ws] … shall accrue as to any Mortgage Loan upon (i) discovery of such Breach by the Purchaser . . . , (ii) failures by [the seller] to cure such Breach or repurchase such Mortgage Loan as specified above, and (iii) demand upon [the seller] by the Purchaser for compliance with this Agreement.
The agreement also contained an indemnification clause, requiring the seller to indemnify the purchaser for damages sustained due to defects in the underlying mortgages.
Six years after the sale, a forensic review of the portfolio revealed that virtually all of the loans in the packages were defective. After much procedural wrangling, the indenture trustee (and other parties) acting on behalf of the beneficial owners of the mortgages brought suit against the seller, asserting claims for both breach of contract and indemnification. The district court granted summary judgment in favor of the seller, ruling that the plaintiffs’ causes of action were barred by the six-year statute of limitations.
Reasoning: Citing 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) and its progeny, the court held that the “delayed accrual” clause was unenforceable under New York law as against public policy. Therefore, since the plaintiffs’ causes of action accrued as soon the defective loans were sold, the statute of limitations had run on all of the claims.
In an effort to escape from the rule in ACE, the plaintiffs argued that their indemnification claims were distinguishable. The court disagreed, holding that these were not true indemnification claims, since the purchaser of the mortgages did not pay a third party and then seek indemnification. Instead, the indemnification claim was a “breach of contract claim, plain and simple.”
Author’s Comment: This rule makes no sense. It empowers fraudsters to sell defective wares by lying about them and then to lay low, hoping that the truth takes a long time to emerge. When it finally does, the bad guys play their ACE in the hole: they walk away with every penny of the purchase money, on the ground that the date of the sale of the mortgages with hidden defects was the magic date on which the clock began to tick, silently destroying the buyer’s claim for damages.
Worse yet, the fraudsters in this case included an express provision: “Don’t worry, your claim will not accrue until the defects, if any, are discovered.” And then the fraudsters had the chutzpah to march into court, stand up, and argue that “public policy” means that this clause was void. I cannot understand why the state and federal courts in New York are still bending over backward to protect the mortgage bundlers who brought us the crisis of 2008.
Yes, ACE says what it says, and it is a decision construing New York law. But ACE is distinguishable: there was no express “delayed accrual” clause in the ACE documents, unlike the agreement in the present case. Why not restrict ACE to its facts?
Second, however, what happened to the sacred doctrine of freedom of contract? These were the most sophisticated parties imaginable. If they wanted to negotiate and implement a rule that was difficult to administer, why would the courts intervene, especially on behalf of the loan originator, the party guilty of the misrepresentations?
Is a discovery rule really so difficult to implement? In every jurisdiction, there are statutes that invoke the discovery rule in connection with causes of action based upon fraudulent misrepresentation. Why would a contractual claim based upon a misrepresentation be any more difficult to administer? Yes, a discovery rule sometimes requires an inquiry into what the plaintiff knew and when she knew it. So what? That is what a finder of fact does.
If this private agreement between competent parties regarding the accrual of remedial causes of action can be invalidated on the grounds of public policy, does the same reasoning then apply to situations in which the parties have specified a shorter date for accrual?
Even if the court system does not have the courage to adopt a rule permitting sophisticated parties to alter the statute of limitations by agreement, will the New York legislature now act to abrogate ACE? If not, why not? Who lobbies against freedom of contract? 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. ACE and its progeny actually present a business opportunity for commercially-significant states like Delaware and California: their legislatures could enact statutes that expressly authorize what New York has now forbidden.
For discussions of other cases dealing with related issues, see:
- 2019-1 Comm. Fin. News. NL 1, Although Statute of Limitations Applicable to Repurchase Obligation Had Run, Mortgage Reseller’s Claim for Indemnification Was Not Time-Barred.
- 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.
- 2016-39 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.
- 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.
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.