New York District Court Rules Constructive Knowledge Sufficient to Satisfy Discovery Issue in RMBS Litigation

As we described in a previous Client Alert, the New York Court of Appeals issued a landmark decision in March of this year regarding a statutory residential mortgage-backed securities (RMBS) redemption dispute. from New York. Decision, U.S. Bank National Association v. DLJ Mortgage Capital2022 WL 801440 (NY March 17, 2022), significantly tightened pre-suit notification requirements in RMBS rebate disputes, holding that the notification requirements of typical RMBS repurchase protocols can only be satisfied by a loan-by-loan notice of material breaches, given before the lawsuit commences.

In an important follow-up decision, a New York County trial court has now addressed a crucial issue raised by the American bank Ruling: Whether, instead of providing the required loan-by-loan notice, an RMBS claimant can instead demonstrate that the defendant had constructive knowledge of the loans’ defaults. In a pre-trial decision in Ambac Assurance Corp. vs. Nationwide home loans, the New York State Supreme Court answered in the affirmative. Specifically, the court held that, to satisfy the “notice or discovery” requirement of the repurchase protocol, it is sufficient to show that the defendant knew or should have known of the defaults in the loans – a demonstration that can potentially be made with respect to all loans as a whole, rather than being made on a loan-by-loan basis.

Background

Ambac’s lawsuit against Countrywide, which began in 2010, arose out of 17 Countrywide-sponsored RMBS transactions that were completed between 2004 and 2006, involving more than 375,000 pooled residential mortgages with an initial principal balance of approximately $25 billion. dollars. As insurer of the securitizations, Ambac has agreed to insure the principal and interest payments due to holders of RMBS certificates for each securitization.

In the governing insurance agreements, Countrywide has made a variety of loan-level representations and warranties regarding the quality of mortgage loans and Countrywide’s loan origination policies, as well as transactions regarding the accuracy of all information provided to Ambac. . As in the American bank In any event, the sole remedy against Countrywide for breaches of representations and warranties was the buy-back protocol, triggered by breaches of representations and warranties that materially and adversely affect the interests of Ambac.

In anticipation of a trial due to begin in September, Countrywide has decided to exclude evidence that it had constructive knowledge of the breaches of representations and warranties in order to trigger the takeover protocol. Following the decision of the Court of Appeal American bank decision, the parties filed briefs seeking rulings regarding the effect of this decision on the evidence to be admitted at trial.

Countrywide argued that, in light of American bank, Ambac should not be allowed to provide evidence to show that Countrywide “discovered” offending loans on an aggregate basis, as opposed to an individual loan. Ambac replied that the Court of Appeal of American bank explicitly stated that the issue of discovery was not before the Court. As a result, Ambac asserted, American bank only addressed the notification aspect of the takeover protocol and not the separate and independent issue of discovery.

The hearing of May 18, 2022

At a preliminary hearing on Countrywide’s motion, the court declined to find that loan-by-loan discovery of the breaches was necessary. Justice Reed agreed with Ambac that because the American bank The decision did not address the issue of when discovery triggers the buyout protocol, the trial court was bound by the determinative precedent of the First Department, which holds that (1) the issue of discovery is a matter of adjudicable fact, and (2) the proper adjudication the legal standard is constructive knowledge, that is, whether Countrywide “knew or ought to have known” of the offending Loans. The court further held that evidence of Countrywide’s policies and practices is relevant to whether Countrywide discovered infringing loans. Consistent with previous First Department rulings in other cases that the standard of discovery is implied notice, Justice Reed held that, if Ambac can establish that Countrywide, as the originator, knew or should have known aware of breaches globally, he will not need to prove Countrywide knowledge on a loan-by-loan basis.

Conclusion

This ruling has important implications for the Ambac case, as well as for RMBS remittance litigation generally. In this case, Ambac provided notice of default for only about 7,000 loans, while Ambac appraisers estimated that nearly 80% of the pooled 375,000 residential mortgages were materially defective. Judge Reed’s decision potentially allows Ambac to prove that Countrywide breached 300,000 loans, rather than just the 7,000 loans for which Ambac had given specific notice. Additionally, Judge Reed’s decision potentially allows Ambac to prove Countrywide’s constructive knowledge of the violations on an aggregate basis, rather than on a loan-by-loan basis. Since Countrywide was the originator, administrator and promoter of the loans in question, evidence of Countrywide’s policies and practices can go a long way toward satisfying this burden of proof.

If other judges follow Judge Reed’s decision, other RMBS cases could be significantly affected in the same way.

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