Securities – New York Appellate Digest

THE $140 MILLION PAID BY BEAR STEARNS TO THE SEC TO SETTLE AN ACTION ALLEGING THE FACILITATION OF LATE TRADING WAS NOT A “PENALTY IMPOSED BY LAW” AND THEREFORE WAS A COVERED LOSS UNDER THE TERMS OF THE INSURANCE POLICIES (CT APP).

The Court of Appeals, reversing the Appellate Division, in a full-fledged opinion by Judge DiFiore, over an extensive dissent, determined the funds paid to the Security and Exchange Commission (SEC) to settle an action alleging Bear Stearns “facilitated late trading” and “deceptive market timing activity” did not constitute a “penalty imposed by law” and therefore was a covered loss under the insurance policies:

… [U]nder relevant New York law, penalties have consistently been distinguished from compensatory remedies, damages, and payments otherwise measured through the harm caused by wrongdoing. Thus, at the time the parties contracted, a reasonable insured would likewise have understood the term “penalty” to refer to non-compensatory, purely punitive monetary sanctions. In this case, the question therefore distills to whether the disputed $140 million settlement payment meets that standard. …

… Bear Stearns demonstrated that the $140 million disgorgement payment was calculated based on wrongfully obtained profits as a measure of the harm or damages caused by the alleged wrongdoing that Bear Stearns was accused of facilitating. This can be contrasted with the $90 million payment denominated a “penalty,” which was not derived from any estimate of harm or gain flowing from the improper trading practices. J.P. Morgan Sec. Inc. v Vigilant Ins. Co., 2021 NY Slip Op 06528, CtApp 11-23-21

November 23, 2021/by Bruce Freeman

Contract Law, Debtor-Creditor, Securities, Usury

A LOAN AGREEMENT WHICH ALLOWS THE LENDER TO CONVERT THE BALANCE TO SHARES OF STOCK AT A FIXED DISCOUNT CAN VIOLATE THE USURY STATUTE, WHICH WOULD THEREBY RENDER THE AGREEMENT VOID AB INITIO (CT APP).

The Court of Appeals, in a full-fledged opinion by Judge Wilson, over a partial dissent. answered two questions posed by the Second Circuit in the affirmative. “1. Whether a stock conversion option that permits a lender, in its sole discretion, to convert any outstanding balance to shares of stock at a fixed discount should be treated as interest for the purpose of determining whether the transaction violates N.Y. Penal Law § 190.40, the criminal usury law. 2. If the interest charged on a loan is determined to be criminally usurious under N.Y. Penal Law § 190.40, whether the contract is void ab initio pursuant to N.Y. Gen. Oblig. Law § 5-511:”

GeneSYS ID, Inc. (“GeneSYS”) is a publicly held corporation that produces various types of medical supplies. Adar Bays, LLC is a limited liability company based in Florida. On May 24, 2016, Adar Bays loaned GeneSYS $35,000. In exchange, GeneSYS gave Adar Bays a note with eight percent interest that would mature in one year. The note included an option for Adar Bays to convert some or all of the debt into shares of GeneSYS stock at a discount of 35% from the lowest trading price for GeneSYS stock over the 20 days prior to the date on which Adar Bays requested a conversion. Adar Bays could exercise its option starting 180 days after the note was issued and could do so all at once or in separate partial conversions. …

Six months and four days after the note was issued … Adar Bays requested conversion of $5,000 of debt into 439,560 shares of stock. GeneSYS refused … seeking to renegotiate the loan. … GeneSYS was trading for $0.024 per share, the conversion price was $0.011. Adar Bays … sued GeneSYS in the … Southern District of New York for breach of contract. GeneSYS filed a motion to dismiss arguing the contract was void because the loan’s rate of interest, including both the stated interest and conversion option, exceeded the criminal usury rate of 25%. Adar Bays, LLC v GeneSYS ID, Inc., 2021 NY Slip Op 05616 CtApp 10-14-21

October 14, 2021/by Bruce Freeman

Civil Procedure, Contract Law, Securities, Trusts and Estates

SUPREME COURT, PURSUANT TO CPLR ARTICLE 77, PROPERLY RESOLVED THE DISTRIBUTION OF A $4.5 BILLION GLOBAL SETTLEMENT PAYMENT BY JP MORGAN CHASE IN THIS RESIDENTIAL-MORTGAGE-BACKED-SECURITIES-RELATED ACTION (FIRST DEPT).

The First Department, in a full-fledged opinion by Justice Manzanet-Daniels, determined Supreme Court properly resolved the distribution pursuant to CPLR article 77 of a $4.5 billion global settlement payment by JPMorgan Chase to investors to be made by residential mortgage-backed securities (RMBS) trusts. The opinion is detailed, fact-specific and cannot be fairly summarized here. The rulings are specific to provisions included in or absent from the relevant pooling and servicing agreements (PSA’s). Matter of Wells Fargo Bank v Aegon USA Inv. Mgt., LLC, 2021 NY Slip Op 04740, First Dept 8-19-21

August 19, 2021/by Bruce Freeman

Fraud, Securities

IN THIS “RESIDENTIAL MORTGAGE BACKED SECURITIES” AND “COLLATERALIZED DEBT OBLIGATION” ACTION, PLAINTIFF RAISED QUESTIONS OF FACT ABOUT WHETHER DEFENDANTS’ FRAUD, AS OPPOSED TO THE 2008-2009 FINANCIAL CRISIS, CAUSED PLAINTIFF’S LOSS, AND WHETHER AN OMISSION ON DEFENDANTS’ PART WAS AN ACTIONABLE MISREPRESENTATION; SUPREME COURT REVERSED (FIRST DEPT).

The First Department, reversing Supreme Court, over an extensive dissent, determined defendants’ motion for summary judgment in this “residential mortgage backed securities (RMBS)” and “collateralized debt obligation (CDO)” fraud action should not have been granted. The plaintiff raised questions of fact whether defendants’ fraud, as opposed to the 2008-2009 financial crisis, caused plaintiff’s loss, and whether an omission on defendants’ part constituted an actionable misrepresentation:

“The empirical evidence shows that Magnetar deals in general, and Auriga in particular, performed worse than other mezzanine CDOs issued during the same period.” For example, the [plaintiff’s] expert noted, “Magnetar deals experienced events of default [‘EODs’] on average approximately four months faster than other mezzanine CDO bonds issued in 2006 and 2007” and Auriga “failed 175 days earlier than the average mezzanine non-Magnetar deal.” The expert further explained, “[a]ll 26 mezzanine Constellation deals experienced an [EOD.] This 100 percent EOD rate contrasts with an EOD rate of 82 percent . . . among non-Magnetar subprime CDOs issued in 2006 and 2007. The difference between these two EOD rates . . . is statistically significant.” * * *

With regard to lack of justifiable reliance on misrepresentations, the other ground on which the motion court granted summary judgment, plaintiff’s fraud claim depends both on an affirmative representation (that Auriga’s collateral manager would independently select the collateral) and an omission or concealment (that defendants structured Auriga to facilitate Magnetar’s net-short strategy). * * *

… [T]o the extent plaintiff relies on an omission, its claim is not barred. … [T]he omission in the instant action came from defendants … . Loreley Fin. (Jersey) No. 28, Ltd. v Merrill Lynch, Pierce, Fenner & Smith Inc., 2021 NY Slip Op 04413, First Dept 7-15-21

July 15, 2021/by Bruce Freeman

Civil Procedure, Contract Law, Securities

THE CONTINUING WRONG DOCTRINE APPLIES TO THIS COMPLEX BREACH OF CONTRACT ACTION SUCH THAT EACH BREACH WAS AN ACTIONABLE EVENT; THEREFORE THE STATUTE OF LIMITATIONS DID NOT START RUNNING FOR ALL SUBSEQUENT BREACHES WHEN THE FIRST BREACH OCCURRED (FIRST DEPT).

The First Department, in a full-fledged opinion by Justice Mazzarelli, over a two-justice dissent, reversing Supreme Court, determined the continuing wrong doctrine applied to this breach of contract action such that each breach was actionable and, therefore, the statute of limitations for all subsequent breaches was not triggered by the first breach. The subjects of the contracts were commercial mortgage-backed securities (CMBS). The complaint alleged defendant CWCI breached a collateral management agreement (CMA):

Generally speaking, a claim accrues for statute of limitations purposes when “all of the factual circumstances necessary to establish a right of action have occurred, so that the plaintiff would be entitled to relief” … . However, the mere fact that a claim has accrued and the time to bring an action on it has commenced to run does not mean that a new claim, with a new limitations period, may not arise out of a new set of facts that forms part of a series with the original wrong. [Plaintiff] maintains that the allegations against CWCI comprise such a series of individual wrongs. Thus, it relies on cases such as Bulova Watch Co. v Celotex Corp. (46 NY2d 606 [1979]). There, a new claim, with a new limitations period, was held to have accrued each time the plaintiff, the obligee under a bond that guaranteed that the defendant roofer would make repairs necessary to ensure the watertightness of the plaintiff’s roof over the 20-year life of the bond, asked the defendant, to no avail, to repair a leak. Accordingly, the plaintiff’s failure to commence suit within the limitations period based on the initial leak did not bar the action. * * *

We find that the continuing wrong doctrine does apply to this case. CWCapital Cobalt VR Ltd. v CWCapital Invs. LLC, 2021 NY Slip Op 02487, First Dept 4-27-21

April 27, 2021/by Bruce Freeman

Contract Law, Fiduciary Duty, Fraud, Negligence, Securities, Trusts and Estates

IT IS NOT CLEAR FROM THE CONTRACT WHETHER DEFENDANT TRUSTEE WAS TO PERFORM A MERELY MINISTERIAL FUNCTION OR A GATEWAY FUNCTION IN ACCEPTING ASSETS FOR THE TRUST FROM A NONPARTY WHICH WAS ACTING FRAUDULENTLY; THERE ARE QUESTIONS OF FACT ABOUT WHETHER THE DAMAGES ASSOCIATED WITH ACCEPTING NON-NEGOTIABLE ASSETS WERE DIRECT OR INDIRECT AND WHETHER A FIDUCIARY DUTY WAS BREACHED (FIRST DEPT).

The First Department, in a full-fledged opinion by Justice Mazzarelli, reversing Supreme Court, determined the breach of contract, breach of fiduciary duty action against defendant trustee, Wilmington, should not have been dismissed. Wilmington acted as a trustee for assets transferred to the trust by a nonparty. The contract stated Wilmington would be responsible only for its own negligence but also stated no non-negotiable assets were to be placed into the trust. The nonparty which transferred assets to the trust acted fraudulently and made risky investments rendering the trust assets out-of-compliance with state law. Plaintiff sued Wilmington for breach of contract and breach of fiduciary duty. Wilmington argued that any damages suffered by plaintiff from the assets transferred by the nonparty were indirect, not direct, and therefore barred by the trust agreements:

… [I]t can be argued that, in light of Wilmington’s promise not to accept nonnegotiable assets into the trusts, and to be responsible for its own negligence, maintaining the value of the assets in the trusts was inherent in the service Wilmington agreed to provide. Thus, there is merit to plaintiffs’ argument that when the assets proved not to be negotiable, they lost the benefit of their bargain and were entitled to recover as direct damages the diminution in value, and the concomitant costs of restoring the assets to negotiable status, such as professional fees. * * *

… [A]t this stage of the litigation, it is difficult to discern whether the parties contemplated that Wilmington would have to pay the damages sought by plaintiffs if it failed to perform under the trust agreements. Again, the agreements provided that Wilmington would be liable for “its own negligence,” which a reasonable factfinder could consider as recognition that Wilmington, if it did not perform its duties in accordance with a minimum level of care, would need to pay more than the nominal damages represented by its fee. * * *

Even though the breach of contract and breach of fiduciary duty claims involved the same conduct, the fiduciary duty claim alleges a breach of a noncontractual duty relating to the trustee’s independent duty to perform nondiscretionary ministerial duties with respect to the negotiability of assets. Thus, the fact that Wilmington’s failure to prevent nonnegotiable assets from entering the trusts breached both fiduciary and contractual duties does not bar plaintiffs from seeking damages related to the former … . Bankers Conseco Life Ins. Co. v Wilmington Trust, N.A., 2021 NY Slip Op 02355, First Dept 4-20-21

April 20, 2021/by Bruce Freeman

Civil Procedure, Contract Law, Securities

IN THIS RESIDENTIAL-MORTGAGE-BACKED-SECURITIES BREACH OF CONTRACT ACTION, THE LAW OF THE CASE DOCTRINE DID NOT PRECLUDE RAISING THE “BORROWING STATUTE” (STATUTE OF LIMITATIONS) DEFENSE IN AN AMENDED ANSWER SERVED AS OF RIGHT (WITHOUT LEAVE OF COURT); LAW OF THE CASE DOCTRINE EXPLAINED IN SOME DEPTH (FIRST DEPT).

The First Department, in a full-fledged opinion by Justice Gische, reversing (modifying) Supreme Court, determined that the amended answer with counterclaims, alleging for the first time that the action was untimely under the borrowing statute (CPLR 202), was properly served “as of right” (without leave of court) and the inclusion of the borrowing statute defense was not barred by the law of the case doctrine (LOTC). The opinion includes an in-depth discussion of the LOTC. The opinion rejected the arguments that certain contract provisions were conditions precedent as opposed to independent contractual obligations and certain breach of contract claims were really claims for indemnification. All of the contracts stem from residential-mortgage-backed-securities and obligations to cover losses from the alleged breach of “representations and warranties” concerning the underlying mortgages. With regard to the LOTC, the court wrote:

The doctrine of LOTC is a rule of practice premised upon sound policy that once an issue is judicially determined, further litigation of that issue should be precluded in a particular case … . It ends the matter as far as judges and courts of coordinate jurisdiction are concerned … . While it shares some characteristics of a larger family of kindred concepts, including res judicata and collateral estoppel, it is not identical … . All these concepts contemplate that the party opposing preclusion had a full and fair opportunity to litigate the underlying determination. LOTC, however, differs in that it only addresses the potentially preclusive effect of judicial determinations made during a single litigation and before a final judgment is rendered … . In addition, while res judicata and collateral estoppel are “rigid rules of limitation,” LOTC has been described as “amorphous” and involving “an element of discretion” … . Discretion, however, is circumscribed where the decision providing the basis for LOTC is by an appellate court. Thus, while LOTC cannot bind an appellate court to a trial court ruling … , it does bind a trial court (and subsequent appellate courts of coordinate jurisdiction) to follow the mandate of an appellate court, absent new evidence or a change in the law … . Matter of Part 60 RMBS Put – Back Litig., 2021 NY Slip Op 02252, First Dept 4-13-21

April 13, 2021/by Bruce Freeman

Civil Procedure, Fraud, Securities

COMPREHENSIVE DISCUSSION OF THE PROCEDURES AND CRITERIA FOR THE ISSUANCE AND QUASHING OF SUBPOENAS IN THIS FRAUD ACTION STEMMING FROM HIGH CREDITWORTHINESS RATINGS GIVEN TO RESIDENTIAL MORTGAGE-BACKED SECURITIES (FOURTH DEPT).

The Fourth Department, reversing Supreme Court, determined plaintiff bank’s motion to quash defendant’s subpoena of a nonparty former employee of plaintiff should not have been granted. The decision provides an extensive discussion of the procedures and criteria for subpoenas and motions to quash, and refused to apply the standing requirement for governmental agency investigative subpoenas. . Plaintiff bank had invested in residential mortgage-backed securities (RMBS) to which defendant had given high creditworthiness ratings. The action sounded in fraud:

… [W]e reject defendant’s contention that plaintiff was not entitled to seek to quash the nonparty subpoena. CPLR 2304, which authorizes a motion to quash a subpoena, provides as relevant here that, “[i]f the subpoena is not returnable in a court, a request to withdraw or modify the subpoena shall first be made to the person who issued it and a motion to quash . . . may thereafter be made in the supreme court.” …

… [P]laintiff, in moving to quash the nonparty subpoena, failed to meet its burden of establishing “either that the discovery sought is ‘utterly irrelevant’ to the action[s] or that the ‘futility of the process to uncover anything legitimate is inevitable or obvious’ ” … . …

… [P]laintiff has not shown that the nonparty’s testimony would be utterly irrelevant or that it was inevitable or obvious that taking the nonparty’s deposition would be futile to uncovering anything legitimate … . …

… [P]laintiff’s own submissions suggest that the nonparty has at least some knowledge of plaintiff’s underwriting practices with respect to the non-prime loans at issue here … . M&T Bank Corp. v Moody’s Invs. Servs., Inc., 2021 NY Slip Op 00706, Fourth Dept 2-5-21

February 5, 2021/by Bruce Freeman

False Claims Act, Securities

THE MOTIONS TO DISMISS THE QUI TAM ACTION ALLEGING THE VIOLATION OF THE NEW YORK FALSE CLAIMS ACT BY SETTING INTEREST RATES ON BONDS PROPERLY DENIED (FIRST DEPT).

The First Department affirmed Supreme Court’s denial of the motions to dismiss this qui tam action alleging defendants violated the New York False Claims Act (NYFCA) in setting interest rates for certain variable rate demand obligations (VRDO) (bonds):

False claims are actionable if the State provides any portion of the funds used to pay the false claims … .

The complaint sufficiently alleges that a portion of the funds the conduit borrower received came from the state. That the state’s money passed to defendant M&T Bank Corporation through private VRDO borrower entities does not make the government any less its source. By issuing conduit bonds, the state “made the funds available,” thereby “providing” money within the meaning of the New York False Claims Act … . State of New York ex rel. Edelweiss Fund, LLC v JP Morgan Chase & Co., 2020 NY Slip Op 08019, First Dept 12-29-20

December 29, 2020/by Bruce Freeman

Contract Law, Negligence, Securities

THE SOLE REMEDY PROVISION IN THE REPRESENTATIONS AND WARRANTIES AGREEMENT IN THIS RESIDENTIAL MORTGAGE-BACKED SECURITIES CASE WAS VALID AND ENFORCEABLE; THE GROSS NEGLIGENCE PUBLIC POLICY RULE DOES NOT APPLY WHERE THE SOLE REMEDY PROVISION IMPOSES REASONABLE LIMITATIONS ON LIABILITY OR REMEDIES (CT APP).

The Court of Appeals, reversing the Appellate Division, in a full-fledged opinion by Judge Fahey, over a partial dissent, held that the sole remedy provision in the Representations and Warranties Agreement (RWA) in this residential mortgage-backed securities (RBMS) case was valid and enforceable. Plaintiff unsuccessfully tried to avoid the sole remedy provision by arguing the defendants breached the contract with gross negligence:

… [W]e … conclude that the parties’ contract, as written, means what it says. In this RMBS put-back action, plaintiff seeks to avoid a provision in the contract … that sets out a sole remedy for a breach by alleging that defendants breached the contract with gross negligence. This sole remedy provision purports to limit, but not eliminate, the remedies available to the plaintiff in the event of a breach. We conclude that, in a breach of contract action, the public policy rule prohibiting parties from insulating themselves from damages caused by grossly negligent conduct applies only to exculpatory clauses or provisions that limit liability to a nominal sum. The rule does not apply to contractual limitations on remedies that do not immunize the breaching party from liability for its conduct. The sole remedy provision is not an exculpatory or nominal damages clause. Plaintiff cannot render it unenforceable through allegations of gross negligence. * * *

We have previously considered the application of the gross negligence public policy rule only in cases where the contract provision at issue was an exculpatory clause, purporting to wholly immunize a party from liability, or a nominal damages clause limiting damages to, at most, $250 … . We have not yet determined whether grossly negligent conduct may render unenforceable contractual provisions that do not wholly insulate a party from liability for its breach, but instead impose reasonable limitations on either liability or the remedies available to the non-breaching party. We conclude that, in a breach of contract case, grossly negligent conduct will render unenforceable only exculpatory or nominal damages clauses, and the public policy rule does not extend to limitations on the remedies available to the non-breaching party. Matter of Part 60 Put-Back Litig., 2020 NY Slip Op 07687, CtApp 12-22-20

December 22, 2020/by Bruce Freeman