Securities Archives - New York Appellate Digest

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, 2020/0 Comments/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

Contract Law, Debtor-Creditor, Securities, Uniform Commercial Code

STRICT FORECLOSURE AT THE DIRECTION OF THE MAJORITY BONDHOLDERS WHICH CANCELLED THE NOTES PRECLUDED RECOVERY BY THE PLAINTIFFS WHO PURCHASED SOME OF THE NOTES IN THE SECONDARY MARKET (CT APP).

The Court of Appeals, in a full-fledged opinion by Judge Garcia, reversing the Appellate Division, over a three-judge dissent, determined the strict foreclosure at the direction of the majority bondholders which cancelled the notes precluded plaintiffs from recovering on notes purchased in the secondary market. The decision is fact-specific, dependent on the wording of documents, and cannot be fairly summarized here:

After the issuer defaulted, plaintiffs, the holders of a minority in principal amount of senior secured debt, brought this lawsuit against the debtor and its guarantors to recover payment of principal and interest. We are called upon to determine whether plaintiffs’ right to sue for payment on the notes survived a strict foreclosure, undertaken by the trustee at the direction of a group of majority bondholders over plaintiffs’ objection, that purported to cancel the notes. We hold that it did … . …

In December 2005, defendant Cleveland Unlimited, Inc. (Cleveland Unlimited), a telecommunications company, issued $150 million of “senior secured” debt in the form of “Notes” pursuant to an indenture agreement (the Indenture). The Notes had a five-year term and required Cleveland Unlimited to pay interest to holders of the Notes (Noteholders or Holders) on a quarterly basis up to and including the maturity date, at which point the principal also became due. The Indenture named Cleveland Unlimited as the “Issuer” of the Notes, eighteen of Cleveland Unlimited’s subsidiaries and affiliates as the “Guarantors,” and U.S. Bank National Association (U.S. Bank) as the Indenture “Trustee.” At the same time the Indenture was executed, the Issuer, the Guarantors, and the Trustee executed a Collateral Trust Agreement and a Security Agreement (collectively, Indenture Documents) … . In April 2010, plaintiffs purchased approximately $5 million of the Notes in the secondary market, amounting to 3.33% of the outstanding principal value.

At issue in this case are certain provisions in the Indenture Documents governing the rights of the Noteholders to receive payment, the remedies available in the event of default, and the power of a majority of Noteholders to direct the Trustee’s choice of remedy. CNH Diversified Opportunities Master Account, L.P. v Cleveland Unlimited, Inc., 2020 NY Slip Op 05976, Ct App 10-20-20

October 22, 2020/by Bruce Freeman

Arbitration, Contract Law, Securities

RESPONDENT WAS A CUSTOMER OF PETITIONER SECURITIES CORPORATION WITHIN THE MEANING OF FINANCIAL INDUSTRY REGULATORY AUTHORITY (FIRA) RULES AND THEREFORE COULD COMPEL ARBITRATION (FIRST DEPT).

The First Department, reversing Supreme Court, over an extensive dissent, determined respondent was a customer of petitioner (LekUS) and therefore could compel FINRA (Financial Industry Regulatory Authority) arbitration. Petitioner had been sued by FINRA in connection with shares of Cannibis Science, Inc. (CBIS) purchased by respondent and held by petitioner for trading:

The record establishes that respondent was a customer of nonparty Lek Securities UK, Ltd. (LekUK), where he had his account, and was also a client of petitioner Lek Securities Corp. (LekUS), with which he had a series of direct agreements. Under those agreements, LekUS conditioned its provision of depository and execution services for certain trades on respondent’s providing certain representations and an indemnity … .

Specifically, respondent purchased shares of Cannabis Science, Inc. (CBIS) in a series of transactions in 2015 and 2016 that required that the shares be held and sold in the United States. For each transaction, respondent executed an agreement (Deposit Agreement) directly with LekUS pursuant to which LekUS deposited the shares in its account at the Depository Trust & Clearing Corporation (DTCC). In each Deposit Agreement, (1) respondent represented that his answers to certain questions were true and acknowledged that LekUS would rely on those representations; (2) LekUS agreed to act as the “Processing Broker” to provide the services of depositing and reselling the shares; and (3) LekUS accepted respondent’s “Deposit Securities Request” on certain conditions, including that any claims by respondent or disputes arising from respondent’s representations in the Deposit Agreement “shall be governed by New York law and subject to the exclusive venue and jurisdiction of the courts and arbitration forums in the City and State of New York,” and that respondent would indemnify LekUS in connection with claims arising from respondent’s representations in the Deposit Agreement or from “the deposit process or the subsequent sale of the securities.”

When respondent sought to trade the CBIS shares deposited with LekUS, he communicated with Michael Mainwald, who was located at the office of LekUS, had a LekUS phone number and email address, and was registered with FINRA as the “principal operating officer” of LekUS.

… LekUS notified respondent that it had been sued by FINRA in connection with CBIS transactions and that LekUS sought indemnification by defendant pursuant to the Deposit Agreements. …

… [R]espondent was a “customer” of LekUS within the meaning of FINRA Rule 12200, and was therefore entitled to demand arbitration. Matter of LEK Sec. Corp. v Elek, 2020 NY Slip Op 01134, First Dept 2-18-20

February 18, 2020/by Bruce Freeman

Civil Procedure, Insurance Law, Privilege, Securities

A PRIVILEGE UNDER WISCONSIN INSURANCE LAW APPLIED IN THIS NEW YORK ACTION CONCERNING INSURANCE CLAIMS STEMMING FROM THE ISSUANCE OF RESIDENTIAL MORTGAGE-BACKED SECURITIES (FIRST DEPT).

The First Department determined a privilege under Wisconsin Law protected certain emails and documents generated in a Wisconsin action by the Wisconsin Commissioner of Insurance concerning the payment of insurance claims stemming from the issuance of residential mortgage-backed securities, The decision doesn’t explain the underlying facts:

The Commissioner appointed a Special Deputy Commissioner (SDC) to oversee all activities … from Ambac’s [plaintiffs’] New York offices, and, at the SDC’s direction, plaintiffs commenced this action in New York, asserting claims of fraudulent inducement and breach of contract in connection with the policies Ambac issued on the securitizations sponsored by defendant. When defendant demanded the production of certain emails and other documents maintained by the SDC, plaintiffs responded by claiming the statutory privilege held by the Wisconsin Office of the Commissioner of Insurance (OCI) under Wisconsin law (see Wis Stat § 601.465). Defendant argued that New York law should be applied because, in adjudicating privilege issues, New York courts must apply the law of the place where the evidence will be introduced at trial or where the discovery proceeding is located. Supreme Court, after engaging in an interest-balancing analysis, determined that the Wisconsin statutory privilege was applicable, and denied defendant’s motion to compel. We affirm.

New York courts “routinely apply the law of the place where the evidence in question will be introduced at trial or the location of the discovery proceeding when deciding privilege issues” … . However, there are circumstances in which an interest-balancing analysis is properly undertaken to decide whether another state’s law should govern the evidentiary privilege … . This is a case that presents such circumstances … . Ambac Assur. Corp. v Nomura Credit & Capital, Inc., 2019 NY Slip Op 06574, First Dept 9-17-19

September 17, 2019/by Bruce Freeman

Civil Procedure, Contract Law, Securities

MOTION TO AMEND THE COMPLAINTS IN THESE RESIDENTIAL MORTGAGE BACKED SECURITIES ACTIONS SHOULD HAVE BEEN GRANTED, COMPETING INTERPRETATIONS OF A CONTRACT SHOULD NOT BE DETERMINED AT THE MOTION-TO-DISMISS STAGE (FIRST DEPT).

The First Department, in a full-fledged opinion by Justice Richter, over a partial dissent, determined plaintiff’s (the Trustee’s) motion to amend its complaints in these residential mortgage backed securities actions should have been granted. The amendment sought to allege defendant breached the underlying contract by failing to notify the trustee of loan breaches. The majority found that the contract provision requiring notice was ambiguous. The dissent argued the contract was not ambiguous and did not require notification:

It is well settled that “[a] request for leave to amend a complaint should be freely given, and denied only if there is prejudice or surprise resulting directly from the delay, or if the proposed amendment is palpably improper or insufficient as a matter of law” … . “A party opposing leave to amend must overcome a heavy presumption of validity in favor of [permitting amendment]” … .

Judged by these standards, the motion court should have granted the Trustee’s motions for leave to file the amended complaints with respect to the express breach of contract claims based on DBSP’s (defendant’s) failure to notify the Trustee of the loan breaches … . It cannot be said, at this early stage of the proceedings, that these claims are “palpably improper or insufficient as a matter of law” … . Nor has DBSP asserted, let alone shown, that it would suffer any prejudice or surprise directly resulting from the delay. * * *

… [B]because the disputed provision is reasonably susceptible to more than one interpretation, “it cannot be construed as a matter of law, and dismissal . . . is not appropriate” … . LDIR, LLC v DB Structured Prods., Inc., 2019 NY Slip Op 03154, First Dept 4-25-19

April 25, 2019/by Bruce Freeman

Civil Procedure, Debtor-Creditor, Securities

ONCE AN ACTION TO RECOVER THE PRINCIPAL OF A BOND IS TIME-BARRED, THERE IS NO LEGALLY COGNIZABLE CLAIM FOR POST-MATURITY INTEREST (CT APP).

The Court of Appeals, in a full-fledged opinion by Judge Feinman, determined that a bond issuer is not obligated to pay interest once a claim for the principal is time-barred:

The United States Court of Appeals for the Second Circuit has asked us to decide … “[i]f a bond issuer remains obligated to make biannual interest payments until the principal is paid, including after the date of maturity … , do enforceable claims for such biannual interest continue to accrue after a claim for principal of the bonds is time-barred?” We answer this question in the negative … . Pursuant to New York common law and the terms of the indenture, in the absence of a timely action to recover principal, a bondholder cannot enforce the conditional obligation to make post-maturity interest payments. * * *

The rule we reiterate today effectuates the agreement negotiated by the parties and reinforces our longstanding view of interest as generally dependent on principal. Moreover, it promotes the purposes underlying the statute of limitations … . For those reasons, we conclude that once a claim on the principal is time-barred, a claim to recover unpaid post-maturity interest payments is not legally cognizable. Ajdler v Province of Mendoza. 2019 NY Slip Op 02151, CtApp 3-21-19

March 21, 2019/by Bruce Freeman

Civil Procedure, Contract Law, Securities

THE SOLE REMEDY PROVISION OF THE CONTRACT IN THIS RESIDENTIAL MORTGAGE BACKED SECURITIES CASE, WHICH REQUIRED THAT THE DEFENDANT BE NOTIFIED AND GIVEN THE OPPORTUNITY TO REPURCHASE DEFECTIVE MORTGAGES, WAS NOT COMPLIED WITH PRIOR TO THE RUNNING OF THE STATUTE OF LIMITATIONS, PLAINTIFF’S TIMELY COMPLAINT WAS PROPERLY DISMISSED WITHOUT PREJUDICE, DESPITE THE FAILURE TO COMPLY WITH THE SOLE REMEDY PROVISION, ALLOWING PLAINTIFF TO REFILE THE COMPLAINT WITHIN SIX MONTHS PURSUANT TO CPLR 205 (CT APP).

The Court of Appeals, in a full-fledged opinion by Judge Rivera, determined that the trustee’s breach of contract action in the residential-mortgage-backed-securities (RMBS) case was properly dismissed without prejudice, allowing plaintiff to refile pursuant to CPLR 205 (which allows a suit to be refiled within six months of a dismissal that is not on the merits). The contractual sole remedy provision, which requires that the defendant (DLJ) be notified and given the opportunity to repurchase any mortgages deemed defective, was not be complied with and the timely complaint was dismissed for that reason:

As a general rule, under CPLR 205 (a) a subsequent action may be filed within six months of a non-merits dismissal of the initial timely-filed matter. Here, we conclude that CPLR 205 (a) applies to an RMBS trustee’s second action when its timely first action is dismissed for failure to comply with a contractual condition precedent. * * *

The difference between a procedural and substantive condition precedent is well-established. A condition precedent is substantive when it “describe[s] acts or events which must occur before a party is obliged to perform a promise made pursuant to an existing contract”… . In other words, the condition is “part of the cause of action and necessary to be alleged and proven, and without this no cause of action exist[s]” … , RMBS notice and sole remedy provisions are not substantive elements of the cause of action, but instead limitations on the remedy for a breach of the mortgage loan representations and warranties … . They serve as a precondition, “a procedural prerequisite to suit,” not a separate undertaking by the trustee … . Since notice and sole remedy provisions “do[] not create a substantive condition precedent” … , they do not affect when the statute of limitations commences because the limitations clock begins to run when the contract is executed.

Nevertheless, DLJ argues that the Trustee had to fulfill the procedural condition precedent before the limitations period expired, and its failure to do so rendered the original action untimely, such that a new action cannot be commenced pursuant to CPLR 205 (a). DLJ’s argument cannot be reconciled with our case law that a suit may be refiled pursuant to CPLR 205 (a) despite a plaintiff’s failure to comply with a condition precedent prior to the expiration of the statute of limitations. U.S. Bank Natl. Assn. v DLJ Mtge. Capital, Inc., 2019 NY Slip Op 01169, CtApp 2-19-19

February 19, 2019/by Bruce Freeman

Appeals, Civil Procedure, Contract Law, Securities

TRUSTEE’S BREACH OF CONTRACT ACTION IN THIS RESIDENTIAL MORTGAGE BACKED SECURITIES CASE WAS TIME-BARRED, THE ACTION COULD NOT RELATE BACK PURSUANT TO CPLR 203 BECAUSE THE TIMELY ACTION BY ANOTHER PARTY WAS PRECLUDED BY THE CONTRACT, THE COURT OF APPEALS COULD NOT CONSIDER WHETHER THE ACTION WAS TIMELY PURSUANT TO CPLR 205, EVEN THOUGH THE ISSUE WAS ADDRESSED BY THE APPELLATE DIVISION, BECAUSE THE ISSUE WAS NOT FULLY ADDRESSED IN SUPREME COURT (CT APP).

The Court of Appeals, in a full-fledged opinion by Judge Rivera, determined that the trustee’s breach of contract action in this residential-mortgage-backed-securities securities case was time-barred. A certificate holder had filed a timely action, but the relevant contract precluded the action by the certificate holder. Therefore the trustee’s action could not be deemed to relate-back to it (CPLR 203). The Court of Appeals could not consider whether the trustee’s action was timely under CPLR 205, despite the fact that the Appellate Division addressed the issue, because the issue was not fully addressed by the parties in Supreme Court and the Court of Appeals does not have interest of justice jurisdiction:

CPLR 203 (f) has no application here because the certificate holder’s pre-existing action was not valid. The lower courts concluded that under the no action clause, the certificate holder could not bring the action on behalf of itself, any other certificate holder, or the Trustee. Those conclusions are not at issue in this Court. Thus, the certificate holder’s action was subject to dismissal, and there is no valid pre-existing action to which a claim in a subsequent amended pleading may relate back. The Trustee’s contention that it may use the relation-back doctrine of CPLR 203 (f) to cure the certificate holder’s lack of a right to sue, and that it may therefore avoid any problem with the identity of the plaintiff upon re-filing pursuant to CPLR 205 (a), is without merit. U.S. Bank Natl. Assn. v DLJ Mtge. Capital, Inc., 2019 NY Slip Op 01168, CtApp 2-19-19

February 19, 2019/by Bruce Freeman

Attorneys, Contract Law, Securities

IN THIS ACTION STEMMING FROM WORTHLESS RESIDENTIAL MORTGAGE BACKED SECURITIES, THE COMPLAINT SUFFICIENTLY PLED THAT GROSS NEGLIGENCE PRECLUDED ENFORCEMENT OF THE ‘SOLE REMEDIES’ CLAUSES AND THE DEMANDS FOR PUNITIVE DAMAGES AND ATTORNEY’S FEES SHOULD NOT HAVE BEEN DISMISSED (FIRST DEPT).

The First Department, in a full-fledged opinion by Justice Kahn, reversing Supreme Court, determined that the complaint in this residential mortgage backed securities (RMBS) action sufficiently pled that gross negligence precluded enforcement of the “sole remedies” clauses in the contracts and that the demands for punitive damages and attorney’s fees should not have been dismissed:

On this appeal, which arises from the securitization and sale of residential mortgages, plaintiff, Deutsche Bank National Trust Company (Trustee), as trustee of the Morgan Stanley ABS Capital I Inc. Trust 2007-NC4 (Trust), challenges the motion court’s pre-answer dismissal of the Trustee’s cause of action for breach of contract to the extent that it included a demand for compensatory damages. The motion court dismissed the Trustee’s compensatory damages demand on the ground that the “sole remedies” clauses in the underlying securitization agreements precluded the Trustee from seeking such relief. The Trustee maintains, however, that it sufficiently pleaded gross negligence on the part of defendants Morgan Stanley Mortgage Capital Holdings LLC (MSMCH) and Morgan Stanley ABS Capital I Inc. (MSAC) to render the “sole remedies” clauses unenforceable. On that issue, we hold, consistent with our decision in Morgan Stanley Mortgage Mtge. Loan Trust 2006-13ARX v Morgan Stanley Mtge. Capital Holdings LLC (143 AD3d 1 [1st Dept 2016]), that the complaint’s allegations of gross negligence in this case are sufficient to render the “sole remedies” clauses unenforceable. We are also called upon to decide whether the motion court properly dismissed the Trustee’s demands for punitive damages and attorneys’ fees. As to those issues, for the reasons that follow, we hold that those demands should not have been dismissed.

Specifically, this action arises from the securitization of subprime mortgages by Morgan Stanley & Co., Inc. in 2007, shortly before the housing market collapsed. The Trustee, as trustee of the Trust, seeks damages for the numerous loan defaults that occurred, rendering the residential mortgage backed securities (RMBS) it sold to outside investors virtually worthless. Matter of Part 60 Put-Back Litig., 2019 NY Slip Op 00368, First Dept 1-17-19

January 17, 2019/by Bruce Freeman