Does “freedom of contract” really exist when it comes to statute of limitations in a mortgage-backed securities contract?
October 22, 2018
Although we generally report on recent Commercial Division decisions, and sometimes commercial cases coming out of the Appellate Divisions, this time we go all the way to the top: the Court of Appeals. Not often do we see commercial cases with a procedural twist coming out of our High Court (of NY). However, last week, the Court rendered a decision in Deutsche Bank Nat’l Bank Trust Co. v. Flagstar Capital Mkts, addressing a thorny statute of limitations issue in a breach of representations and warranties claim arising out of a residential mortgage-backed securities contract. Even more interesting is that the decision was only a 4-2 vote, drawing two separate dissents from Judges Rivera and Wilson. Judge Garcia took no part.
The case arose out of a series of mortgage loans originated by defendant Quicken Loans, Inc. that were initially sold to Morgan Stanley Mortgage Capital, Inc. and eventually sold to a trust for the purpose of issuing residential mortgage-backed securities. The document at issue, the Second Amended and Restated Mortgage Loan Purchase and Warranties Agreement (“MLPWA”), contained two provisions at issue. The first, the “Sole Remedy” provision, stated that the purchaser’s only remedy was seller’s obligation to sure or repurchase the nonconforming loan. The second, the so-called “accrual clause” provided that “[a]ny cause of action against the Seller . . . shall accrue . . . upon (i) discovery of such breach . . . (ii) failure by the Seller to cure such breach . . . and (iii) demand upon the Seller by the Purchaser for compliance.”
Against this backdrop, seven years after the loans were originated, plaintiff claimed breach. Defendants immediately moved to dismiss on statute of limitations grounds, relying on the Court of Appeals’ decision in ACE Sec. Corp. v. DB Structural Prods., Inc., which held that a cause of action for breach of representations and warranties accrues when the contract was executed.
The case was dismissed at the trial court level, on the statute of limitations defense. Affirmed by the Appellate Division, First Judicial Department (143 AD2d 15), the Court of Appeals granted leave to consider whether the statute of limitations could be extended beyond the Court’s decision in ACE.
In a split decision, the Court held that the “accrual clause” did not create a substantive condition precedent. In addition, the Court held that the accrual period could not be used to extend the statute of limitations. Rather, the Court distinguished NY General Obligations Law 17-103, which allows parties to extend a statute of limitation after the cause of action accrues. In rejecting plaintiff’s claims of “freedom of contract” the Court held that “[w]hen the public policy favoring freedom to contract and the public policy prohibiting extensions of the limitations period before accrual of the cause of action come into conflict, however, the latter must prevail.”
The dissents were strong. Judge Rivera, criticizing the majority for “misconstru[ing] decisional law” by departing from “our longstanding recognition of the freedom to contract,” found no statute or public policy to be a bar to the enforcement of the accrual. Judge Wilson, agreeing with Judge Rivera’s dissent, in even stronger language concludes the Court “created bad law” and “fundamentally misinterpreted the structure of RMBS agreements.”
The takeaway? Not sure, but at least for now, the drafters of agreements that contain clauses seeking to extend the period within which to assert a claim for breach of a representation and warranty — particularly in the RMBS arena — must take care in ensuring the “accrual” of the claim is not postponed, but rather the period within which to sue is extended.