New York’s First Department Creates Split Authority on Inducement Claims by Guaranty Insurers, Weighs in on “Backstop” Claims in RMBS Suits. On May 16, 2017, the New York Appellate Division, First Department, issued a decision in Ambac Assurance Corporation, v. Countrywide Home Loans, Inc., --- N.Y.S.3d ----, 2017 WL 2115841 (1st Dep’t 2017), that creates a conflict within New York law regarding the elements of an insurer’s cause of action for inducement of a contract by misrepresentation. Ambac, a financial guaranty insurer, sued the mortgage loan originator Countrywide over 17 residential mortgage-backed securities (“RMBS”) trusts. Ambac had issued unconditional and irrevocable insurance policies for the trusts, which guaranteed payments of principal and interest to the trusts’ investors. Ambac alleged it had issued the policies based on Countrywide’s application, and that in the application Countrywide purportedly made a series of false statements about its own operations and about the securitized loans.
Reversing the motion court, the First Department held that, to prevail on its inducement by a misrepresentation claim, Ambac had to prove both its justifiable reliance on Countrywide’s false statements and also that the false statements caused Ambac’s losses—just as is required for a common-law fraud claim. Id. at *1. Relying principally on cases outside of the insurance context, the court concluded that New York’s Insurance Law §§ 3105 and 3106 do not dispense with the general common-law requirements that fraud plaintiffs must prove loss causation and justifiable reliance. Id. at *2. The court also held these Insurance Law provisions did not abrogate the common-law fraud rules by implication. Id.
Remarkably, the unanimous Ambac panel expressly declined to follow a prior ruling by another unanimous First Department panel in MBIA Ins. Corp. v. Countrywide Home Loans, Inc., 963 N.Y.S.2d 21 (1st Dep’t 2013), which held insurers did not need to prove loss causation to prevail on a claim for inducement by misrepresentation. In MBIA, in which the insurer MBIA brought fraud and breach- of-contract claims against Countrywide, the First Department had held that “pursuant to Insurance Law §§ 3105 and 3106, plaintiff was not required to establish causation in order to prevail on its fraud and breach of contract claims.” Id. at 22.
In Ambac, the First Department acknowledged its prior decision in a footnote, but stated: “We decline to follow that part of the decision.” Ambac, 2017 WL 2115841 at *2 n.3. The court provided no further explanation. As a result, Ambac creates a split within the First Department as to whether insurers must establish loss causation in pursuing inducement by misrepresentation claims. Ambac has petitioned the First Department for leave to appeal to the New York Court of Appeals, to resolve the contradictory decisions.
* * *
On May 11, 2017, the New York Appellate Division, First Department, issued a decision in Bank of New York Mellon, v. WMC Mortgage, LLC, --- N.Y.S.3d ----, 2017 WL 1946017 (1st Dep’t 2017), that clarified the time-frame for bringing certain types of claims for repurchase of defective loans in RMBS. Bank of New York Mellon (“BONY”), as Securities Administrator of an RMBS trust, had brought (among others) claims against WMC Mortgage, which originated the loans, and JP Morgan Mortgage Acquisition Corp (“JPMMAC”), which securitized the loans. BONY sued WMC for breaching the warranties it had made in a mortgage loan purchase agreement, and it sued JPMMAC for breaching a promise it had made in a separate pooling and servicing agreement to repurchase loans that breached WMC’s warranties if WMC did not do so.
The motion court and the First Department concluded that JPMMAC’s breach-of-warranty claims against WMC were time-barred, because they were brought more than six years after WMC made and allegedly breached its warranties. JPMMAC argued that this meant its “backstop” obligation to repurchase defective loans was effectively void— because, it argued, if WMC was no longer “obligated” to repurchase the loans, then JPMMAC was not required to do so either.
The First Department issued a split decision. It noted that, under Court of Appeals precedent, “[t]he law is now well-settled that the expiration of a time period set forth in a statute of limitations does not extinguish the underlying right, but merely bars the remedy.” Id. at *3. Despite this, the court held that “WMC’s legal obligation to repurchase effectively expired when the statute of limitations ran.” Id. at *4. The court thus concluded that BONY could not pursue backstop claims based on notices of defective loans provided to WMC after the limitations period for breach-of-warranty claims against WMC had run.
The First Department did allow backstop claims against JPMMAC based on notices of defective loans provided to WMC before the limitations period against WMC ran, even though BONY did not file suit against JPMMAC until after that time. The court noted that, under the contracts, BONY was required to seek to enforce WMC’s repurchase obligation before JPMMAC’s backstop obligations were triggered, hence “[t]o the extent the backstop obligation is attached to a valid WMC liability—albeit one that cannot be enforced against WMC because it is time-barred—the JPMAC obligation came into existence when WMC failed to repurchase.” Id. at *5. The First Department thus allowed BONY to pursue backstop claims against JPMMAC based on a notice of defective loans provided to WMC shortly before the limitations period for claims against WMC expired.
Both parties have petitioned the First Department for leave to appeal its decision to the New York Court of Appeals.