Thousands of mortgage lenders across the country either recently received, or will soon be receiving, from Lehman Brothers Holdings Inc. a document that may seem innocuous, but likely presages a future lawsuit by LBHI against the recipient. The document is notice of a motion to approve a proposed settlement of residential mortgage-backed securities (RMBS) claims asserted by trustees and investors against LBHI over the last few years. The notice of proposed settlement includes proposed findings of fact, sets a deadline (June 22) for objections to the settlement, and schedules a hearing date (July 6) for approval of the RMBS settlement.
The companies receiving this document are apparently those that LBHI believes originated and sold loans that are now part of the proposed settlement. The proposed resolution sets an estimated settlement price of $2.416 billion to be paid by LBHI to settle the claims against it. Service of this notice document is almost certainly a prelude to new payment demands (for alleged breaches of contractual representations and warranties) by LBHI against the mortgage lender/correspondent at some time after the bankruptcy court approves the settlement. This notice likely is also specifically motivated by LBHI’s desire to attempt to preclude one of the potential defenses to a contractual indemnity claim, "failure to give notice." Paragraph 3 of the proposed order appears to relate to that issue.
I have spent a great deal of time since the 2008 financial crisis defending companies against RMBS-related claims for contractual indemnification or repurchase relief (aka "mortgage buyback" or "mortgage put-back" claims). There are numerous strong defenses, legally and factually, to claims seeking that type of relief in this kind of factual context (i.e., claims, years after purchases of residential mortgage loans, that the loan seller allegedly breached representations and warranties, or applicable underwriting standards, and thus must remedy the purported problem by indemnifying the purchaser or repurchasing the loan).
Beyond potential statute of limitations problems for claimants, here is an overview of just a few of the additional defenses that can be asserted against claims of this type:
- The Purpose and Effect of "Stated Income" and Other "Reduced Documentation" Loan Programs
A key question is whether, under a fair reading of the parties' loan purchase agreement (including applicable seller guidelines), a loan seller can be deemed to have made representations and warranties as to subjects that it was expressly precluded — by the very party purportedly "relying" on those representations and warranties — from verifying and documenting. For example, if the fundamental nature of a stated income loan product is that a borrower's self-reported income is not to be verified by the loan seller, doesn't a general representation or warranty that a particular loan file is in all respects "true and accurate" necessarily mean, as to income, that the file truly and accurately represents what the borrower stated his or her income to be? Or was all risk of any possible borrower misstatement placed in all instances on each of the literally thousands of entities that sold loans to the major aggregators of loans, such as LBHI before its descent into bankruptcy, for many years? The historical record, not least of which includes public statements in securities filings by LBHI as to its detailed analyses of the risks associated with reduced documentation/reduced verification loans, offers abundant evidence that contradicts the notion that LBHI shifted all risk to the thinly capitalized correspondent lenders that sold it loans.
- Causation and Materiality
Plaintiffs in this type of action routinely make payment demands despite the fact that any loss allegedly incurred by them has little or nothing to do with the "defect" or "violation" that they contend justify their demands. But considerations of causation and materiality cannot simply be dispensed with by plaintiffs under common law, and often a causal link between "breach" and injury is called for under the key contractual provisions as well.
- Put-Back Demands and Mortgage Insurance Rescissions Spurred by a Plaintiff's Own Representations and Warranties
In reselling or securitizing the loans that they acquired from loan originators/sellers, the purchaser typically made independent representations and warranties (often extensive ones) to investors and mortgage insurance companies. The fact that those investors or insurers later made repurchase or indemnification demands against the loan purchaser, or an insurer purported to "rescind" mortgage insurance, in connection with those representations and warranties is an issue for the loan purchaser. Moreover, there is often a lengthy paper trail of the purchaser demonstrating that it believes the claims against it are entirely without merit (conversely, and just as helpfully, it is sometimes evident that the loan purchaser failed to raise various defenses readily available to it; instead, it simply made a substantial settlement payment for which it now claims entitlement to reimbursement by the loan originator/seller). Even if a plaintiff's claims against a loan originator can be regarded as true "contractual indemnification" claims (as opposed to breach-of-contract claims for which "indemnification" is identified as a contractually available remedy, which is my clients' strong belief as to the true nature of this type of claim), some extent of demonstration that the settlement payment was actually required to be paid under the existing circumstances is generally necessary.
With regard to LBHI in particular, the RMBS settlement, once it is approved by the bankruptcy court (LBHI has been in bankruptcy since September 2008), will likely usher in a "fourth wave" of lawsuits by LBHI against the lenders that sold it residential mortgage loans. First, LBHI typically sued lenders in venues close to the lenders' headquarters. They then shifted strategies, filing claims in Colorado, close to the headquarters of their affiliate Aurora. After setbacks in each of those first two waves, LBHI began bringing lawsuits against lenders in the U.S. Bankruptcy Court for the Southern District of New York. It commenced a third wave of litigation seeking reimbursement for settlement payment commitments it made to Fannie Mae and Freddie Mac. Now, the fourth wave — seeking reimbursement for RMBS settlement payment commitments — appears to be on the horizon. No doubt, significant legal and financial challenges lie ahead for all who are sued, or threatened with suit. Again, however, the potential to assert strong legal and factual defenses exists for most businesses in the crosshairs of this type of claim.
This article is reprinted with permission from Law360.