April 25, 2013
S&P Myth #1: No One Could Have Known
S&P filed its Memorandum in Support of Defendants’ Motion To Dismiss the DoJ lawsuit filed back in February. The memorandum states that S&P’s inability, along with other market participants, “to predict the extent of the most catastrophic meltdown since the Great Depression reveals” only “a lack of prescience” and “not fraud.” (1) This short phrase requires some serious unpacking.
First, it ignores the fact that many of the analysts who engaged in fact-based investigations of the rated securities were sounding warnings but were overruled by higher ups who demanded that market share be maintained. So if S&P and “other market participants” is defined to exclude all of those analysts, risk officers, underwriters and due diligence providers that worked for all of those market participants, then S&P is certainly right. But if plaintiffs can demonstrate that facts were ignored to the extent that short term profits would be hurt by them, then S&P’s characterization is less compelling.
A second related point is that S&P’s argument that “its views were consistent with those of virtually every other market participant” is not compelling if plaintiffs can demonstrate that it ignored the facts before it and the findings of its own models.
Finally, its characterization of the Subprime Bust as “the most catastrophic meltdown since the Great Depression” fails to acknowledge that an S&P AAA rating offers quite the stamp of approval: “An issuer or obligation rated ‘AAA’ should be able to withstand an extreme level of stress and still meet its financial obligations. A historical example of such a scenario is the Great Depression in the U.S.” (The quote is from S&P’s website and can be accessed here on page 58.) But mortgage-backed securities with that S&P triple A did not quite live up to their promise.
This is not to say that S&P has not raised serious legal issues with Justice’s complaint in its motion to dismiss, but just that its rationalizations of its own behavior (which echo those of Dick Fuld and many others at the helm of various “market participants”) don’t stand up against the record.
April 25, 2013 | Permalink | No Comments
April 24, 2013
Supreme Court of New York County Rules Against Credit Suisse’s Motion to Dismiss MBS Investor Suit
In Stichting Pensioenfonds ABP v. Credit Suisse Group AG, 2012 WL 6929336 (N.Y.Sup. Nov. 30, 2012), the Supreme Court in New York County ruled that the lawsuit against Credit Suisse related to sales of MBS would proceed. The court denied Credit Suisse’s motion to dismiss with respect to (1) the statute of limitations, (2) fraud, (3) fraudulent inducement, and (4) officers and directors aiding and abetting fraud. The court granted the motion with respect to (1) negligent misrepresentation and (2) punitive damages.
With respect to the statute of limitations, the court held that a plaintiff must provide prompt notice under Dutch Law to sustain a claim, and whether the claim was prompt is within the competence and traditional purview of a jury. With respect to fraud, the court held that cure provisions (requiring Credit Suisse to replace bad mortgages in the securitization pool) in the offering documents did not change Credit Suisse’s representations about the process of selecting mortgages. It also held that the allegations about systematic underwriting failure are sufficient to state a claim and do not need to be accompanied by reference to specific loans. Allegations that Credit Suisse knew that many representations in its offering documents were false were also sufficient to state a claim. Finally, the plaintiff’s allegations of justifiable reliance on Credit Suisse’s representation and its losses are sufficient to state a claim.
With respect to fraudulent inducement, the court held that the offering documents are evidence extrinsic to the contracts and, drawing all reasonable inferences from the complaint, they induced the plaintiff to enter into a purchase agreement. The court also denied the motion to dismiss claims against individual officers and directors of Credit Suisse for aiding and abetting fraud. The complaint alleged that the individuals “directed, supervised and otherwise knew of the abandonment of underwriting practices and the utilization of improper appraisal methods; the inaccuracy of the ratings assigned by the ratings agencies; and the failure to convey to the Issuing Trusts legal title to the underlying mortgages.” The court held that those allegations were sufficient to provide the defendants “more than enough information regarding the claims against them to mount their defense.”
The court granted the motion to dismiss the negligent misrepresentation claim because the plaintiff failed to establish that Credit Suisse owed it a duty. The court also held that the plaintiff failed to establish that the fraud was aimed at the public generally, so punitive damages were not warranted.
April 24, 2013 | Permalink | No Comments
No Scarlet Letter for Robo-Signing
An “admitted robo-signer” and her bank were let off the hook in Grullon v. Bank of America et al. (Mar. 28, 2013, No. 10-5427 (KSH) (PS)) (D.N.J.). (19) Grullon, a homeowner, alleged that he, and others similarly situated, was entitled to relief under New Jersey’s Consumer Fraud Act because of BoA’s “bad practices, including: robo-signing, foreclosure documents, concealing the true owner of loans from the borrowers, and initiating foreclosure proceedings before it had the right too, resulted in unreliable and unfair foreclosure proceedings and ascertainable losses.” (1)
Grullon alleged a variety of fraudulent robo-signing practices, including for affidavits and assignments. The Court found that in “light of the lack of- or de minimis nature of- the errors found on the documents said to have been “robo-signed,” and Grullon’s lack of standing to challenge the Assignment, the Court is not satisfied that Grullon has proffered sufficient evidence to support his NJCFA claim on this basis.” (21) The Court was also not satisfied that Grullon “has adequately shown that he suffered any ascertainable loss as a result of the 2009 NOI [Notice of Intention to Foreclosure] or the ‘robo-signed’ documents.” (24) The Court also appears to find that the “robo-signing” of assignments presents no problem as the signer is not attesting to the truth of such a document. (20-21)
Bottom line: one needs to demonstrate that there was a wrong and that harm resulted from it. Scatter shot allegations of robo-signing don’t work.
April 24, 2013 | Permalink | No Comments
April 23, 2013
Cherryland, Very Strange
I looked at the Cherryland decision yesterday. Law360 ran a story (behind a paywall) about it today, quoting me and others. To recap, the original Cherryland case appeared to unexpectedly open up many commercial borrowers in Michigan to personal liability. The most recent Cherryland opinion reversed this result as a result of Michigan’s newly passed Nonrecourse Mortgage Loan Act.
The story reads in part:
Cherryland and Schostak reaped the benefits of the NMLA. But many CMBS loan documents are similarly written, and other borrowers and guarantors “may not have the saving grace of a politically connected developer getting a law passed very rapidly,” said Brooklyn Law School professor David Reiss.
“If I was an existing borrower [or borrower’s counsel], I would look at this very carefully,” Reiss told Law360. “And new borrowers should try to negotiate new language that protects for this, saying that becoming insolvent is not something that is going to trigger the bad boy guarantee.”
After the initial decision was handed down last year, attorneys say they and their colleagues all took a hard look at the language in their clients’ nonrecourse loan documents to be sure that if they found themselves in a similar situation they would be protected without the cover of a law like Michigan’s NMLA or Ohio’s Legacy Trust Act, which followed shortly thereafter.
In fact, experts say they don’t believe many other states will likely follow suit with their own guarantor-protecting statutes. So even though Wells Fargo lost out in the Cherryland row, lenders will likely keep the case in mind when considering deals.
Although “most people believe that the [pre-NMLA] decision in Cherryland was not what was intended by virtue of the documents,” said Schulte Roth & Zabel LLP real estate partner Jeff Lenobel, the solvency covenant was drafted in a way that allowed it to be read as a bad boy trigger.
This has led many who represent borrowers and guarantors to seek more due diligence and spend more time making sure loan language is just right.
More than $1 trillion in CMBS loans are coming due over the next several years, and Lenobel said he wouldn’t be surprised to see the issue come up again in a different court.
While the Cherryland case is all but over, another similar suit — Gratiot Avenue Holdings LLC v. Chesterfield Development Co. LLC — is making its way through Michigan’s federal courts. And attorneys aren’t ruling out the possibility of an appeal to the U.S. Supreme Court to ultimately determine the responsibilities of a guarantor in a nonrecourse loan.
“It may be a very smart move by the lending industry to appeal to the Supreme Court,” Reiss said.
April 23, 2013 | Permalink | No Comments
Bounced Mortgage Relief Checks
In February, federal banking regulators reached a $9.3 billion pact with 13 major lenders to settle claims of foreclosure abuses like bungled loan modification and flawed paperwork. Under the deal, homeowners can receive up to $125,000 in cash relief.
Unfortunately, as some of the 1.4 million homeowners entitled to settlement funds went to go cash their much-anticipated checks, they found themselves on the receiving end of some bad news– the “funds were not available.”
Since the settlement, there have been a number of problems. For example, in Ohio, problems arose at Rust Consulting, a firm chosen to distribute the checks. After collecting the $3.6 billion from the banks, Rust had failed to move the money into a central account for distribution. Second, there have been bureaucratic delays like those arising from checks made out jointly to estranged divorcees.
Even though the settlement is supposed to bring relief to million of homeowners, this fiasco of “bounced checks” is just one of the latest “runarounds” leaving homeowners increasingly exhausted at the process.
Article here.
Read about settlement here.
April 23, 2013 | Permalink | No Comments
April 22, 2013
Cherry Bombs in Michigan
An ongoing Michigan state case, Wells Fargo Bank, N.A. v. Cherryland Mall L.P. et al., has been generating a lot of heat over an obscure but important issue for commercial mortgage borrowers, the scope of carveouts from standard nonrecourse provisions in loan documents. And now the most recent opinion issued in the case raises important constitutional issues as well.
This case (as well as the similar Chesterfield case (a federal court case also in Michigan)) took many in the real estate industry by surprise by reading language in the loan documents at issue in those cases so as to gut their nonrecourse provisions. Michigan (as well as neighboring Ohio) quickly passed legislation to return the nonrecourse language to how it was commonly understood.
The Michigan courts’ interpretations of the language in the loan documents was inconsistent with how such provisions were typically understood in the industry. While the new statutes returned things to how they were commonly understood to be before the cases were decided, they did so in a way that raises more fundamental issues. Most importantly, such statutes potentially violate the Contracts Clause of the United States Constitution which bars the “impairing” of “the Obligation of Contracts.”
The most recent Cherryland opinion upheld the constitutionality of the new Michigan statute and rightly notes that the Contracts Clause is not read literally. This has been true at least since the Depression era U.S. Supreme Court case of Home Building & Loan Association v. Blaisdell did not invalidate Minnesota’s mortgage moratorium. The U.S. Supreme Court had thereby given states some leeway pursuant to their police power to remedy social and economic problems, notwithstanding the text of the Contracts Clause. The situation in the Cherryland case is less sympathetic than that in Depression-era Blaisdell, where many, many homeowners were being foreclosed upon. The Cherryland borrower, in contrast, is a politically-connected real estate developer. But the point remains that the Contracts Clause is not an absolute bar to legislative revision of privately negotiated contracts. How politically connected, you might ask. The court indicates that
defendant [David] Schostak is co-chief executive officer of defendant Schostak Brothers & Company, Inc., and that Robert Schostak is co-chairman and co-chief executive officer. . . . Robert Schostak is “a high ranking Republican Party leader in Michigan, with many years of involvement in assisting the party’s candidates to gain election in the legislature.” We note that Robert Schostak has been chairman of the Michigan Republican Party since January 2011, was finance chairman through the 2010 election cycle, and had served on campaign fundraising teams for prominent Republicans. (8, note 3)
The borrowers here are as well positioned to get helpful legislation passed as anyone. There is much to chew over here, not the least of which is the Court’s finding that the statute was not “intended to benefit special interests.” (8)
There are also important practical aspects to the case. For instance, it is quite possible that courts in other jurisdictions will read the typical CMBS nonrecourse language similarly to how the Michigan courts read it. Lenders will want to take a look at their loan documents to determine whether they mean what they say and say what they mean. And borrowers should read the language in their loan documents carefully before signing on the dotted line. They have been warned.
April 22, 2013 | Permalink | No Comments
