Be Careful What You Contract For . . .

Justice Ramos of the Commercial Division of the New York State Supreme Court NY County) issued an opinion in Assured Guar. Corp. v. EMC Mtge., LLC, 2013 NY Slip Op. 50519(U) (April 4, 2013).  Assured, a monoline insurer, “alleges that Bear Stearns grossly misrepresented the risk of the underlying pooled loans” that Bear Stearns had used as collateral in RMBS deals that it had underwritten. (1) Assured alleged that loan warranties in nearly 90 percent of the loans in one of the pools at issue had been breached.  The court noted that more than half of the loans in that pool had either “defaulted or are seriously delinquent.” (2) Bear Stearns’ successor-in-interest refused to repurchase the breaching loans.

The Court found that the deal documents make “clear that the parties intended to limit Assured’s remedies for breach of the representations and warranties relating to the quality and characteristics of the pooled loans to the Repurchase Protocol . . .” and the Court indeed so limited Assured’s remedies. (4) Justice Ramos relied on the opinion by Judge Rakoff (SDNY) in Assured Guar. Mun. v. Flagstar Bank, that reached a similar result.

One wonders how monoline insurers will seek to change deal documents going forward.  Will they be so willing to treat representations and warranties as mere risk allocation devices between the parties?  As risk allocation devices, the reps and warranties typically make only limited remedies available.  Or will they demand that they be treated as something more — perhaps as actual representations and warranties about the underlying transaction and upon whose shoulders broader remedies could be hung?

Rakoff Rules for Monoline Insurer Against Securitizer

Judge Rakoff ruled for Assured Guaranty against Flagstar and awarded Assured more than $90 million.  The 103 page order is a pretty compelling read as it is a careful review of a battle of the experts and has lots of details about the loans in two Flagstar securitizations.  Some interesting bits:

  • the third-party due diligence providers, the Clayton Group and the Bohan Group, “were only expected to flag issues if something in the loan files appeared ‘ridiculous.’” (18)
  • the court found that many of the loans had “blatant” defects. (75)

Ultimately, the court found “that the loans underlying the Trusts here at issue pervasively breached Flagstar’s contractual representations and warranties.” (91)  The court’s findings may have unexpected relevance to other burning issues coming out of the financial crisis, such as whether these securitizations complied with the REMIC rules.