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Law Debenture Trust Co. of New York v. WMC Mortgage, LLC

United States District Court, D. Connecticut

August 8, 2017

LAW DEBENTURE TRUST COMPANY OF NEW YORK, solely in its capacity as Separate Trustee of the Securitized Asset Backed Receivables LLC Trust 2006-WM2, Plaintiff,


          CHARLES S. HAIGHT, JR., Senior United States District Judge

         This is one of the many residential mortgage backed securities ("RMBS") cases generated by the collapse in 2008 of the United States real estate market. That earthquake may have subsided, but its aftershocks remain, as exemplified by this energetically conducted litigation.

         The case at bar is now before the Court on Defendant's motion for partial summary judgment, which Plaintiff resists in its entirety. This Ruling resolves that motion. Familiarity is assumed with the Court's prior Rulings, reported at 2014 WL 1289234 (denying Defendant's motion to dismiss Plaintiff's complaint), and 2015 WL 9581729 (granting Plaintiff's motion to expedite determination of statistical sampling and denying Defendant's motion to exclude testimony of Plaintiff's expert witness).

         I. Background

         The case at bar follows the typical pattern. A residential mortgage is created when a home owner applies for and receives a loan from a financial institution. The home owner's obligation to repay the loan and interest is secured by a mortgage on the residence, which the financial institution holds. In RMBS parlance, the financial institution is referred to as the "originator, " an appropriate designation for the entity that decided whether or not to make the loan requested by the home owner.

         Thus far, we inhabit that earlier, uncomplicated world, where modestly sized banks on Main Street lend money to farmers on the edge of town, acquire mortgages on the farm, and everyone hopes for years of bountiful crops. We enter the dramatically different RMBS world when thousands of separate residential mortgages are bundled together into a trust, which then issues certificates purchased by the investing public, designated "certificateholders." Payments of principal and interest by thousands of underlying homeowner mortgagees find their way, not to the vaults and balance sheets of rustic banks on Main Street, but rather into the pockets of trust certificateholders. If the mortgages are sound and the mortgagees make their obligated payments, the trust investors realize significant profits. If there are widespread defaults on the mortgages, the certificates become valueless and the investors suffer significant losses.

         The "originator, " who made the loans creating the corpus of the trust, receives its profit early on, when the trust and its attendant agreements are executed and become effective. The certificateholders' economic anxiety about the mortgagees' subsequent performance is not shared by the originator - at least, not until lawyers get involved.

         Turning to the case at bar, the present record shows that Defendant WMC Mortgage, LLC is the successor entity to WMC Mortgage Corp., which originated the residential home mortgage loans involved in the case. I will refer to these entities collectively as "WMC." The documents which accomplished the securitization in suit were executed in 2006. As the result of those agreements, a pool of 5, 162 separate residential loans, all originated by WMC, were ultimately deposited into the Securitized Asset Backed Receivables LLC Trust 2006-WM2 (the "Trust"). The Trust issued certificates that were sold to investors.[1] Plaintiff's complaint [Doc. 1] alleges in ¶ 1 that at this time, WMC sold this pool of residential mortgages "to the Trust for approximately $1 billion." Plaintiff in the case is Law Debenture Trust Company of New York ("Law Debenture"), described in the complaint caption as "solely in its capacity as Separate Trustee" of the Trust. Wells Fargo Bank, National Association, the original Trustee, was replaced by Law Debenture as successor and Separate Trustee by an order of a Minnesota state court in June 2012, under circumstances it is not necessary to recount.

         Plaintiff's theory of the case is that over time, there were a multitude, even a pervasive number, of defaults in the underlying mortgages, resulting in losses to investors, for recourse of which the Trustee, pursuant to authority conferred upon it by the Trust, sues WMC. It has become apparent, as discovery progresses, that at the eventual bench trial, counsel for Plaintiff intends to rely significantly upon expert opinion testimony, to prove liability on the part of WMC and the quantum of damages. It is in the context of Law Debenture's proffered expert opinion testimony that WMC makes its present motion for partial summary judgment.

         II. Defendant's Motion for Partial Summary Judgment

         The stage for WMC's motion for partial summary judgment is set by the Court's earlier ruling, 2015 WL 9581729, which resolved motions focusing upon the proffered opinion testimony of an expert witness designated by Law Debenture: Nelson R. Lipshutz, Ph.D. Dr Lipshutz is a statistical consultant who has previously testified on behalf of plaintiffs in bench trials of RMBS cases: before Judge Rakoff, in Assured Guaranty Municipal Corp. v. Flagstar Bank, FSB, 920 F.Supp.2d 475 (S.D.N.Y. 2013), and before Judge Castel, in U.S. Bank, National Association v. UBS Real Estate Securities, Inc., 205 F.Supp.3d 386 (S.D.N.Y. 2016).

         As a statistical consultant for Law Debenture in the case at bar, Dr. Lipshutz turned his attention to the 5, 162 residential mortgages originated by WMC and thereafter placed in the Trust pool. Dr. Lipshutz calculated that 4, 170 of those loans had not been paid in full as of the time of his retention.[2] He then "devised a randomly selected, statistically significant sample of 400 loans out of 4, 170 loans not paid in full." 2015 WL 9581729, at *2. Dr. Lipshutz will then "conduct a review of the loans in the sample to determine whether the loans are in breach of WMC's representations and warranties, " "mathematically determine the breach rate among the loans in the sample, " and "extrapolate the breach rate among the remainder of the loans in the Trust to a reasonable degree of scientific certainty." Id. at *3 (citation omitted). The amount of money damages would then be calculated by Dr. Joseph Mason, another expert witness designated by Law Debenture. Id. I summarized Law Debenture's trial strategy in the prior Ruling:

Law Debenture's game plan for the trial, then, is to call Dr. Lipshutz as a statistical expert whose testimony based on sampling will, if the trial judge accepts it, establish WMC's liability for breaches of contractual representations and warranties across the broad scope of nonperforming mortgages within the Trust. Dr. Mason will follow up as a damages expert whose damages calculations will proceed from the breach rate statistically established by Dr. Lipshutz.


         Confronted by that proffered expert opinion testimony, WMC filed a Daubert motion to exclude or limit what Dr. Lipshutz would be permitted to say at trial. I denied that motion, for the reasons stated in the earlier opinion and not repeated here. See 2015 WL 9581729. However, it is important for present purposes to note one observation the Court made during the course of the prior opinion. Since day one of this litigation, WMC has argued that Law Debenture's claims for money damages are barred by what WMC refers to as the "sole remedy clause" in the governing Trust contract. True to its conviction, WMC's counsel gave voice to that argument as the parties prepared for oral argument on the Daubert motion. I thought it right to say at that time:

Prior to the hearing, the Court entered a Scheduling Order which eliminated WMC's first stated objection to Dr. Lipshutz's report from the subjects to be considered as part of a Daubert hearing. That Order said: "While an argument can be made for shoehorning the 'sole remedy' substantive merits issue into a Daubert inquiry into the validity of the methodology by which Dr. Lipshutz arrived at his statistical opinion, I think the better practice is to require WMC to make a separate, free-standing motion in limine if it wishes to press the sole remedy theory (as I suspect it does)."

Id. at *3.

         WMC's next tactical step was to file the present motion for partial summary judgment, pursuant to Fed.R.Civ.P. 56. The Notice of Motion [Doc. 136] specifies two related but separate requests for summary disposition. First, it is contended that

WMC is entitled to summary judgment with respect to those loans in the trust for which there is no genuine dispute that Law Debenture did not satisfy the notice provision set out in the governing contract. That agreement dictates that, at least by the time of summary judgment, Law Debenture give notice of any breach for which it seeks recovery, or offer evidence that WMC itself actually discovered the alleged breach. Absent loan-by-loan evidence of notice or actual discovery, the plaintiff cannot obtain a recovery for the loan.

Doc. 136, at 1. Second, WMC contends that the Court should grant WMC partial summary judgment on two representative loans "where Law Debenture indisputably cannot prove, as required by the governing agreement, that any alleged breach materially and adversely affects the value of the loan." Id. at 2.

         These particular contentions may not fit squarely within WMC's consistently reserved "sole remedy" theory, but they arise principally from the trust agreement's provisions about notice or knowledge of mortgage defaults and resulting remedies. In any event, a partial summary judgment and a ruling in limine confer comparable relief upon a successful movant. Either is a an appropriate procedural vehicle.

         III. The Pooling & Service Agreement

         The core contract in this case is called the Pooling and Service Agreement ("PSA"). The PSA created the Trust and defines the rights and obligations of, inter alia, Law Debenture as successor Trustee (acting on behalf of the certificate investors) and WMC (defined by the PSA as the "Responsible Party"). On WMC's motion for partial summary judgment, the briefs and arguments of counsel focus upon certain provisions in § 2.03 of the PSA, captioned in part "Representations, Warranties and Covenants of the Responsible Party . . . " The following partial quotations from the PSA focus upon the particular provisions cited by counsel.

         Section 2.03(b) provides: "The Responsible Party hereby makes the representations and warranties set forth in Schedule III and Schedule IV to the Depositor and the Trustee, as of the Closing Date." The "representations and warranties" in Schedules III and IV are those promises respecting the quality of a loan with which this litigation is concerned.

         Section 2.03(c) provides: "Upon discovery by the Responsible Party, the Depositor, the Trustee or the Servicer of a breach of any of the foregoing representations and warranties, the party discovering such breach shall give prompt written notice to the others." Section 2.03(d) provides: "[W]ithin 60 days of the earlier of either discovery by or notice to the Responsible Party of any breach of a representation or warranty, set forth in Section 2.03(b), that materially and adversely affects the value of any Mortgage Loan or the interest of the Trustee or the Certificateholders therein, " the Responsible Party must "use its best efforts" to cure the breach, or replace the nonconforming mortgage with a substitute mortgage loan, or repurchase the nonconforming loan.

         Section 2.03(k) provides in a separate paragraph that "the obligation of the Responsible Party under this Agreement to cure, repurchase or substitute any Mortgage Loan as to which a breach of a representation and warranty has occurred and is continuing, together with any related indemnification obligations of the Responsible Party set forth in Section 2.03(h), shall constitute the sole remedies against such Person respecting such breach available to Certificateholders, the Depositor and any of its Affiliates, or the Trustee on their behalf."

         IV. What is WMC's Motion for Partial Summary Judgment Really About?

         This question is posed because, after extensive briefing on the present motion, during oral argument a disagreement between counsel emerged about what WMC's motion for partial dispositions is really about.

         Counsel for WMC began his argument by saying: "Our partial summary judgment motion presents two issues - notice and materiality." Tr. 11.[3] That distinction tracks the two separate bases for judgment specified in the Notice of Motion. "Materiality" relates to the narrow issue posed by the two representative loans described in the second specification. "Notice" is a broader issue, applicable to the universe of nonperforming loans in the Trust. As to them, counsel argued that

the plaintiff must come forward with loan-specific evidence of a breach, either by giving notice of the breach or by coming forward with evidence that the defendant itself had discovered the breach. . . . . We acknowledge that Law Debenture has come forward with notice for 876 loans out of approximately 5, 000 in the pool. Those loans are in the case, at least for purposes of summary judgment . . . . Four-and-a-half years later, they have no notice, they have not pointed to any problem with any other loan. So they get to go forward on the loans that they have satisfied their burden at summary judgment, but they don't get to go forward on the rest.

Tr. 12, 15-16.

         Counsel for Law Debenture opened by saying:

I would suggest, your Honor, that will due respect to WMC and its counsel, this is not a case - it's not a case about notice; it's a case about sampling, or a motion, I should say, about sampling.

Tr. 62.

         At the conclusion of forceful arguments, counsel summed up in manners consistent with their openings. Counsel for WMC said:

We would like the Court to rule in the following manner: On the notice and discovery issue, that the plaintiff is entitled to go forward on the 876 loans for which there is some evidence of notice plus the other 17 loans, the 13 and four, that we are not contesting discovery, and that WMC receive summary judgment as to the balance of the loans in the trust.

Tr. 58-59 (emphasis added). Counsel for Law Debenture said:

Notice would be futile, and notice is not required on every single loan when you have sampling . . . . You don't then have to analyze every single loan. It would defeat the purpose of sampling. It would eliminate sampling.

Tr. 85 (emphasis added).

         What is this motion really about - notice or sampling? The labels affixed by counsel in their arguments reflect the exigencies of advocacy. It is inherent in human nature that perceptions of reality are not wholly objective, and may differ significantly with respect to the same subject. To decide the present motion, the Court need not choose between characterizing the motion as about notice or about sampling. Both concepts are implicated by the complex contracts governing the case and the welter of bad feelings resulting from the nonperformance of vast numbers of securitized residential mortgages. The Court will decide WMC's motion for partial summary judgment by analyzing the particular claims Law Debenture asserts in its complaint, and then determining whether the standards governing Rule 56 practice entitle WMC to the requested partial summary disposition with respect to those claims.

         V. The Claims Law Debenture Asserts in its Complaint Against WMC

         Law Debenture's complaint against WMC [Doc. 1] comprises 31 pages and 98 numbered paragraphs. Paragraphs 1 through 84 contain detailed factual allegations, interspersed with argumentative or conclusory passages and contentions regarding applicable law.

         The complaint then sets forth two separate causes of action. The First Cause of Action, ¶¶ 85-92, is captioned "Breach of Contract/Breaches of Representations and Warranties." The Second Cause of Action, ¶¶ 93-98, is captioned "Breach of Contract/Failure to Notify."

         Each cause of action incorporates by reference ¶¶ 1-84 of the complaint. Paragraph 5 alleges:

WMC, as the originator, was in a far superior position to know the true nature of the Loans it was selling - far superior to the Trustee (whose duties were contractually restricted) and far superior to the eventual purchasers of the mortgage-backed securities that would bear the brunt of WMC's shoddy origination practices.

         What the complaint means by "shoddy origination practices" is amplified in succeeding paragraphs. Paragraph 8 alleges that "[a] loan-level investigation initiated by certain Certificateholders" revealed breaches by WMC of representations and warranties "with respect to numerous Loans." Paragraph 9 alleges that further investigations by "Forensic Review Firms" uncovered breaches of representations and warranties in many more loans, which included "overstatement of borrower income, understatement of borrower liabilities, and misstatement of the occupancy status of the mortgaged property." Paragraph 11 alleges that additional "recent independent investigations" have revealed that

WMC systematically disregarded its underwriting guidelines and engaged in underwriting practices that directly violated the Representations and Warranties. These revelations, combined with the pervasiveness and severity of the breaches of Representations and Warranties found in the sample reviewed by the Forensic Review Firms, indicate that the Loans were not originated on any legitimate foundation, and strongly suggest a high breach rate throughout the entire Loan pool in the Trust. Nonetheless, despite its receipt of loan-specific breach notices and repurchase demands, as well as evidence that WMC is and has been aware of the breaches plaguing the Loans since origination, WMC has failed to repurchase any of the Defective Loans from the Trust. It is therefore clear that WMC has abandoned its duty to notify all applicable parties of breaches of its representations and warranties, as well as its repurchase obligation under the PSA, and any further notice to WMC would be futile.

         Law Debenture considers this conduct by WMC to be deplorable. The complaint derives WMC's obligations to pay the Certificateholders' resulting damages from provisions in the PSA, the contract under which the bundled WMC-originated loans were transferred into the Trust.

         Specifically, the Preliminary Statement in the complaint alleges in ¶ 6 that, under § 2.03(d) of the PSA, if any loan is in breach of a representation or warranty which materially and adversely affects the value of the loan or the interest of the Trust or Certificateholders, WMC must cure the breach or repurchase the loan "within 60 days of the earlier of WMC's discovery of, or receipt of notice of, such breach or Defective Loan." In addition, ¶ 7 of the complaint alleges that § 2.03(c) of the PSA provides that "[u]pon discovery by Responsible Party [WMC] . . . of a breach of any of the foregoing representations and warranties, the party discovering such breach shall give prompt written notice to the others [i.e., the Trustee, Servicer and Depositor]." The two causes of action pleaded in the complaint track these allegations of WMC's contractual obligations. The first cause of action focuses upon WMC's obligation to cure or replace a nonperforming loan when WMC acquires or receives from others notice of a material breach of the representations and warranties. The second cause of action focuses upon WMC's obligation to give to others notice of breaches of which WMC has acquired actual or constructive knowledge. The two claims differ in that, with respect to the relationship between the Trust and WMC, the giving of notice of loan breaches flows in different directions: to WMC in the first cause of action, from WMC in the second.

         Law Debenture's theory of the case is that WMC's wrongful conduct, beginning at the time of WMC's origination of the loans and continuing throughout the establishment of the Trust and thereafter, breached each of these several duties WMC owed to certificateholders under these terms of the PSA. The complaint concludes with a prayer for relief which includes, inter alia, "specific performance of WMC's obligation under the PSA to repurchase the Defective Loans in the Trust, " and "compensatory, consequential, rescissionary, equitable damages and/or indemnification compensating for the Trust's losses relating to WMC's failure to notify the Trustee and the Separate Trustee of its breaches of representations and warranties relating to the Loans." The first of these two requested forms of relief arises from the first cause of action pleaded in the complaint; the second form of relief arises from the second cause of action.

         WMC's motion for partial summary judgment, if granted, would significantly reduce Law Debenture's first claim and eliminate the second. The first claim would be reduced because the effect of granting the motion would be going forward with a trial limited to those separate loans, less than one thousand, where Law Debenture gave WMC notice of, or WMC had acquired, some evidence of breaches. WMC would "receive summary judgment as to the balance of the loans in the trust, " to quote its counsel's submission at the hearing [Tr. 58-59], thereby disposing of thousands of additional loans in the pool, a ...

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