Wells Fargo Asks Court to Reject JPMorgan’s “Ostrich Defense” to CMBS Representation and Warranty Breaches, as Additional Putback Litigation Hits Civil Dockets

When I posted last, I was preparing to speak on a Federal Bar Association panel amid growing concerns of a reckoning coming in the CMBS and broader commercial real estate (CRE) space, and mounting interest in the potential litigation to come. What I have learned during that enlightening panel, and since, is that many thought leaders in this space share our belief that the commercial market’s reliance on “extend and pretend” is unsustainable, and red flags of prevalent misconduct continue to emerge like cracks spreading across a frozen lake.

Today, I wanted to provide updates on one of the more significant CMBS putback cases that we are currently following, as well as alerts regarding two new putback cases that were filed within the last few months.

Wells Fargo v. JPM II Updates

Both my initial comeback post about the cracks in the CRE market and my subsequent deep dive into the application of RMBS putback precedent to the burgeoning CMBS putback space have highlighted Wells Fargo, National Association, as Trustee of JPMCC 2019-MPF v. JPMorgan Chase Bank, N.A., et al., Case No. 25cv1943 (SDNY, filed March 10, 2025) (“Wells Fargo v. JPM II”), as a canary in the CRE coal mine, signaling the widespread presence of the toxic fumes of fraud. This case only continues to offer interesting clues about the state of commercial lending over the past several years.

On September 18, 2026, the parties to this dispute over JPM’s obligation to repurchase the at-issue mortgage—a $481 million loan backed by a portfolio of 43 multifamily properties (the “Loan”)—filed their letters for leave of Court to brief motions for summary judgment (“MSJ”), identifying the key issues they seek to resolve ahead of trial. In its Letter to Court Requesting Leave for Summary Judgment Briefing (Dkt. 105) (“Plaintiff’s MSJ Letter”), Wells Fargo revealed  interesting evidence uncovered during discovery and unveiled a wrinkle to their contractual claims that could impact the strength and viability of both the instant case and CMBS putback claims generally.

As I discussed in my last update on this case, JPM’s primary argument on its since-denied motion to dismiss focused on the position that Wells Fargo’s repurchase claim failed to satisfy the knowledge qualifier included in the case’s central loan-level representation and warranty (“R&W”). Here, the knowledge qualifier preceding R&W No. 4, the primary R&W at issue in the case, regarding the absence of Events of Default in the underlying Loan, states, “to the best of the Seller’s Knowledge (as defined below) after due inquiry….” In its motion to dismiss at the outset of this case, JPM argued that this qualifier limited its liability to only those breaches where it had actual knowledge of the breach at the time the CMBS trust closed. This is an argument I’ll refer to as the “Ostrich Defense” – in essence, that as long as JPM heard and saw no evil, it was permitted to bury its head in the sand without running afoul of any representations requiring actual knowledge. In denying JPM’s motion to dismiss, Judge Ho reasoned that a mere “indicia [of evidence] that would allow the inference of actual knowledge” was sufficient to establish actual knowledge at the dismissal stage of the case, and that such indica was present here. WF v. JPM II, Decision and Order on Motion to Dismiss (Dkt. 87) at 7. But, of course, the Judge was required to draw all reasonable inferences in the plaintiff’s favor at the motion to dismiss stage.

Recognizing that JPM will continue to lean on this defense, which will be more difficult to defeat at the MSJ stage, Wells has made the knowledge qualifier a central focus of its proposed MSJ, both in noting what its discovery into JPM’s actual knowledge has revealed and in calling into question whether JPM can even take advantage of this defense. As to the latter, Wells seeks to shift the focus of the Court from the language of the knowledge qualifier itself to the language that surrounds it.

Namely, Wells Fargo trains its sights not on the “Seller’s Knowledge” portion of the knowledge qualifier, but on the “after due inquiry” portion, arguing that this creates an affirmative obligation for JPM to have conducted a reasonable inquiry, and that JPM cannot escape liability due to its lack of knowledge if it failed to conduct such an inquiry. Plaintiff’s MSJ Letter at 3. In doing so, Wells seeks to turn the Ostrich Defense on its head, arguing that JPM must prove it actually sought to acquire knowledge before it can use its lack of knowledge as a defense.

Namely, Wells Fargo trains its sights not on the “Seller’s Knowledge” portion of the knowledge qualifier, but on the “after due inquiry” portion, arguing that this creates an affirmative obligation for JPM to have conducted a reasonable inquiry, and that JPM cannot escape liability due to its lack of knowledge if it failed to conduct such an inquiry. Plaintiff’s MSJ Letter at 3. In doing so, Wells seeks to turn the Ostrich Defense on its head, arguing that JPM must prove it actually sought to acquire knowledge before it can use its lack of knowledge as a defense.

This threatens to throw a wrench into JPM’s plans to limit its liability to what it actually knew, by arguing that the Court should not even reach that question if JPM buried its head in the sand and never made a reasonable inquiry to learn the truth about any existing or potential Events of Default in the first place. Whether this representation creates an affirmative obligation and, if so, what type of inquiry was required of JPM under these circumstances will be one of the thornier and more novel issues in this case that Judge Ho will have to decide.

In addition, Wells has submitted a significant amount of new evidence with its MSJ Letter based on discovery into JPM’s actual knowledge, including both deposition transcripts and documentary evidence. One of the most interesting witnesses deposed in the case is Borko Milosev, an individual who conducted due diligence on behalf of the Borrower, the Chetrit Group. Mr. Milosev’s deposition testimony was noteworthy in that he indicated that JPM was specifically told that its underwriting on the Loan was based on incorrect and fraudulent information, yet JPM still used the false information in its underwriting and investor disclosures, to the astonishment of Chetrit’s advisors. See Plaintiff’s MSJ Letter  at 2; id., Exs. 19, 25-26.

Even after Chetrit’s advisers agreed to point this out to JPM before closing, Wells Fargo alleges that JPM never requested nor received corrected financial information, and proceeded to use the same inaccurate financial statements to securitize the loan. Id. at 2, Exs. 19, 22. Thereafter, Wells alleges that Milosev described the performance of the properties as “a total sh*t show” immediately following securitization due to the existence of far more vacancies and far less rental income than what was originally reported, which were precisely the sort of discrepancies Wells alleges that a proper underwriting process was meant to catch. See Plaintiff’s MSJ Letter at 2; id., Ex. 19.

As far as documentary evidence goes, Wells Fargo submitted JPM’s own internal CMBS underwriting guidelines from 2016, which purported “to set forth the standards, requirements, and procedures to be followed, and forms and documents to be used, by J. P. Morgan CMBS [], JPMorgan Chase Bank, N.A. [], and any other J.P. Morgan entity in connection with the origination and closing of commercial mortgage loans intended to be distributed within the capital markets.” Id., Ex. 13 at 3. These requirements and procedures include, “[c]omplet[ing] a reconciliation of actual cash receipts (bank deposits) to the monthly rents used for underwriting” when underwriting loans collateralized by multifamily properties. See id., Ex. 13 at 38.

Wells Fargo alleges that JPM did not follow its own underwriting guidelines, including  diligence checklist items, when it failed to obtain and review bank records. Plaintiff’s MSJ Letter at 2. Wells Fargo further argues that these guidelines were required to be followed in order for JPM to perform the “due inquiry” required of it by R&W No. 4, particularly given the issues it alleges JPM knew to exist with respect to the Loan. Id. This could be powerful evidence in Wells Fargo’s favor, though it remains to be seen whether Judge Ho finds that JPM actually warranted that it would follow these guidelines (in connection with its “after due inquiry” R&Ws or otherwise) as to this Loan, which was acquired for securitization rather than originated by JPM itself.

Milosev described the performance of the properties as “a total sh*t show” immediately following securitization due to the existence of far more vacancies and far less rental income than what was originally reported, which were precisely the sort of discrepancies Wells alleges that a proper underwriting process was meant to catch.

Naturally, JPM filed its own Letter to Court Requesting Leave for Summary Judgment Briefing (Dkt. 106) (“Defendant’s MSJ Letter”), in which it both responded to issues raised by Wells Fargo and raised issues of its own. In particular, JPM advanced various counterarguments regarding the implications of “after due inquiry,” and noted that it plans to address the issue in its own offensive MSJ. Defendant’s MSJ Letter at 3. JPM further stated that it plans to argue that it has no obligation to perform any “due inquiry” in the first place because to create such an obligation out of that language would “eviscerate” the knowledge qualifier itself. Id. While this argument may have some surface appeal (and has at least some support in the law), it’s not clear it will resolve the issue in JPM’s favor on these facts.

A requirement that a Seller have actual knowledge is not “eviscerated” or rendered superfluous by a requirement that it conduct an inquiry. These are two distinct concepts, and it would be reasonable for parties to contract in such a way that a Seller was only responsible for certain defects of which it had actual knowledge, provided that it had at least conducted a reasonable inquiry. Interpreted in that manner, the Seller is still protected by such a provision against liability for defects that it did not actually discover through reasonable diligence (though I note that JPM also argues in its Letter that due inquiry is different than “due diligence,” with the former being apparently less stringent). As a policy matter, Wells Fargo’s interpretation of R&W No. 4 also seems like the most reasonable approach to allocating responsibility as to potential Events of Default, as it prevents a responsible party from engaging in (or at least disincentivizes) willful ignorance, while not placing upon it the onerous burden of responsibility for every potential or actual Event of Default that was not reasonable discoverable.

Not to be outdone, JPM submitted with its MSJ Letter a significant amount of its own discovery into its knowledge and offered a competing narrative about what the evidence suggests.  In particular, JPM has presented the testimony of one of its own employees (Brian Baker), maintaining that JPM was unaware of any fraud or inconsistencies in the financial data with respect to the Loan at the time the CMBS closed. However, it seems to me that the word of an employee from a company that has already admitted to wrongdoing (The Chetrit Group) will be generally more credible and believable than the word of an employee who continues to be employed by a company that is in the process of defending itself and has not admitted to any wrongdoing (JPM). Further, testimony like Mr. Baker’s will likely be insufficient to win the day in the face of the documentary evidence presented thus far that seems to confirm JPM’s actual knowledge of these issues.

Ultimately, the above summarizes just a fraction of the evidence that has been filed in this case in connection with the MSJ Letters, and those interested are encouraged to dig further into the deposition transcript excerpts and documentary evidence now available on the docket.  In addition, both parties, as well as Meyer Chetrit, have now filed letters in opposition to the initial MSJ Letters. There should be no shortage of interesting legal battles and developments worth following and reporting upon as this case continues. We expect the Court to be back shortly with a response to the MSJ Letters, either scheduling a hearing to discuss the issues to be briefed or simply granting leave to proceed with summary judgment briefing on the issues already identified.

In particular, I think the outcome of the dispute over the interpretation of the knowledge qualifier will be the decision most impactful on the broader legal landscape in CMBS putbacks, as many CMBS deals have similar knowledge qualifiers around key R&Ws (a feature frequently added to CMBS 2.0 after the Global Financial Crisis), and they frequently include some version of the “after due inquiry” language. If the Court agrees that “after due inquiry” creates an affirmative obligation to perform an inquiry sufficient to make the related R&W in the first place, how many Sellers would be exposed to liability simply because they did not make any reasonable inquiry into the basis for various R&Ws? And if the Court agrees that the inquiry required here is for JPM to underwrite CMBS loans it purchases pursuant to its own internal policies and procedures (as Wells has argued), what are the odds that banks in a similar position could meet that standard? Would we expect that the same banks that drove the explosion of defective RMBS issuance back in the mid-2000s would suddenly begin conducting careful due diligence on loans being originated or securitized in the commercial space in the mid-2010s and into the 2020s?

Update on New CMBS Putback Cases

Beyond the developments in WF v. JPM II, I wanted to flag that we are seeing an increasing number and scope of other CMBS-related cases hitting civil dockets in the past few months. From a rise in commercial foreclosures and guarantor actions, to new actions by borrowers against special servicers, to actions by CMBS trustees against borrowers for fraud, and even to actions for breach of contract by lenders against appraisers, this litigation space is experiencing an acceleration in the volume and type of cases being filed. These filings collectively signal the existence of the most important factor for the viability of investor actions – widespread, systemic fraud in the origination and securitization process. 

Though each type of case supplies its own interesting piece of the puzzle, we will continue to follow most closely the investor-driven CMBS putback cases as likely the most well-established avenue available for investors to recover existing or forthcoming losses in the CRE space.  And in that regard, there are two additional CMBS putback actions that were filed within the last couple months that readers may find of interest.

Computershare Trust Company, National Association, as Trustee of WFCMT 2024-5C1 and Lead Note Holder under Co-Lender Agreement v. LMF Commercial, LLC, Case No. 26-cv-07165 (S.D.N.Y., filed Aug. 21, 2026) (“Computershare v. LMF”) is a putback action brought in connection with a $53,000,000 loan collateralized by multifamily commercial property located in Euclid, Ohio. The underlying claims are straightforward, though based on seemingly brazen acts on the part of the borrower and/or significant negligence on the part of the lender. Computershare alleges that falsified insurance certificates were submitted as part of the related loan file and that the required property insurance was not in place on the subject property, breaching various R&Ws (including, potentially, a version of the No EOD R&W discussed above, which did not include the “after due inquiry” language). As obtaining property insurance is a standard requirement in nearly every commercial lending deal, the alleged absence of property insurance raises significant questions about why insurance was not able to be obtained. The allegations of falsification of insurance certificates suggest that whatever that issue was, it was known and intentionally obscured.

Computershare Trust Company, National Association, as Trustee of BMO 2024-5C5 v. Starwood Mortgage Capital LLC, Case No. 655096/2026 (N.Y. Sup. Ct., filed September 4, 2026) (“Computershare v. Starwood II”) is a putback action brought in connection with a $46,850,000 loan collateralized by multifamily commercial property located in Houston and Pasadena, Texas. Computershare alleges that the subject loan securitized into BMO 2024-5C5 was never in a senior position, as required, and that when the subject property became distressed and foreclosure occurred, the loan was completely wiped out. How a securitized and purportedly senior loan can somehow end up subordinated to a more senior loan is beyond me, and suggests a significant breakdown in the gatekeeping process, both for commercial lending and CMBS issuance. It seems certain there’s a story here worth investigating.

We’ll continue to follow these and other interesting filings in the commercial real estate space in the coming months. As always, I welcome any questions or input from folks interested in these developments and the potential opportunities they engender.

Author’s Note: Special thanks again to Nathan van Loben Sels for his significant contributions to the research and writing of this post.


Isaac Gradman is a partner at Perry Johnson Anderson Miller & Moskowitz in Santa Rosa, California, where he specializes in structured finance litigation, bankruptcy and restructuring, investment fraud, and other complex commercial and financial disputes.

Posted in allocation of loss, banks, bondholders, Chetrit, CMBS, Complaints, contract rights, CRE, discovery, fraud, gatekeeper litigation, improper documentation, investors, irresponsible lending, JPMorgan, Judicial Opinions, junior liens, knowledge qualifiers, lawsuits, lenders, lending guidelines, litigation, misrespresentation, mortgage fraud, negligence and recklessness, Ostrich Defense, private label MBS, putbacks, rep and warranty, repurchase, responsibility, securitization, sellers and sponsors, summary judgment, underwriting guidelines, underwriting practices, Wells Fargo | Tagged , , , | Leave a comment

Federal Bar Association to Host Exciting Panel this Week – The Next Commercial Mortgage-Backed Securities Reckoning: Enforcement, Whistleblowers, and Putback Litigation

This Thursday, June 18, I’m excited to join an extremely knowledgeable panel hosted by the Federal Bar Association entitled, “The Next Commercial Mortgage-Backed Securities Reckoning: Enforcement, Whistleblowers, and Putback Litigation.” I’d be honored to have any fans of The Subprime Shakeout in attendance, and my readers can get free access by using the code, “CMBSLitigationCLE.” Details and registration can be found here and a description of the event can be found below. I look forward to seeing you there!

*****

As the last remnants of RMBS litigation work their way through the courts following the Great Financial Crisis (“GFC”), another structured asset class, Commercial Mortgage-Backed Securities (“CMBS”), has suddenly found itself in the crosshairs of investors and litigators. A shift away from brick-and-mortar shopping in retail and a shift towards remote work in office space have combined with an already weak commercial real estate (“CRE”) market to create clear signs of distress in this space.  Combine this with revelations of widespread fraud and, in particular, the falsification of borrower operating income in commercial mortgage originations over the last 10 years, and you have the makings of another flood of government investigations and litigation driven by investors and whistleblowers. Only this time, litigators will not be starting essentially from scratch, as they were with novel post-GFC government enforcement actions and residential mortgage repurchase litigation. 

Part one of this two-part panel, which will be led by Caleb Hayes-Deats from Lowell & Associates, PLLC and Justin Ellis from Molo Lamken LLP, will examine what actions federal and state enforcement agencies might take in response to potential CMBS fraud. Following the GFC, the DOJ and the SEC sued many of the largest banks in the country, often under theories the government had never pursued before. Panelists will draw on their experience both in and out of government to discuss how the theories enforcers pursued previously could be used against CMBS fraud and what new theories the government might pursue. They will also discuss the proliferation of new whistleblower programs since the GFC and examine how those programs might impact government enforcement. Topics will include: bank fraud, the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), Federal and State False Claims Acts, and whistleblower programs now offered by the SEC and DOJ.

Part two, which will be led by Isaac Gradman from Perry Johnson Anderson Miller & Moskowitz LLP and Mr. Ellis will leverage the deep experience gained from the front lines of litigating RMBS putback cases over the past two decades. This panel of expert structured finance and distressed investment litigators will discuss how this deep well of analogous cases is already guiding the course of existing CMBS litigation, and providing predictability and efficiencies for the CMBS litigation to come.  This program will educate participants on the building blocks and key hurdles to overcome in pleading viable commercial mortgage repurchase claims, from questions of standing and repurchase clause triggers to identifying key representations and warranties, establishing materiality of breaches, and overcoming knowledge qualifiers.  Panelists will address recent high-profile cases, including the putback litigation filed against JPMorgan Chase in relation to JPMCC 2019-MFP, while drawing from bellwhether cases from the not-so-distant past, shedding light on what investors and litigators can expect from this new wave of CMBS-related litigation. Topics covered will include: securitization mechanics; comparison of RMBS and CMBS representations and warranties; procedural requirements like sole-remedies clauses and no-action clauses; available remedies and damages calculations; and strategic considerations for uncovering breaches, conducting forensic reunderwriting, and positioning the case for settlement or success at trial.

Join this panel of experts on Thursday, June 18, 2026, to earn CLE credits while learning what regulators, plaintiffs and defendants should expect as this next wave develops!

Posted in allocation of loss, Attorneys General, banks, bondholder actions, bondholders, borrower fraud, Certificateholders, CMBS, Complaints, contract rights, CRE, damages, fraud, impact of the crisis, investigations, investors, irresponsible lending, JPMorgan, lawsuits, lenders, liabilities, litigation, MBS, MCLE, mortgage fraud, mortgage market, oversight, Presentations, probes, putbacks, regulation, Regulators, rep and warranty, repurchase, RMBS, SEC, securities, securities fraud, securitization, sole remedy, statutes of limitations, The Subprime Shakeout, underwriting practices | Tagged , , , , , , , , , | Leave a comment

Wells Fargo Borrows Heavily from RMBS Greatest Hits to Prevail in First Major Test for CMBS Putbacks

California Sunlight

Sweet Calcutta Rain

Honolulu Starbright

The Song Remains the Same

– Led Zeppelin, The Song Remains the Same, Houses of the Holy

In my last post in The Subprime Shakeout’s relaunch, I discussed the all-too-familiar sounds emanating from the commercial real estate market, ushering in a potential new wave of litigation with echoes of the residential mortgage putback cases from the prior decade. In particular, I focused on the ongoing CMBS putback case entitled, Wells Fargo v. JPM II, in which Wells Fargo, as Trustee of the J.P. Morgan Chase Commercial Mortgage Securities Trust 2019-MFP, seeks recoveries for investors based on claims that JPMorgan, the Seller on the deal, knowingly utilized false financial information (certain T12 operating statements associated with the underlying real property) when underwriting and selling the at-issue loan to the Trust. When we left off in March, JPMorgan’s motion to dismiss remained pending, with the bank attempting to have the case thrown out at the initial pleading stage.

A decision on JPMorgan’s motion to dismiss (available here) has now come down, and it has been denied in its entirety. In doing so, Judge Dale E. Ho followed Wells Fargo’s suggestion that he look to some of RMBS’s greatest hits to determine that all of Wells Fargo’s causes of action had adequately stated claims for relief.

A decision on JPMorgan’s motion to dismiss has now come down, and it has been denied in its entirety. In doing so, Judge Dale E. Ho followed Wells Fargo’s suggestion that he look to some of RMBS’s greatest hits to determine that all of Wells Fargo’s causes of action had adequately stated claims for relief.

Judge Ho grouped JPMorgan’s arguments in support of its motion to dismiss Wells Fargo’s repurchase claims into two overarching categories. First, His Honor addressed JPMorgan’s claim that the complaint failed to adequately allege that JPMorgan was aware, at the time the deal closed, of the falsity of loan-level representations and warranties (the “Actual Knowledge Issue”). Second, Judge Ho addressed JPMorgan’s argument that if there were any breaches of representations and warranties, they did not materially and adversely affect the value of the underlying loan or the interest of the Certificateholders therein (the “Materiality Issue”). And as to both issues, Judge Ho’s opinions cited heavily to putback cases from the not-so-distant past involving legacy RMBS, reinforcing my view that this well-developed line of cases will be seen as both analogous and binding on judges asked to evaluate this new wave of MBS putback litigation.

On the Actual Knowledge Issue, Judge Ho applied a liberal standard for stating a breach of contract claim where a contractual warranty requires a defendant to have knowledge of the breach, finding that plaintiffs do not need to refer to breaches of particular representations and warranties, or allege actual knowledge of the breach of those warranties, to survive a motion to dismiss. Wells Fargo v. JPM II, Opinion & Order at 6-7. “Rather,” the Court found, “at the motion to dismiss stage, it is sufficient to allege breach through indicia that would allow the inference of actual knowledge.” Id. at 7.

[A]t the motion to dismiss stage, it is sufficient to allege breach through indicia that would allow the inference of actual knowledge.

Wells Fargo v. JPM II, Opinion & Order at 7

In making these findings, Judge Ho relied on the 2016 RMBS case, Blackrock Allocation Target Shares: Series S Portfolio v. Bank of N.Y. Mellon, 180 F. Supp. 3d 246 (SDNY 2016), in which Blackrock sued Bank of New York Mellon, as trustee on a variety of RMBS deals, alleging that the trustee had breached its duties to the Trust and Certificateholders by, among other things, failing to redress breaches of representations and warranties by various deal parties in legacy RMBS. In that case, certain of Blackrock’s claims against BNYM survived dismissal because the Court found that BNYM was alleged to have had general knowledge of breaches due to “warning signs, high default rates, credit ratings declines, losses, and government and newspaper reports about the abandonment of underwriting standards.” Id., 180 F. Supp. 3d at 258-59.

Applying that reasoning to this case, Judge Ho noted that Wells Fargo had alleged JPMorgan had direct knowledge of an Event of Default (the underlying basis of the breach claim) based on the falsification of valuation and operating income information related to the underlying property for “over five months” prior to the deal closing through correspondence with other deal and loan parties, and that JPMorgan was in possession of documents (both falsified and corrected financial statements) that should have made it independently aware of the Event of Default. Wells Fargo v. JPM II, Opinion & Order at 7. In short, Judge Ho found that Wells Fargo did not need to allege that JPM had actual knowledge that a particular representation and warranty was false at the time of the offering, but that Wells Fargo’s allegations of JPM’s general knowledge of the false operating statements were sufficient to allege breach through indicia that would allow the inference of actual knowledge.

On the Materiality Issue, Judge Ho relied once again on two well-known RMBS cases, the first involving the HEAT 2006-1 Trust, Home Equity Mortg. Tr. Series 2006-1 v. DLJ Mortg. Cap., Inc., 109 N.Y.S.3d 231, 233 (N.Y. App. Div. 2019), in a case that reached the highest appellate court in New York, and the second involving the MARM 2006-OA2 Trust, MASTR Adjustable Rate Mortg. Tr. 2006-OA2 v. UBS Real Est. Secs. Inc., No.12 Civ. 7322, 2015 WL 764665, at *15 (S.D.N.Y. Jan. 9, 2015), one of the few RMBS putback cases to have been litigated through trial. Both cases are part of the long line of RMBS repurchase opinions that held that a breach need not be proven to have caused an actual loss to be deemed material (what I’ve referred to previously as banks’ “loss causation” defense), but merely that it led to an increased risk of loss. Potentially in an effort to avoid this line of cases, JPM had couched its argument on the Materiality Issue as something a bit different—arguing that Wells Fargo had not alleged that any breach had a “material impact” on the value of the mortgage loan held by the trust, because Wells Fargo had not alleged how overstated net operating income ultimately impacted the value of the real estate portfolio itself. Wells Fargo v. JPM II, Opinion & Order at 7-8, citing Defendant’s Memo at 18-19.

Judge Ho found those arguments unavailing, and indistinguishable from the loss causation arguments that had been overruled in the RMBS context. The Court reasoned, “Wells Fargo has adequately alleged that JPMorgan’s failure to disclose the falsified financial records underlying its valuation of the real estate portfolio collateral to the mortgage loan materially increased the loan’s risk,” and that this failure (an alleged inflation of net operating income by 25%) led to an overvaluation of the real estate portfolio as presented to prospective certificateholders. Wells Fargo v. JPM II, Opinion & Order at 8. In finding these allegations sufficient to state a material breach at the pleading stage, Judge Ho also cited to CMBS-related caselaw—Bank of N.Y. Mellon Tr. Co. v. Morgan Stanley Mortg. Cap., Inc., No. 11 Civ. 505, 2011 WL 2610661, at *6 (SDNY June 27, 2011)—where the Southern District of New York found that an allegation that an anchor tenant had vacated a commercial property provided the basis for a material breach, even if the tenant was potentially replaceable with another tenant and no loss had yet been caused, because it increased the risk of loss. Id. at *6.

Thus, all of Wells Fargo’s claims survived JPMorgan’s motion to dismiss, and Wells Fargo will be free to push its case forward through discovery.

This opinion does not strike me as an outlier, but as a logical application of well-trodden ground in the analogous RMBS context. And it further confirms my hypothesis that when it comes to this new wave of MBS litigation, plaintiffs will not have to reinvent the wheel with protracted and expensive trial court and appellate litigation to establish precedent for each of the key elements underlying repurchase claims. Instead, plaintiffs will be able to rely on this rich trove of plaintiff-friendly decisions, and will be aware of the pitfall issues and defenses that must be avoided, to position their cases more quickly and less expensively for settlement or trial. Despite certain differences in the structure of CMBS and RMBS, I believe at the core of both cases, as Robert Plant once wailed in Led Zeppelin’s iconic opening tune on the Houses of the Holy album, “the song remains the same.”

Barring the unexpected, I should have further updates later this year as this case moves into the summary judgment stage. However it plays out, this case should make for an interesting watch (and listen)!

Author’s Note: Special thanks to Nathan van Loben Sels, as always, for his contributions to the research and writing of this post.

Posted in allocation of loss, banks, bondholder actions, bondholders, borrower fraud, Certificateholders, Chetrit, CMBS, contract rights, CRE, discovery, fraud, investors, JPMorgan, Judge Dale Ho, Judicial Opinions, lawsuits, lenders, liabilities, litigation, loss causation, MBS, misrespresentation, mortgage fraud, motions to dismiss, PIMCO, pooling agreements, private label MBS, putbacks, quinn emanuel, rep and warranty, repurchase, RMBS, securities, securitization, sellers and sponsors, The Subprime Shakeout, Trustees, underwriting practices, Wall St., Wells Fargo | Tagged , , , | Leave a comment

Cracks in Commercial Real Estate Market Usher in All-Too-Familiar CMBS Putback Litigation and Risk of Broader Distress

It has been said that history repeats itself. This is perhaps not quite correct; it merely rhymes.

– Theodor Reik, 1965, Curiosities of the Self: Illusions We Have about Ourselves 

I am reminded frequently of the above quote when I look at the state of the commercial real estate (“CRE”) market today, and track the first of what will likely be many more repurchase or “putback” actions being filed in the commercial mortgage-backed securities (“CMBS”) space. Interestingly, the quote itself seems to exemplify its underlying messaging, as several thinkers have said similar things, and there is some controversy over its attribution. Namely, while this quote is often misattributed to Mark Twain, there is no record of him including it in any of his writings. Instead, it seems to have first appeared in a 1965 essay by Psychoanalyst Theodor Reik, where it was preceded by the prescient words, “There are recurring cycles, ups and downs, but the course of events is essentially the same, with small variations.” Twain, for his part, did say something similar, and even more colorful: “History never repeats itself, but the Kaleidoscopic combinations of the pictured present often seem to be constructed out of the broken fragments of antique legends.”

History never repeats itself, but the Kaleidoscopic combinations of the pictured present often seem to be constructed out of the broken fragments of antique legends.

– Mark Twain

Both quotes seem particularly appropriate at this moment, and their implications have prompted me to return to blogging after a years-long hiatus, during which the representation of clients in the structured finance and distressed investment space has taken precedence over continuing with The Subprime Shakeout. However, as I’ve seen an increasing number of red flags and signals of distress in the CMBS market (particularly involving office, retail, and lodging properties), it has compelled me to begin writing again and highlight the similarities in the market conditions that were fomenting in the residential mortgage-backed securities (“RMBS”) market in the run-up to the Global Financial Crisis (“GFC”) of 2007 and 2008.

Namely, in my structured finance practice at Perry Johnson Anderson Miller & Moskowitz (“PJAMM”), we are seeing many of the same “rhyming” indicators of the overextension of credit to the CRE market generally, along with revelations of potential systemic fraud and misrepresentations in the offering documents for financial products like CMBS that are backed by commercial real estate. Most prominently, allegations of widespread inflation of net operating income (“NOI”) figures provided at origination by borrowers across the CMBS market suggest that some of the same cavalier attitudes towards underwriting that infected the structured finance market for residential mortgages have now extended to commercial mortgages. And while such misrepresentations or omissions in the offering documents typically go unnoticed or unenforced during good times, once there is a downturn (or even just a leveling-out) in the market, losses typically follow, prompting investors to investigate breaches of representations and warranties as a basis for legal action to mitigate those losses. Indeed, as we’ll discuss later in this article, we are just beginning to see CMBS trustees and servicers filing mortgage repurchase or “putback” actions in the CMBS space that read very much like the wave of RMBS putback cases we predicted and then helped litigate and settle over the past 18 years.

Level Setting – CRE Market Context

This is the precipice at which I believe we stand today in the CRE and CMBS markets. Commercial lending and securitization of the resulting mortgages continued to expand throughout the late 2010s and early 2020s, with a peak CRE lending volume of $816 billion in 2022. The CRE market was thus slow to adjust to foundational changes in the commercial property space that began after the turn of the millennium (think online shopping and pressure on brick and mortar retailers), and accelerated with the outbreak of COVID-19 (with the normalization of online shopping, the rise of remote work, and the drop in utilization of office space). As interest rates rose rapidly during 2022 and the cost of debt increased—while NOI has fallen for many commercial properties— it has become progressively more difficult for borrowers to refinance commercial loans, particularly those structured with interest-only payments due during the life of the loan and balloon payments due at maturity (as are commonly utilized in the commercial property space).  

Counterintuitively, commercial loan origination spiked running up to and through the COVID pandemic (at a time when commercial property would have been particularly unprofitable, with revenues often unable to cover even interest payments on commercial loans), which bubble is putting additional pressure on the CRE market now. Given these conditions, it is only a matter of “when” and not “if” the pressure will ultimately lead to a severe downturn in the market and defaults in the commercial lending space.

Though delinquencies and defaults have certainly increased over the past couple of years, particularly in office space, we haven’t yet seen the “crash” that many folks keeping an eye on this market have predicted based on the CRE market downturn, the number of distressed loans, and the relatively high interest rates that would stand in the way of a smooth recalibration. Part of this stems from market participants’ willingness to engage in what is commonly known as “extend and pretend.” Essentially, when these short-term, often 5- or 10-year loans reach maturity, and the principal portion of the loan comes due, lenders and servicers have thus far been largely willing to work with borrowers on creative solutions whereby the maturity date of a severely delinquent or soon-to-be defaulted loan is kicked out 12- to 18-months, possibly with the infusion of some additional capital, an interest rate adjustment, and/or a deferred payment plan.

However, these creative solutions do not tend to resolve the underlying, structural problem, and instead become more akin to “kick the can down the road” measures. Barring a positive change to the market environment, the fundamental issue remains: many commercial properties are cash-flowing (and therefore are valued) far less than was expected at the time of origination and reaching maturity in an environment in which refinance options are limited.

While “extend and pretend” measures do allow property owners and investors to spread out potential defaults and avoid a credit crunch, giving them some measure of control over when and where the defaults, foreclosures, and/or legal actions should occur, they cannot continue forever. Indeed, while there was a spike in loans hitting maturity in 2025, there is another wall of looming maturities that will need to be worked out in 2026 and into 2027. Needless to say, some market institutions that predicted a relatively robust recovery last year are still waiting. As Deloitte put it in its recent 2026 CRE Outlook report, “[W]e anticipated that 2025 could mark a recovery for the global CRE industry … As we write a year later, it hasn’t exactly played out that way.”

We anticipated that 2025 could mark a recovery for the global CRE industry … As we write a year later, it hasn’t exactly played out that way.


 – Deloitte Center for Financial Services, 2026 Commercial Real Estate Outlook, September 29, 2025

The Rise of CMBS Repurchase Actions

Meanwhile, the CMBS putback actions have officially begun, signaling the limits of “extend and pretend.” In March 2025, Wells Fargo, as trustee of the J.P. Morgan Chase Commercial Mortgage Securities Trust 2019-MFP, filed suit against J.P. Morgan, as the seller on the deal, for breaches of loan-level representations and warranties. Wells Fargo v. JPMorgan II, Case No. 25cv1943 (SDNY, filed Mar. 10, 2025). The allegations in the complaint, if true, indicate the presence of rot in the foundation of the CRE market.

For instance, Wells Fargo alleges that JPMorgan knowingly and intentionally utilized fraudulent financial information as part of the subject loan’s underwriting, allegedly inflating the NOI on the underlying properties by 25%, and then sold bonds to investors based on the fraudulent figures. JPMorgan’s motion to dismiss Wells Fargo’s primary claim—breach of contract for failure to repurchase the underlying loan—is still pending before the Court, and relies heavily on whether the complaint adequately alleges JPMorgan had “actual knowledge” of the issue, as the representation and warranty Wells Fargo is alleging was breached is limited by a “knowledge qualifier” (requiring the loan seller to have actual knowledge of the breach at the time of subject loan’s origination for the representation to be actionable). Notwithstanding the pending motion to dismiss, fact discovery is well underway in the case and expert discovery is set to be completed by June of this year.

Already, discovery in that case has yielded some telling disclosures. During a dispute over Wells Fargo’s efforts to obtain documents from and depose Brian Baker, a key member of JPMorgan’s credit committee that Wells Fargo alleges directly knew about problems with the financial information submitted by the borrower (but approved the loan anyway), Wells Fargo submitted to the court internal JPMorgan communications revealing knowledge of systemic issues at one of the largest players in the CMBS space. In the instant message communication snapshotted below, Deborah Lipman, a member of the JPM credit committee, noted in May of 2019—less than a month before the subject loan was put before the JPM credit committee for final approval—that JPM, and others involved with the loan, were engaging in some of the same practices with CMBS that had led to the residential real estate crash of 2007 and 2008:  

Wells Fargo v. JPM II, Plaintiff’s Letter to the Court, Ex. 6 (Doc No. 81-6) at 2.

This statement highlights, not just that JPM apparently had concerns about its commercial mortgage lending and securitization processes with respect to this one at-issue loan prior to securitizing it, but that at least some decisionmakers at JPM appeared to have concerns about something much more widespread: that “we are doing 2007 all over again.” Indeed, if this abandonment of basic diligence is occurring at one of the largest commercial lenders in the United States, as has been alleged, it suggests these practices were and are likely quite widespread, as lending is historically subject to a race-to-the-bottom. Further bolstering that conclusion, JPMorgan has now alleged in its own letter to the court that SitusAMC, an affiliate of Situs Holdings, LLC (the special servicer who is bringing this repurchase case on behalf of Wells Fargo), assisted JPMorgan with its pre-closing due diligence on the subject loan and was aware of the allegedly inflated NOI and other issues with the borrower’s financial information itself! See Wells Fargo v. JPM II, Defendant’s Letter to the Court (Doc. No. 85) at 1. All of this suggests that these issues were not isolated, but rather were symptoms of more systemic problems in the commercial loan industry.

Right on cue, another CMBS repurchase action was filed earlier this month, styled Computershare Trust Company, as Trustee of the BBCMS 2023-C19 trust, v. Starwood Mortgage Capital, LLC, Case No. 26cv01695 (SDNY, filed Mar. 2, 2026). While still in its early stages, there are a couple of interesting points we can take away from the initial filings:

  1. We know the underlying loan-level representation and warranty breach is not based on fraudulent financial information, but rather on the condition of the underlying property, specifically a parking garage sitting beneath a mixed-use (office/retail) commercial space.
  2. The representation and warranty that is alleged to have been breached, as in Wells Fargo v. JPMorgan II, is limited by a knowledge qualifier.
  3. The loan seller here, Starwood, is an affiliate of the Chetrit Financial Group, and Chetrit is involved in Wells Fargo v. JPMorgan II, discussed directly above, as a defendant. The Chetrit Group has been the focus of mounting legal trouble over the past year-plus, and one of its founders, Meyer Chetrit, was just indicted (along with an indicted unarraigned co-defendant, and their companies, including The Chetrit Group) and charged with harassment of two rent-regulated tenants. (Note: All of this smoke is enough to suggest that if you are invested in any underperforming CMBS or commercial real estate assets (particularly any involving the Chetrit Group, or its affiliates), it would be worth investigating the circumstances and determining whether any action should be taken.)

Takeaways and Action Items

Mortgage repurchase actions in the commercial space show particular promise, as they can take advantage of the well-trodden ground and well-established case law that has formed through the flood of RMBS putback cases litigated over the past two decades, while also frequently featuring several advantages. For example, some CMBS deals allow certificateholders to initiate dispute resolution proceedings—including, potentially, more expedient arbitration and mediation processes—rather than requiring a minimum percentage of holders (usually 25%) to band together to direct and indemnify the CMBS trustee to take action. This suggests that for every putback dispute that has come to light due to the filing of litigation, there are likely many more disputes that are being, or already have been, resolved behind the scenes.

In addition, many CMBS deals are single-asset, single-borrower deals (so-called “SASB” deals), or feature only a small number of loans as collateral, making the reunderwriting process much more efficient and affordable than RMBS deals with thousands of loans to reunderwrite. But we’ve also learned from RMBS putback actions that statutes of limitations are short and unforgiving, and they run from the closing date of a deal, not from the date that breaches are discovered. Indeed, the RMBS investors who acted quickly in the wake of the crisis tended to be far more successful than those who waited, as statute of limitations defenses proved to be the primary (and sometimes only) defense to well-pled RMBS putback cases.

[We’ve] learned from RMBS putback actions that statutes of limitations are short and unforgiving, and they run from the closing date of a deal, not from the date that breaches are discovered. Indeed, the RMBS investors who acted quickly in the wake of the crisis tended to be far more successful than those who waited, as statute of limitations defenses proved to be the primary (and sometimes only) defense to well-pled RMBS putback cases.

It is not just the filing of these few repurchase actions that indicates a broader wave is coming, as research and analysis by my team PJAMM has revealed a number of concerning trends in the CRE space. Through the tracking of new filings in New York County, we are seeing an uptick in the type of debt collection and foreclosure matters that tend to foreshadow broader losses and repurchase actions in structured debt instruments. 

We are also tracking commercial lenders’ reporting of disputes over repurchase demand activity pursuant to SEC Rule 15Ga1, and have noted a gradual, but ever-growing increase in repurchase activity reporting over the last several quarters. Earlier this year, a commercial real estate lender brought an action in federal court against several affiliates of a well-known, national commercial real estate appraiser (mentioned sarcastically by Deborah Lipman in the same string of instant messages referenced above), as well as an individual appraiser, alleging defective appraisals of the commercial property backing the at-issue loan, which in turn improperly inflated the value of the commercial property (importantly, CRE appraisals take into account NOI in order to understand the value of any given commercial space). Meanwhile, CRE borrowers have begun to bring actions against CMBS trusts and special servicers claiming bad faith in the loan modification process when they became delinquent on their payments, including allegations that special servicers exploited this distress to extort fees that were contrary to the best interests of the borrower and the securitization vehicle.

While we’ve highlighted just a few examples here, the broader CMBS space is continuing to see an increase in key indicators of distress. These include signs of the fraud that typically results from an overheated market and then drives both its collapse and the strongest legal claims for recoveries, not just in individual cases like Wells Fargo v. JPM, but more broadly across the industry. Tellingly, in 2024, we saw the GSEs publish new guidelines in an attempt to keep fraudulent loans out of their pipelines amid rising delinquencies and fraud concerns, while in 2025, we saw revelations of fraud uncovered by Fannie Mae following a multiyear investigation into the CRE on its books. Given the GSEs’ critical role in finding a path to recovery after the RMBS crash, the exposing of fraud by Fannie and Freddie in the CRE and CMBS spaces should be carefully noted as a precursor of things to come. In sum, several data points serve as a harbinger that additional CRE distress and a new wave of CRE-related litigation is likely on the horizon.

Are these the “broken fragments of antique legends” that Twain was talking about in constructing the “Kaleidoscopic combinations of the pictured present,” or the rhyming of history referenced by Reik, signaling a potential CRE crisis along the lines of the GFC? Only time will tell, but certainly these various signs should not be ignored by anyone invested in commercial real estate (or considering making such an investment). In particular, rising delinquencies, defaults, or losses in CRE portfolios should not be assumed to be simply the inevitable product of a market downturn (or that they will be straightened out given enough time), but should be investigated as the potential consequence of misrepresentations at origination or offering that hid deeper problems. Otherwise, the default outcome will be that the investors left holding CRE derivatives—who typically relied on the deal parties who originated the loans and structured the deal to perform ordinary due diligence—will be saddled with the losses caused by the non-performing commercial real estate assets backing their investments, regardless of whether they were the product of misrepresentations or a market downturn. It is incumbent upon these investors (and insurers) to make sure, as The Who once sang, that “We don’t get fooled again”!

Author’s Note: Special thanks to Nathan van Loben Sels for his significant contributions to the research and writing of this post. With this post, I plan to begin blogging again on a semi-regular basis, expanding The Subprime Shakeout beyond the residential mortgage market to discuss issues in commercial and consumer lending. Stay tuned for future articles addressing the collapse of several consumer lenders in the subprime auto loan space. 


Isaac Gradman is a partner at Perry Johnson Anderson Miller & Moskowitz in Santa Rosa, California, where he specializes in structured finance litigation, investment fraud, and complex commercial and financial disputes.

Posted in allocation of loss, banks, bondholder actions, bondholders, borrower fraud, broader credit crisis, Certificateholders, Chetrit, CMBS, contract rights, CRE, Deloitte and Touche, Fannie Mae, fraud, Freddie Mac, interest rates, investors, JPMorgan, lawsuits, liabilities, litigation, MBS, misrespresentation, mortgage fraud, mortgage market, pre-investment due diligence, putbacks, re-underwriting, rep and warranty, repurchase, responsibility, securities, securitization, sellers and sponsors, servicers, statutes of limitations, The Subprime Shakeout, underwriting practices | Tagged , , , | 2 Comments

Who’s Watching the Watchmen? RMBS Trustees Come Under Fire as Investors Launch Next Wave of Lawsuits

“When one door closes, another door opens; but we so often look so long and regretfully upon the closed door, that we do not see the ones which open for us.”

― Alexander Graham Bell

The face of RMBS litigation took a dramatic turn last month when the focus of aggrieved mortgage bondholders moved beyond seeking recompense from the large banks who packaged and sold defective mortgage loans, and began targeting the other large banks that were hired to protect investors from such wrongdoing.  On June 18, 2014, a large group of investors that includes BlackRock and PIMCO filed six largely identical lawsuits in New York State Supreme Court against the six most prominent mortgage bond Trustees: Bank of New York Mellon (“BNYM”), U.S. Bank (“USB”), Wells Fargo, Citibank, Deutsche Bank, and HSBC.  The lawsuits collectively target over 2,200 residential mortgage-backed securities Trusts with an aggregate original principal balance of over $2 trillion, and alleged losses of over $250 billion.  An exemplar complaint is available here.

With these salvos, the fallout zone from the Mortgage Crisis has officially expanded, leaving very few players untouched.  However, this development was not surprising – at least to this humble long-time observer of and participant in residential mortgage backed securities (“RMBS”) litigation.  I have been predicting since as far back as 2010 that the Trustees who ignored or stood in the way of investor efforts to mitigate their losses would eventually face a day of reckoning.  In early 2011, I laid out the choice facing RMBS Trustees – protect investors or face their wrath – in the context of an iconic protest song by Bob Dylan.  But never did this potentiality come into sharper focus than with the filing of these six massive lawsuits last month.  As us litigation geeks are fond of saying, a complaint is worth a thousand words.

Towards the end of this article, I will delve into what exactly is being alleged in these suits, and what this shift means for existing and future putback lawsuits and settlements, as well as for Trustees, issuers and originators trying to deal with the fallout from the lingering mushroom cloud of the Mortgage Crisis.  But to understand why we have only now seen a major effort in this regard, let’s examine the top 5 developments that brought us to this point.

No. 5 – ACE II Closes Door on Non-Tolled Investor Actions, At Least For Now

No conversation about Trustee suits can take place without first understanding the status of the underlying mortgage repurchase litigation by investors against the issuing and originating banks, and particularly the evolving case law on the statute of limitations for such claims.  In particular, the key development in this space is the decision handed down by New York’s First Department Appellate Court just before the close of 2013 in ACE Securities Corp. v. DB Structured Products, Inc., 112 A.D.3d 522 (1st Dep’t 2013) (“ACE II’).  Therein, the Court held that putback claims filed after the 6-year anniversary of the Closing Date of a particular RMBS Trust are time-barred.

So, what exactly did ACE II entail?  In a three-page opinion that was as short on reasoning as it was long on significance, the First Department reversed the well-reasoned holding by Supreme Court Justice Shirley Korneich and found that contractual rep and warranty claims (i.e., “putback claims”) on ACE 2006-SL2 were time barred.  In doing so, the Court held that the 6-year statute of limitations for putback claims began to run from the RMBS Trust’s Closing Date, when any breach of the seller’s representations and warranties purportedly occurred.  It also held that it was a condition precedent to enforcement of putback claims to provide the seller with contractually-specified notice periods for cure and repurchase, without explaining how the claims could accrue for statute of limitations purposes while a condition precedent remained unfulfilled.  Finally, it held that the Trustee’s later substitution into the case did not “relate back” to an earlier filing by Certificateholders, since those bondholders lacked standing to sue on their own, and therefore the claims were untimely.

There is no topic that generates more questions from my consulting and legal clients these days than the impact of ACE II on the future of RMBS litigation.  Consistently, I have answered that regardless of what I think of the merits of the opinion, so long as the First Department’s restrictive view of the statute of limitations for these claims remains the law of the land, RMBS Trustees will face liability for sitting on their hands and blowing these claims.

However, to the extent it’s not apparent from my description of the holding, let me make something perfectly clear: I disagree completely with the conclusions reached by the First Department in ACE II.  I believe the decision was guided more by pragmatic concerns over the flood of litigation that might result if Justice Kornreich’s opinion became the law of the land than by the well-settled principles of New York Law and the language of the contracts at issue.  This is evidenced by the dearth of any meaningful logical reasoning in the ACE II opinion, as well as by its internal inconsistencies.  For example, the First Department consistently refers to the contractual prerequisite to a repurchase claim of notice, opportunity to cure and demand for repurchase (the “Repurchase Protocol”) as a “condition precedent,” but then does not treat the Protocol as a condition precedent for purposes of the accrual of the repurchase claim (as the relevant authority dictates).

Instead, the Court holds that while filing a repurchase claim before complying with the Repurchase Protocol renders a repurchase claim a “nullity,” it also holds that the clock begins ticking on a repurchase claim before this Protocol has been fulfilled.  In other words, the claims in ACE II had been filed, according to the Court, both too early and too late.

No. 4 – Leave to Appeal ACE II is Granted

I am not the only one who feels that this decision was incorrect, and indeed, HSBC Bank USA (“HSBC”), the Trustee of ACE 2006-SL2, has decided to appeal ACE II all the way up to the Court of Appeals, the highest court in New York.  Though HSBC was not entitled to appeal ACE II as a matter of right, just last week the Court of Appeals granted such leave, while also granting motions from CXA-13 Corp. and the Association of Mortgage Investors to file amicus briefs in support of HSBC’s position.  Briefing on this appeal should now take place over the next few months, with oral argument likely to be scheduled a few months after briefing is complete.  This means that we are unlikely to see a decision on this appeal before the first quarter of 2015.

HSBC has also hired former U.S. Solicitor General and top appellate dog, Paul Clement, to head their appellate team, showing that they take this appeal very seriously.  In his first action as counsel of record, Clement participated in a motion to reargue, or in the alternative, to seek leave to appeal to the Court of Appeals.  Therein, he argued on behalf of HSBC that the First Department’s “brief fails to grapple” with existing New York precedent “in a meaningful way,” and “did not even address, let alone attempt to reconcile” its decision with other New York cases relating to continuing obligations.  Though the Court of Appeals may be inclined, as the First Department likely was, to restrict the flow of future putback litigation that is currently clogging its lower court dockets, they will certainly have a serious legal effort and strong arguments to contend with before doing so.

But this is not to say that the ACE II was a bolt from the blue.  To the contrary, I have been writing for years that this outcome was a possibility, and have been counseling clients that putback claims should be filed before the 6-year anniversary expires in the event that the courts find that the repurchase obligation was not a continuing one (such that it renews each time a party fails to repurchase a defective loan upon notice of same).  And certainly, the Trustees were aware, or should have been aware, that courts examining this relatively new question of law could go in either direction, and thus they should have filed any claims within six years in an abundance of caution.

Unfortunately, many Trustees dragged their heels, despite bondholders’ efforts to compel them to file claims before the 6-year anniversary.  Indeed, as the timing of many investor cases can attest – including ACE II itself – though investors believed that the statute of limitations should be a continuous one, they filed many of these cases in their own name on the eve of the six-year anniversary in an attempt to preserve their claims.  In many of these cases, the Trustees eventually substituted in as plaintiff (albeit after the six-year anniversary and, according to ACE II, too late), thereby acknowledging that the claims were valid and that the Trustee was the proper party to bring them.  Should ACE II survive, these cases will carry with them some of the strongest threats of liability against Trustees.

Certainly, the Court of Appeals may reverse ACE II, which would render much of this moot, so long as the Trustees then take up the mantel of now-timely putback litigation in earnest.  Note that even without a hard and fast time bar, it’s safe to say that bondholders would still have viable claims for damages against Trustees based on, among others, delays by the Trustees in enforcing their rights, the failure to monitor and enforce servicing obligations, and a failure to investigate or enforce a whole host of other practices by the various deal parties that ultimately cost the Trusts money.  However, in the absence of such a reversal, RMBS Trustees and investors alike must assume that this will be the law of the land going forward.  This means we are likely to see a flood of litigation against Trustees alleging that the banks sat on their hands and blew the statute of limitations on valuable putback claims.

No. 3 – Trustees Begin Facing Suits Even Before Statute of Limitations Issues Arise

A lot of folks have asked me if we can look to any precedents in assessing the recent complaints by BlackRock and PIMCO.  The short answer is yes, but only a few.  The law firm of Scott + Scott LLP filed three lawsuits in the Southern District of New York (Case Nos. 1:11-cv-05459, 1:11-cv-08066 and 1:12-cv-02865), in which they sued Trustees for failing to protect bondholder interests.  These cases were filed well before ACE II brought the statute of limitations into focus, and are framed as class actions rather than derivative actions.  Nevertheless, these suits have been largely successful thus far.

The suits are notable in part for their reliance on the Trust Indenture Act (“TIA”) to support some of their claims against the Trustee.  Under the TIA, indenture trustees are charged with certain minimum fiduciary duties, even in the absence of contractual language in the trust indenture itself.  In fact, while this Act was passed back in 1939, it was intended to address a similar situation as the one we’re faced with today – that investors in a bond structure are forced to rely on a trustee to protect their interests, but the trustee instead takes a passive role in reliance on the minimal language in the indenture.

In response, the trustees and certain amici from the banking industry began jumping up and down and hollering that the industry never intended the TIA to apply to RMBS Trusts, as those trusts were really more like equities than debt securities.  Thus far, two out of three judges in SDNY have rejected this argument in denying motions to dismiss on this theory, and the third ruling is currently being appealed before the Second Circuit.  This suggests that courts are willing to hold Trustees to at least minimum duties of loyalty and care in their oversight of RMBS trusts.

[Full disclosure: I have worked with Scott + Scott on certain aspects of these cases.]

In April 2014, we saw another effort by investors to hold RMBS Trustees accountable for breaching their contracts, common law duties and the Trust Indenture Act.  In Royal Park Investments v. U.S. Bank National Association, Case No. 14-CV-2590 (S.D.N.Y. 2014), bondholder Royal Park has purported to bring a class action on behalf of holders of bonds in over two dozen RMBS trusts against U.S. Bank.  Royal Park styles the Complaint as a “Class Action and Verified Derivative Complaint,” though the Court is likely to force Royal Park to choose one or the other structure for the litigation.  Though the suit is long-winded and a bit unfocused (here is the Complaint, for those who really want to get into the weeds, and it’s 221 pages long), it seeks over $6.7 billion in damages and contains extensive factual recitation regarding why U.S. Bank failed to live up to its obligations, and thus it must be taken seriously by the Trustee.

But these actions were only a prelude in size and scope of the massive actions we that were filed last month.

No. 2 – Major Investors File Sweeping Actions on Heels of ACE II; But End Game Remains Unclear

Though they never mention ACE II by name, the Complaints filed last month by BlackRock, PIMCO, et al. (collectively, the “Institutional Investors”) repeatedly suggest that by failing to act, the Trustee has lost the chance to do so, and the Trusts have been permanently damaged.  This is, I believe, what prompted these huge institutions to file their suits now.  In essence, the Complaints all allege that the Trustees were conflicted from the outset, in violation of their duty of independence (a.k.a. the duty of loyalty), and that this caused them to breach their contractual, statutory and common law duties to take action against the sponsors of the trusts and the servicers of the loans in the trusts.

I have had a unique view into the potential for claims against Trustees, as a major component of my practice is representing investors in dealings with Trustees, including many in which the Trustees and investors are potentially or actually adverse to one another.  Thus, I have seen firsthand the asymmetry in interests between Trustees and the bondholders they are generally charged with protecting.  But long before I was representing investors, I was writing about the struggles those investors were facing in compelling Trustees to protect their interests.

I wrote an article back in July 2010 about investors firing a warning shot across Trustee bows, and noting that Trustees may be sued for failing to live up to the fiduciary duties they acquire when they become aware of specific breaches by parties to the Trust Agreement.  In January 2011, I wrote about potential Trustee liabilities stemming from their duties to confirm that mortgages were properly transferred into the Trusts.  Later that month, I wrote an apropos article that laid out the choice with which Trustees were being presented – sue or be sued – and how certain Trustees were beginning to cooperate with investors.  Notably, I wrote that, “[t]he [active] trustees seem to be recognizing that while they were willing to drag their heels at first in the name of industry solidarity, this isn’t their battle, and they don’t want to find themselves on the hook for the errors and omissions of subprime lenders.”

Unfortunately, the deals in which Trustees ultimately took action were and remain the minority; and we are now seeing the consequences of this, as major institutions turn on the Trustees for burying their collective heads in the sand on the bulk of the subprime and Alt-A deals where defects ran rampant.

So, who is behind these massive suits, and what are their motives?  At the outset, it’s important to note that the Pooling and Servicing Agreements covering most RMBS Trusts provide the Trustee with rights to indemnity from the Seller or Sponsor against any costs or liabilities arising out of the Seller or Sponsor’s breach of its representations and warranties.  As such, the large RMBS issuers likely will continue to bear the brunt of the liabilities arising out of these latest lawsuits against the Trustees.  It is for this reason that the Institutional Investors’ filing of these six massive Complaints against all six major Trustees gives me pause.

Remember, the Institutional Investors behind these lawsuits are largely the same parties that were the architects of the $8.5 billion Countrywide settlement that I have repeatedly referred to as a “sweetheart deal” because of the size of the potential recoveries and the manner in which the investors and Trustee in that deal showed up to a gun fight with a water pistol.  [For background, see prior articles here, here, here and here.]  As the New York Supreme Court recently approved most parts of that settlement, these investors likely have been emboldened to cobble together similar pennies-on-the-dollar global settlements that threaten to put to bed all putback claims against JP Morgan and Citigroup, respectively.  I could devote an entire article to the similarities and differences between these various deals, but suffice it to say that while these last two settlements are procedurally on stronger footing than the Countrywide deal (giving Trustees the option to accept or reject the settlement on a deal-by-deal basis), they still amount to paltry payoffs compared to what could have been recovered.

Thus, when these latest Trustee cases were filed, my initial reaction was that these were similar efforts to place a cap on liabilities by engineering a global settlement, so that the Institutional Investors could keep their own investors, the large banks (their frequent business partners), and the Trustees (often affiliates of their business partners) happy.  The filing of the Complaints as derivative actions, meaning the plaintiffs are purporting to act on behalf of the entire Trusts to enforce (or settle) all potential claims the Trusts might have, only further suggests that the plaintiffs were setting up a global settlement that would cut off future suits.

And the countervailing fact that the Complaints were filed by respected plaintiff’s law firm Bernstein Litowitz, instead of Kathy Patrick’s Gibbs & Bruns, was not enough to convince me otherwise; it’s clear that Patrick was conflicted and would have had a hard time taking positions adverse to Trustees in any event.  That is, she just spent years in the Countrywide settlement proceedings arguing that BNYM, as Trustee, had acted reasonably, without conflict and above reproach, in an effort to see her settlement (and $85 million payday) approved.  It could potentially harm her efforts to see that settlement finally approved (it is still up on appeal, with oral argument coming sometime this fall) if she were to now file a complaint against BNYM claiming that the bank was actually operating under a massive conflict of interest.

Even so, the Institutional Investors have softened the conflict of interest language in the BNYM Complaint as compared to those of the other Trustees.  While the Plaintiffs allege in their claim for Breach of Fiduciary Duty of Independence (the Third Cause of Action) in the five non-BNYM lawsuits that the Trustees are “economically beholden to the sellers” because so much of their business comes from the sellers, Plaintiffs allege that BNYM is conflicted only because it “did not want to incur the associated transactional costs of exercising the Trusts’ rights against these entities or shine the light on its own wrongful conduct.”  It seems clear that with the New York Supreme Court’s approval of the $8.5 billion Countrywide settlement still subject to appeal, the investors are reluctant to take a position that could be used against them.  At a minimum, this raises questions about how aggressively the Institutional Investors will be pursuing these claims.

However, upon reading the Complaints themselves, I must allow for the possibility that these institutions may truly be seeking justice, or at least to maximize their recoveries, rather than placate the large banks.  The Complaints throw the book at the Trustees, bringing up all of the strongest arguments as to why Trustees had a duty to act, knew about problems in the Trusts, and failed to lift a finger.  They pull in literally thousands of Trusts, which increases the potential size of the claims, and have thrown around the $250 billion number as the potential damage figure, which would make it more difficult to settle for, say, another few billion dollars.

Yet, the aspect of these Complaints that, more than any other, forced me to consider that they were actually bona fide attempts at mitigating losses was not the Trusts and claims included in these Complaints, but the Trusts and claims that were not.  Namely, the six Complaints exclude potentially the strongest claims and the most powerful fact patterns by excluding any deals in which putback litigation has been initiated or significant putback activity has taken place.  That is, they have not sued the Trustees on deals like the one at issue in ACE II, where the investors seemed to take all the right steps to compel the Trustee to act, were forced to file on the day before the statute of limitations expired when the Trustee failed to act, and then had their case dismissed when the Trustee decided to step in only after the six-year anniversary had passed.  These situations present some of the strongest fact patterns for potential lawsuits against Trustees.

Similarly, in deals where active investors submitted repurchase claims through the Trustee to the responsible parties and obtained certain repurchases (but only a fraction of the claimed defective loans), and/or where the responsible parties filed Rule 15Ga-1 disclosures with the SEC regarding repurchase requests, investors also have potentially very strong cases against the Trustees.  There, they can argue that the Trustees were put on actual notice of widespread defects by way of the repurchase demands (and resulting repurchases, which validated those findings), but did nothing to enforce the bulk of the loans where lenders ignored their contractual repurchase obligations.  So, the Institutional Investors’ decision to exclude these deals suggests that they realize that those stronger claims don’t belong in their generic mass action that differentiates very little between deals.

At the same time, the lawsuits by the Institutional Investors also exclude the deals that are currently subject to the global settlements proposed for Countrywide/BofA, JP Morgan and Citigroup.  So, perhaps part of the impetus for these suits was to encourage the Trustees to accept the deals, by insinuating that so long as the Trustee accepts a settlement (even one that’s pennies on the dollar), it won’t face liability.  I think it’s safe to say that the jury’s still out on what is really motivating these suits, and what end game the plaintiffs’ are envisioning, but I think that RMBS Trustees, industry players and observers alike must allow for the possibility that while these Complaints suggest the plaintiffs mean business, the ultimate global settlement may reveal otherwise.

No. 1 – Additional Trustee Lawsuits Continue to Pour In, Suggesting Material Risk to Trustees

Since the Institutional Investors’ filing of their six massive lawsuits, we’ve seen at least four other Trustee suits filed over the last week.  On June 27, 2014, Commerce Bank and several other funds, credit unions, insurance companies and banks, filed a complaint against BNYM (Index No. 651967/2014, available here) requesting an accounting on 93 separate Countrywide RMBS Trusts, alleging that BNYM “engaged in a widespread failure to obtain and hold critical documents evidencing the mortgage loans belonging to the Trusts.”  It also seeks to preserve claims against BNYM for entering into the $8.5 billion settlement with BofA, to the extent the settlement is not finally approved.

On the same day, the Federal Home Loan Bank of Topeka, Doubleline Capital, and other funds filed three separate suits against HSBC, Wells Fargo, and Citibank, respectively (Case Nos. 651972/2014, 651973/2014, 651974/2014).  Though these cases are pre-RJI, and thus no Complaint is yet available, the Summonses with Notice indicate that these suits are for breach of contract, violations of the TIA, negligence and breach of fiduciary duty, on behalf of the plaintiffs and the trusts, based on the Trustees’ failure to take action to force Countrywide to repurchase loans sold to Trusts other than Countrywide-sponsored Trusts.  That is, the Summones allege that while BNYM took action as to the Countrywide-sponsored Trusts (which “constitute an attempt, however inadequate, to address defective mortgages in Countrywide trusts”), “[n]othing has been done by Defendant, or anyone else, to address the problem of defective mortgage loans in non-Countrywide trusts.”  The Summonses go on to detail some of the evidence that emerged from the BNYM Article 77 hearing, and seek redress on the remaining Countrywide loans for similar issues.

It’s safe to say that this is only the beginning of Trustee-focused litigation.  But, how do we get our arms around the real risk to Trustees?  As I mentioned, Trustees are indemnified to the extent that they can prove to a court that these losses arose out of breaches of reps and warranties by the issuing banks.  However, Trustees will likely have significant transactional costs in fighting these suits and establishing their indemnity claims against the large Wall St. banks.  In addition, Trustees do not have the right to be indemnified for their own gross negligence, bad faith, or willful misconduct.  In some deals, this exception also applies to plain old negligence.  Since such negligence is being alleged all over these latest complaints, there is some risk that the Trustees themselves will have to pay at least a portion of any judgment or settlement out of pocket.

And what is the size of that potential liability?  Well, the way I see these cases playing out is that they will be similar to an attorney malpractice case, where they will take the form of a “case within a case.”  That is, the plaintiffs will have to prove that the Trustee had a duty to act and didn’t, but also must prove the that underlying action would have had merit and have resulted in sizeable damages.  In theory, the Trustees (or their indemnitors) could be liable for the entire amount of damages that the unfiled putback claims could have recovered.  Also just in theory, but based on my experience in putback cases, that size could average 75-80% of the losses in these deals (so, for example, the damages in the Institutional Investor suits could approach $200 billion on the $250 billion in claimed losses, if all claims were successful) based on typical breach rates in deals of this vintage.

But, with BlackRock and PIMCO already having settled the Countrywide claims for approximately 8% or less of losses, they may be hard pressed to argue they would have recovered much more than that (or approximately $20 billion) through litigation/settlement.  This is yet another reason to be skeptical about the aggressiveness/representativeness of the Institutional Investor actions.  At the end of the day, much of that ultimate damage number is attributed to Trustee negligence or gross negligence depends on how much dirt the plaintiffs can uncover about what the Trustees knew or should have known, and what they did in response, and whether the factfinder is convinced that such conduct rises to the level of negligence or gross negligence.

Epilogue: Other Ramifications and Final Thoughts

In addition to the potential liabilities engendered by these six lawsuits themselves, the suits also put pressure on the Trustees to accept global deals that they’re currently evaluating on the JP Morgan and Citigroup deals, at least as to the deals that are not in active litigation or subject to an active direction letter from bondholders.  In those latter deals, the Trustees open themselves up to even greater liability if they were to settle claims where bondholders have been actively reviewing and/or putting back loans for the same price as claims where very little has been done.

The Trustees would also be biting off their noses to spite their faces, because in those deals, they’re already subject to a binding direction, and being provided indemnity by the bondholders, to pursue putbacks.  But for the remainder of the deals, the BlackRock/PIMCO lawsuits underscore the risks of doing nothing and passing on a deal that would settle the underlying putback claims.

Finally, these lawsuits demonstrate that there are potentially even greater liabilities (on a per-deal basis) awaiting Trustees who failed to act, or acted too late, on deals where active investors with the requisite holdings were putting back loans and/or attempting to direct the Trustees to take action.  As discussed above, these are the cases with the most compelling facts, and those about which the Trustees must be most wary as the tide begins to shift against them.

Posted in ACE, Alt-A, appeals, Bank of New York, Bank of New York Mellon, banks, Bernstein Litowitz, BlackRock, BofA, bondholders, Certificateholders, Citigroup, Commerce Bank, Countrywide, Credit Unions, DB Structured Products, Deutsche Bank, Doubleline Capital, Federal Home Loan Banks, fiduciary duties, global settlement, HSBC, Institutional Investors, investors, JPMorgan, Justice Kornreich, Kathy Patrick, lawsuits, liabilities, litigation, MBS, New York State Supreme Court, Paul Clement, PIMCO, pooling agreements, putbacks, repurchase, RMBS, SEC, servicers, settlements, statutes of limitations, subprime, TIA, Trustees, US Bank, Wall St., Wells Fargo | 7 Comments