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.
