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Royal Park Investments SA/NA v. HSBC Bank USA National Association

United States District Court, S.D. New York

March 10, 2017

ROYAL PARK INVESTMENTS SA/NA, Plaintiff,
v.
HSBC BANK USA NATIONAL ASSOCIATION, Defendant. BLACKROCK BALANCED CAPITAL PORTFOLIO FI, et al., Plaintiffs,
v.
HSBC BANK USA, Defendant. PHOENIX LIGHT SF LIMITED, et al., Plaintiffs,
v.
HSBC BANK USA, NATIONAL ASSOCIATION, Defendant. NATIONAL CREDIT UNION ADMINISTRATION BOARD, et al., Plaintiffs,
v.
HSBC BANK US, NATIONAL ASSOCIATION, Defendant. COMMERZBANK A.G., Plaintiff,
v.
HSBC BANK US, NATIONAL ASSOCIATION, Defendant. TRIAXX PRIME CDO 2006-1, et al., Plaintiffs,
v.
HSBC BANK USA, NATIONAL ASSOCIATION, Defendant.

          OPINION & ORDER

          SARAH NETBURN United States Magistrate Judge

         This case is brought by dozens of certificateholders of residential mortgage-backed securities (“RMBS”) trusts against the trustee, HSBC Bank USA, National Association (“HSBC”). The Court assumes the parties' familiarity with the case. The plaintiffs[1] seek leave to re-underwrite a sample of loans to establish pervasive breach rates across the underlying loans of the trusts at issue to prove liability and damages. HSBC opposes the motion because it believes the plaintiffs cannot prove their case through sampling but rather must prove each element of their claims on a loan-by-loan and trust-by-trust basis. A resolution of this question before re-underwriting findings have been produced is appropriate, given that the Court's decision will affect the number of loans that the parties' experts will re-underwrite, as well as the accompanying costs and time needed to re-underwrite those loans.

         The Court heard oral argument on the subject on October 27, 2016, and thereafter ordered consolidated briefing to determine whether sampling is appropriate. Having reviewed the submissions, affidavits, and exhibits, the Court, by Order dated February 24, 2017, denied plaintiffs' motion to re-underwrite a sampling of loans. The Court's reasoning for that Order follows.

         BACKGROUND

         The underlying claims arise from HSBC's role as trustee for 295 RMBS trusts. As trustee, HSBC owed certain “limited, contractual” duties to the certificateholders set forth in the governing agreements, generally identified as the pooling and servicing agreements (“PSAs” or the “Agreements”) and other related agreements, including the Mortgage Loan Purchase Agreements and Servicing Agreements. Royal Park Investments SA/NV v. HSBC Bank USA, Nat'l Ass'n, 109 F.Supp.3d 587, 595 (S.D.N.Y. 2015) (“Royal Park”). In general, an indenture trustee's duties are “strictly defined and limited to the terms of the indenture.” Elliott Assocs. v. J. Henry Schroder Bank & Trust Co., 838 F.2d 66, 71 (2d Cir. 1988). An indenture trustee undertakes no obligations other than those expressly set forth in the agreements. See id.; see also Cruden v. Bank of N.Y., 957 F.2d 961, 976 (2d Cir. 1992) (construing indentures as contracts in accordance with traditional contract interpretation principles); CFIP Master Fund, Ltd. v. Citibank, N.A., 738 F.Supp.2d (S.D.N.Y. 2010) (the duties of RMBS trustees “are limited, administrative, and ministerial (rather than substantive) in nature”).

         The most pertinent of the governing agreements to this motion are the PSAs-the contracts between the loan depositor, the trust administrator, the trustee, and the loan servicer. The PSAs contain representations and warranties (“R&W”) made by the depositors, sellers, sponsors, and originators attesting to the credit quality and other characteristics of the underlying mortgage loans and their origination. Pursuant to the PSAs, HSBC had specific duties with respect to enforcing the obligations of the loan sellers in the event of an R&W breach. For the purposes of this Opinion, the PSAs' relevant provisions and terms are largely identical. No party asserts that any variation between the PSAs would affect the outcome of the Court's decision.

         Plaintiffs' claims against HSBC sound in contract. They are rooted specifically in Sections 2.03 and 8.01 of the PSAs. First, Section 2.03 provides in relevant part:

Upon discovery or receipt of notice of any materially defective document in, or that a document is missing from, a Mortgage File or of a breach by the Seller of any representation, warranty or covenant under the Mortgage Loan Purchase Agreement in respect of any Loan that materially and adversely affects the value of such Loan or the interest therein of the Certificateholders, the Trustee shall promptly notify the Seller of such defect, missing document or breach and request that the Seller deliver such missing document, cure such defect or breach within 60 days from the date the Seller was notified of such missing document, defect or breach, and if the Seller does not deliver such missing document or cure such defect or breach in all material respects during such period, the Trustee shall enforce the obligations of the Seller under the Mortgage Loan Agreement to repurchase such Loan from the Trust Fund at the Purchase Price within 90 days after the date on which the Seller was notified of such missing document, defect or breach, if and to the extent the Seller is obligated to do so under the Mortgage Loan Purchase Agreement.

DBALT 2006-AR5 PSA § 2.03. Section 2.03 imposes two threshold requirements before HSBC must enforce the loan seller's repurchase obligation. HSBC must “discover[]” or obtain written notice of missing documentation in a mortgage file or an R&W breach. Id. And the breach or deficiency must “materially and adversely” affect the value of the particular loan. Id. Upon both requirements being satisfied, HSBC's specific obligations as trustee are triggered. HSBC must promptly notify the loan seller of the defect in the particular loan. If the seller fails to cure or repurchase the defective loan within 60 days, HSBC must then “enforce the obligations of the Seller under the Mortgage Loan Purchase Agreement to repurchase such Loan.” Id. This remedy, also referred to as the “put-back” remedy, is the “sole remedy” in the event of an R&W breach. Id.

         Without specifying particular loans, plaintiffs allege HSBC breached its Section 2.03 obligations when it “discovered” breaching loans that had a material and adverse effect and failed to require cure or repurchase. The parties dispute (1) the meaning of “discovery” for purposes of Section 2.03 and (2) the appropriate method of proving HSBC's breach of its Section 2.03 obligations. Plaintiffs argue that “discovery” requires only inquiry notice of breaches, which triggers HSBC's duty to investigate breaches, determine breach rates, and enforce the seller's repurchase obligation. HSBC responds that “discovery” requires plaintiffs to prove it had actual knowledge of breaches and that it had no duty, before the occurrence of a defined Event of Default, to investigate breaching loans. Regarding the method of proof for showing breach, plaintiffs argue that statistical sampling performed by their retained experts, rather than reviewing the entire universe of at-issue loans, has been allowed by other courts in this District and is appropriate in this context. According to plaintiffs, sampling will generate breach rates to the at-issue Trusts, as well as prove what a prudent person would have found if an investigation of breaches had been performed. HSBC contends that plaintiffs must show it knew of loan-specific breaches with a material and adverse effect and that sampling cannot capture such loan-level specificity.

         Second, with respect to plaintiffs' claims regarding Events of Default (“EOD”), an EOD is defined in the PSAs as a failure of the Master Servicer to perform its servicing duties in compliance with the governing agreements and to cure such failure within a 30 days. See DBALT 2006-AR5 PSA § 8.01(a)(ii). HSBC's obligations under Section 8.01 are triggered by actual knowledge or written notice of an EOD:

For purposes of this Section 8.1, the Trustee shall not be deemed to have knowledge of a Master Servicer Event of Default unless a Responsible Officer of the Trustee assigned to and working in the Trustee's Corporate Trust Office has actual knowledge thereof or unless written notice of any event which is in fact such a Master Servicer Event of Default is received by the Trustee and such notice references the Certificates, the Trust or this Agreement.

DBALT 2006-AR5 PSA § 8.01. According to plaintiffs, in the aftermath of the housing and financial crisis, the failure of servicers to promptly notify HSBC upon their discovery of mortgage loan R&W breaches constituted an EOD. Plaintiffs further contend that HSBC obtained actual knowledge of such failures based on publicly available information. Once HSBC acquired actual knowledge or written notice of a defined EOD, the PSAs required it to assume heightened post-default responsibilities. Specifically, HSBC was to provide prompt, written notice of the EOD to noteholders. It was also required to “use the same degree of care and skill in its exercise as a prudent person would exercise or use under the circumstances in the conduct of such person's own affairs.” DBALT 2006-AR5 PSA § 9.1. According to plaintiffs, HSBC's failure to perform that investigation, to then uncover the existence and rate of defective loans, and finally to enforce repurchase was a breach of its obligation under Section 8.01 of the PSAs to act as a prudent person.

         DISCUSSION

         I. Rule 26 and Proportionality

         In general, statistical sampling is an accepted method of proving liability in this District, “including in cases relating to RMBS and involving repurchase claims.” Assured Guar. Mun. Corp. v. Flagstar Bank, FSB (“Flagstar”), 920 F.Supp.2d 475, 512 (S.D.N.Y. 2013); see, e.g., Assured Guar. Mun. Corp. v. DB Structured Prods., Inc., No. 650705/2010, 2014 WL 3282310, at *6, 8 (N.Y. Sup. Ct. 2014); Syncora Guarantee Inc. v. EMC Mortg. Corp., No. 09 Civ. 3106 (PAC), 2011 WL 1135007, at *6 n.4 (S.D.N.Y. 2011). But a court should not authorize the expense and burden of sampling if it is not “proportional to the needs of the case.” Fed.R.Civ.P. 26(b)(1). Indeed, it is a core function of the court to prevent unwarranted costs and delays in the resolution of every action. See Fed.R.Civ.P. 1. While Rule 26 sets forth various factors to evaluate proportionality, on this discovery motion, the Court's focus is on “the importance of the discovery in resolving the issues” and “whether the burden or expense of the proposed discovery outweighs its likely benefit.” Id. The Court will not authorize discovery that, in its estimation, is unlikely to advance any claim or defense in this case. See Henry v. Morgan's Hotel Grp., Inc., No. 15 Civ. 1789 (ER)(JLC), 2016 WL 303114, at *3 (S.D.N.Y. Jan. 25, 2016) (internal citation and quotation marks omitted) (Rule 26(b)(1) is “intended to encourage judges to be more aggressive in identifying and discouraging discovery overuse by emphasizing the need to analyze proportionality before ordering production of relevant information.”).

         The parties have represented that the contemplated sampling will be costly, time consuming, and will likely result in challenges to the admissibility of the evidence. And as set forth more fully below, the defendant believes such evidence cannot prove plaintiffs' claims. Such discovery should not be undertaken lightly. Critically, however, the Court's ruling is on a discovery motion. And while this opinion reaches a conclusion on the burden of proof for the parties' claims and defense, such conclusion is intended to guide the Court's proportionality analysis. Accordingly, at summary judgment or trial, conclusions of law set forth in this opinion should not be deemed to have law-of-the-case effect.

         II. Section 2.03 Breach of Representation ...


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