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Blackrock Allocation Target Shares: Series S Portfolio v. Wells Fargo Bank, National Association

United States District Court, S.D. New York

March 10, 2017

BLACKROCK ALLOCATION TARGET SHARES: SERIES S PORTFOLIO, et al., Plaintiffs,
v.
WELLS FARGO BANK, NATIONAL ASSOCIATION, Defendant. ROYAL PARK INVESTMENTS SA/NV, Plaintiff,
v.
WELLS FARGO BANK, N.A., Defendant. NATIONAL CREDIT UNION ADMINISTRATION BOARD, Plaintiff,
v.
WELLS FARGO BANK, N.A., Defendant. PHOENIX LIGHT SF LTD. et al.,
v.
WELLS FARGO BANK, N.A., COMMERZBANK A.G., Plaintiff,
v.
WELLS FARGO BANK, N.A., 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, Wells Fargo Bank, National Association (“Wells Fargo”). The Court assumes the parties' familiarity with the case. The plaintiffs 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. Wells Fargo 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 28, 2016. Consolidated briefing was then ordered to determine whether sampling is appropriate in this matter. 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 Wells Fargo's role as trustee for 53 RMBS trusts.[1] As trustee, Wells Fargo owed certain limited, contractually-derived 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. 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).

         The most pertinent of the governing agreements to this decision 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, Wells Fargo had specific duties with respect to enforcing the obligations of the loan sellers in the event of an R&W breach. The PSAs' relevant provisions and terms are largely identical. No party asserts that any variation between the PSAs would affect the outcome of this decision.

         Plaintiffs' claims against Wells Fargo 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 written notice of any materially defective document in, or that a document is missing from, a Mortgage File or of the breach by the Originators or the Seller of any representation or warranty under the related Originator Mortgage Loan Purchase Agreement or the Mortgage Loan Purchase Agreement, as applicable, in respect of any Mortgage Loan which materially adversely affects the value of such Mortgage Loan, Prepayment Charge or the interest therein of the Certificateholders, the Trustee shall promptly notify the applicable Originator or the Seller, as the case may be, the Servicer and the NIMS Insurer . . .and request that, in the case of a defective or missing document, the Seller cure such defect or deliver such missing document within 120 days from the date the Seller was notified of such missing document or defect or, in the case of a beach of a representation or warranty, request the related Originator or the Seller, as applicable, cure such breach within 90 days from the date the applicable Originator or the Seller, as the case may be, was notified of such breach. Notwithstanding the foregoing, any breach of a Deemed Material and Adverse Representation with respect to a Group 1 Mortgage Loan or Group 2 Mortgage Loan shall automatically be deemed to materially and adversely affect such Mortgage Loan or the interest of the related Certificateholders therein.
If the Seller does not deliver such missing document or cure such defect or if the related Originator or the Seller, as applicable, does not cure such breach in all material respects during such period, the Trustee shall enforce such Originator's or the Seller's obligation, as the case may be, under the applicable Originator Mortgage Loan Purchase Agreement or the Mortgage Loan Purchase Agreement, or Additional Mortgage Loan Purchase Agreement as applicable, and cause such Originator or the Seller, as applicable, to repurchase such Mortgage Loan from the Trust Fund at the Purchase Price on or prior to the Determination Date following the expiration of such period (subject to Section 2.03(d)).

ABFC 2006-OPT1 PSA § 2.03(a). Section 2.03 imposes two threshold requirements before Wells Fargo must enforce the loan seller's repurchase obligation. Wells Fargo 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, Wells Fargo's specific obligations as trustee take effect. Wells Fargo must promptly notify the originator or seller of the defect in the particular loan. If the seller fails to cure or repurchase the defective loan within either 120 days (if the defect is a missing document) or 90 days (if the defect is an R&W breach), Wells Fargo must then “enforce such Originator's or the Seller's obligation . . . to repurchase such Mortgage Loan.” Id. This cure and repurchase mechanism, also referred to as the put-back remedy, constitutes the “sole remed[y]” in the event of an R&W breach. Id.

         Without specifying particular loans, plaintiffs allege Wells Fargo 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 Wells Fargo's breach of its Section 2.03 obligations. Plaintiffs argue that “discovery” requires only inquiry notice of breaches, which triggers Wells Fargo's duty to investigate breaches, determine breach rates, and enforce the seller's repurchase obligation. Wells Fargo 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 and extrapolate 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. Wells Fargo 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 regards to plaintiffs' claims regarding Events of Default (“EOD” but often referred to in the PSAs as an Event of Termination), an EOD is defined in the PSAs as a failure of a servicer to perform its servicing duties in compliance with the governing agreements and to cure such failure within 30 days. See ABFC 2005-OPT1 PSA § 7.01(a). Wells Fargo's obligations under Section 8.01 are triggered by actual knowledge or written notice of an EOD:

[T]he Trustee shall not be charged with knowledge of any failure by the Servicer to comply with the obligations of the Servicer referred to in clauses (i) and (ii) of Section 7.01(a) or any Servicer Event of Termination unless a Responsible Officer of the Trustee at the Corporate Trust Office obtains actual knowledge of such failure or the Trustee receives written notice of such failure from the Servicer, the NIMS Insurer or the Majority Certificateholders. In the absence of such receipt of such notice, the Trustee may conclusively assume that there is no Servicer Event of Termination.

Id. at § 8.01. According to plaintiffs, in the aftermath of the housing and financial crisis, the failure of servicers to promptly notify Wells Fargo upon their discovery of mortgage loan R&W breaches constituted an EOD. Plaintiffs further contend that Wells Fargo obtained actual knowledge of such failures based on publicly available information. Once Wells Fargo acquired actual knowledge or written notice of a defined EOD, it was required to “exercise such of the rights and powers vested in it by this Agreement, and use the same degree of care and skill in their exercise, as a prudent person would exercise or use under the circumstances in the conduct of such person's own affairs.” Id. Plaintiffs construe this prudent person standard to require Wells Fargo to have performed a thorough investigation of the loans in the trusts. According to plaintiffs, Wells Fargo'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 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 cost hundreds of thousands, if not millions, of dollars, will require months to conduct, and will likely result in challenges to the admissibility of the evidence. And as set forth more fully below, Wells Fargo 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 ...


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