Don Hawthorne is a Partner in the New York office of Axinn Veltrop & Harkrider. Don’s practice focuses on litigation involving complex financial instruments, credit crisis litigation, antitrust litigation and counseling, and international disputes. He frequently represents insurers, hedge funds, and private equity firms, and represents both plaintiffs and defendants. Don recently spoke with DS News about a crucial pending case, ACE Securities Corp. et al. v. DB Structured Products, Inc., which will determine whether the statute of limitations has run on all repurchase, or “putback,” claims for pre-credit crisis residential mortgage-backed securities (“RMBS”), or whether such claims can continue to be brought.
What is the latest in the Ace Securities v. DB case?
The arguments were presented in a hearing last week, and now we're waiting for a decision. I don't think that there was a clear signal from the Court on where they're going to go.
This will be a significant decision for credit crisis litigation in general. It will decide whether the six-year statute of limitations on RMBS putback claims runs from a bank’s refusal to repurchase defective loans, or from the date of the securitization. If the New York Court of Appeals adopts the latter view, essentially all new repurchase claims will be time-barred. There is a lot of money riding on this decision.
The court seemed concerned about the real world effect of its decision on investors’ willingness to invest in these types of securities. RMBS are a very important source of capital for real estate markets, and therefore a major driver of growth for the economy. Having watched the hearing, I don't think the defense answered those concerns.
Did you read anything from the court's reaction to the arguments presented?
Some members of the court seemed to think it was reasonable to expect investors to do due diligence on the underlying loans before they invested. With respect to the court, I don't think that is a very realistic view of the world. Few if any RMBS investors thought that they were taking on the risk that there could be massive numbers of breaches, but that repurchase claims would be extinguished if not brought within six years. There would have been few buyers of RMBS if each investor was expected to do due diligence on 10,000 individual mortgages.
It is interesting that there was no consideration here of the parties’ intent. Both sides suggested that it was clear from the face of the contracts what they meant. It will be unfortunate if the case is dismissed without getting to that issue. There seems to me to be something fundamentally misguided if New York is saying: you can put together the most complex financial instruments in the world, but if investors can’t perceive defects in them within six years, the originators and sponsors get off scot-free, and there is nothing the parties can do, ex ante, to address that problem or decrease investor risk. It is a surprisingly rigid approach for the most sophisticated financial center in the world. If New York is going to impose these kind of rigid rules, apparently out of an interest in conserving judicial resources, it may find its role tarnished as a center of global finance.
What will be the long-term effects of the court's decision?
If the court rules in favor of the defendant and holds that the six-year statute of limitations bars further repurchase claims, it is going to put wind in the sails of lawsuits against the trustees charging them with breach of fiduciary duty for failing to bring or preserve repurchase claims before the statute of limitations ran out. That is apparent from the oral argument. The attorney for DB Securities told the court that the trustee knew that the statute was going to expire, declined to get a tolling agreement, and consciously decided not to take action. If he is right about that, the trustees should be worried about their liability for breach of duty to the noteholders.
If the court rules in favor of the plaintiff, repurchase litigation will be with us for some time. It may also help to revive the market for RMBS, which has been pretty dead since the credit crisis. If you want to grow the economy, it can only be a good thing now to make more capital available to real estate markets. A ruling for the plaintiff will encourage investors to invest in RMBS, because they won't be taking on the risk that the banks are doing a slipshod job of originating loans in ways that will not be immediately apparent.
(Editor's note: Click here to be directed to the page where a download of the webcast of the hearing is available)