Wells Fargo Bank N.A. v. Sovereign Bank, N.A.

Citations: 44 F. Supp. 3d 394; 2014 U.S. Dist. LEXIS 125274; 2014 WL 4412397Docket: Nos. 13 Civ. 1222(NRB), 13 Civ. 4313(NRB)

Court: District Court, S.D. New York; September 8, 2014; Federal District Court

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Wells Fargo Bank, N.A., as Trustee of the Sovereign Commercial Mortgage Securities Trust 2007-C1, through its Sub-Special Servicer Waterstone Asset Management, LLC, has initiated two legal actions against Sovereign Bank, N.A. for breach of contract and breach of warranty related to a commercial mortgage-backed securities (CMBS) transaction involving 264 mortgage loans valued over $1 billion. The first action concerns one loan (Eneo Loan Action), while the second involves five loans (Five Loans Action). Wells seeks repurchase of these loans due to alleged breaches. The court is currently considering Sovereign's motion to dismiss and for summary judgment, alongside Wells' motions to amend complaints to include further claims. Following oral arguments on August 14, 2014, the court has ruled to grant Sovereign's motion to dismiss and for summary judgment, denying Wells' motions for amendment. The CMBS transaction involved Sovereign selling the loans to Morgan Stanley Capital I, Inc. under a Mortgage Loan Purchase Agreement (MLPA) dated June 8, 2007, with a closing date of June 21, 2007. The loans were subsequently pooled into a trust and assigned to Wells as Trustee via a Pooling and Service Agreement (PSA) executed on June 1, 2007, also closing on June 21, 2007. The MLPA and PSA are identified as the key contracts relevant to this case.

Shares of a mortgage loan pool were sold to investors as certificates following the creation of a Trust. Investors, known as certificateholders, had access to the Mortgage Loan Pool Agreement (MLPA), the Pooling and Servicing Agreement (PSA), and a Confidential Offering Memorandum (COM) prepared by Sovereign and Morgan Stanley, which contained comprehensive information about the certificates and the underlying mortgage loans. The COM disclosed details about certain second mortgages secured by properties not held by the Trust, particularly noted in the Mortgage Loan Schedule. Specific data for six mortgage loans relevant to the litigation included subordinate financing amounts for each loan, with various amounts detailed for properties such as the Caroline Arms Loan and the Grand Loan. 

The MLPA and PSA included copies of the Mortgage Loan Schedule, but an error resulted in missing text for certain footnotes, specifically affecting footnote numbers 1, 5, 9, 10, 12, and 18. Allegations of breaches of Representations and Warranties made by Sovereign in the MLPA center on three pertinent representations: Rep 18, which asserts that no mortgage loan is secured by a property not listed in the Mortgage Loan Schedule; Rep 10, concerning the legality and propriety of loan origination and servicing practices; and Rep 7, which states there are no material defaults or breaches related to the mortgage loans. The plaintiff claims that these representations were breached regarding the mortgage loans at issue.

In the Eneo Loan Action, the complaint alleges that the defendant breached Representation 18 (Rep 18) by failing to disclose a second mortgage of $170,000 on the property securing the Eneo Loan in the Mortgage Loan Purchase Agreement (MLPA) Mortgage Loan Schedule. The proposed Amended Complaint seeks to include a new cause of action for breach of Representation 10 (Rep 10) related to various defects in the loan's origination and servicing.

The Five Loans Action involves five specific loans: the Linden Loan, Caroline Arms Loan, Magnolia Terrace Loan, Grand Loan, and Marina Palms Loan. In this action, the complaint alleges breaches of Rep 18 concerning the Linden, Caroline Arms, Magnolia Terrace, and Grand Loans due to undisclosed second mortgages. Additionally, it claims breaches of Rep 10 for all five loans due to loan origination and servicing issues, and breaches of Rep 7 for the Caroline Arms Loan, Grand Loan, and Marina Palms Loan because the borrowers were in material default as of the loan closing date. The claims related to the Magnolia Terrace Loan are no longer pursued since it has been fully paid.

Furthermore, both actions assert breaches of Section 2.03(b) of the Pooling and Servicing Agreement (PSA). This section requires prompt notification of any breach that materially affects the value of a Mortgage Loan or the interests of the Trustee or Certificateholders. The plaintiff claims that the defendant, as the initial Special Servicer, failed to notify relevant parties of its own breaches and did not repurchase the loans after being notified of certain breaches, as required under the PSA.

On February 9, 2012, the plaintiff notified the defendant of a breach of Representation 18 (Rep 18) related to the Eneo Loan, citing an undisclosed second mortgage. The plaintiff requested that the defendant cure or repurchase the loan within 90 days, which the defendant refused, asserting no breach had occurred but offering to discharge or assign the second mortgage to the Trust—a proposal the plaintiff rejected. 

On March 19, 2013, during ongoing litigation regarding the Eneo Loan, the plaintiff informed the defendant of additional breaches concerning the Five Loans, specifically citing breaches of Reps 18 and 10 due to undisclosed second mortgages and issues with loan origination practices. The defendant denied these breaches and declined to repurchase the loans.

The procedural history indicates that the plaintiff filed an original complaint in the Eneo Loan Action on February 22, 2013, alleging breaches of Rep 18 and Section 2.03(b) for failing to disclose the second mortgage. Subsequently, on June 20, 2013, the plaintiff filed the original complaint in the Five Loans Action, asserting claims for breaches of Reps 18 and 10 and Section 2.03(b). 

Defendant moved to dismiss or for summary judgment in both actions on October 25, 2013. After the plaintiff opposed the motion and the defendant replied, the plaintiff amended the complaint in the Five Loans Action, adding claims for breach of Rep 7 and expanding Rep 10 claims to include various origination and servicing flaws. 

On January 10, 2014, the court ordered additional briefing to allow the plaintiff to amend its complaint in the Eneo Loan Action and for the defendant to respond to the amended complaint in the Five Loans Action. The plaintiff subsequently moved for leave to amend the Eneo Loan complaint on February 14, 2014, to add claims related to Rep 10 and Section 2.03(b). The defendant opposed this motion and also sought to dismiss the amended complaint in the Five Loans Action. The plaintiff countered by cross-moving for leave to file a second amended complaint in the Five Loans Action on April 11, 2014, which the defendant opposed on May 2, 2014.

Defendant presents seven grounds for dismissing the actions and denying plaintiff's motions to amend. The first ground asserts that the disclosure of second mortgages in the COM and other documents, alongside footnote number 5 in the MLPA’s Mortgage Loan Schedule, precludes plaintiff's Rep 18 claims. Second, defendant claims that plaintiff did not provide the necessary notice and opportunity to cure regarding alleged Rep breaches unrelated to second mortgages. Third, defendant argues that plaintiff has inadequately alleged illegal or improper origination and servicing of loans. Fourth, the assertion that defendant breached Section 2.03(b) by not disclosing various Rep breaches is deemed too conclusory, and it fails because no underlying Rep breaches exist. Fifth, it is stated that New York law does not support a separate cause of action for failure to repurchase loans. The sixth ground indicates that the Five Loans Action should be dismissed due to being filed after the statute of limitations expired. Lastly, defendant contends that the proposed amended claims in both actions do not relate back to the original complaints.

In terms of legal standards, a motion to dismiss under Federal Rule of Civil Procedure 12(b)(6) requires the court to accept all factual allegations as true and draw reasonable inferences in favor of the plaintiff. The complaint must contain sufficient facts to state a plausible claim for relief. If the claims are deemed merely conceivable, they will be dismissed. Additionally, when considering a motion to dismiss, the court may examine documents attached to or referenced in the complaint, as well as those known to the plaintiff.

For a motion for summary judgment, it is granted when there is no genuine issue of material fact and the moving party is entitled to judgment as a matter of law. A fact is considered material if it could affect the outcome of the case, and an issue is genuine if a reasonable jury could return a verdict for the non-moving party. The moving party must initially demonstrate the absence of genuine issues of material fact, after which the non-moving party must present specific evidence to show a genuine dispute, avoiding reliance on conclusory allegations or speculation.

Rule 15(a)(2) permits courts to grant leave to amend freely when justice requires, but the district court has discretion to deny such leave for reasons including undue delay, bad faith, repeated failure to address prior deficiencies, undue prejudice to the opposing party, or amendment futility. Futility is evaluated under the standard for a Rule 12(b)(6) motion to dismiss. The defendant contends that certain claims in the current and proposed amended complaints should be dismissed due to the plaintiff's failure to provide required notice, which is a condition precedent under New York law. A condition precedent must be explicitly stated in the contract, and clear language is necessary to establish it. 

Section 2.03(b) of the PSA mandates that the plaintiff provide written notice of any representation breach and allows the defendant 90 days to act. Section 6.5 of the MLPA reinforces that the defendant's obligation to remedy a breach is contingent upon receiving this notice. The analysis indicates that the obligation to remedy is exclusively triggered by receipt of notice, not by discovery of the breach. This distinction aligns with other CMBS cases, where obligations triggered solely by notice are considered conditions precedent. Thus, the contractual language unambiguously establishes that notice is required before the defendant is bound to remedy a breach.

The PSA (Purchase and Sale Agreement) and MLPA (Mortgage Loan Purchase Agreement) require that the plaintiff provide the defendant with 90 days’ notice before initiating a lawsuit for a Rep breach. This notice is essential as it allows the defendant the opportunity to cure the breach or replace the affected loan, which could be more cost-effective than repurchasing the loan. The plaintiff's interpretation of a specific provision in Section 2.03(b) is incorrect; it only excuses delays in providing prompt notice, not the requirement to notify the defendant of a breach. Consequently, notice is deemed a condition precedent for filing claims, meaning that the plaintiff can only assert claims for which prior notice was given.

The plaintiff issued two notices of breach: one on February 9, 2012, concerning the Eneo Loan, and another on March 19, 2013, regarding five loans. Both notices alleged breaches related to undisclosed second mortgages. As a result, the defendant can only be held liable for claims associated with these second mortgages, leading to the dismissal of claims regarding Rep 7 and parts of Rep 10 and Section 2.03(b) that do not pertain to the second mortgages. Claims in proposed amendments unrelated to second mortgages are also considered futile.

Regarding Rep 18, the defendant is accused of failing to disclose second mortgages on various properties, which allegedly breach the representation that no mortgaged loan is secured by property that secures another mortgage loan not listed in the Mortgage Loan Schedule. The defendant argues for summary judgment on these claims, asserting that the second mortgages were adequately disclosed in the Mortgage Loan Schedule and other documents, and alternatively claims that any breach should be excused due to mutual mistake or scrivener’s error.

Three grounds support the granting of summary judgment on the Rep 18 claims. First, Rep 18 was not breached. It indicates that there are second mortgages on at least one of the Trust’s mortgaged properties, thus alerting any party relying on it. A clerical error resulted in the omission of detailed second mortgage information from footnote 5 of the Mortgage Loan Schedule, although this information is included in the COM. Despite the blank footnote, the language of Rep 18 and the disclosures in the COM sufficiently fulfill the defendant's obligation to disclose the existence of second mortgages. The missing data, indicated by multiple blank footnotes, logically directs a reasonable reader to find the necessary information in the Mortgage Loan Schedule. The MLPA’s “no due diligence” clause does not permit neglecting obvious disclosures.

Second, any potential breach is waived by the plaintiff, who was aware of and accepted this breach prior to contract execution. Under New York law, if a seller discloses the inaccuracy of warranties upfront, the buyer cannot claim to have relied on those warranties if they proceed with the transaction knowingly. The inaccuracy of Rep 18 is evident from the MLPA, as the Mortgage Loan Schedule does not identify any loans with second mortgages, demonstrating that the plaintiff could not have believed it was purchasing assurances regarding the truth of Rep 18. Thus, the plaintiff waived any claim of breach.

Plaintiff is unable to invoke the “no due diligence” clause to avoid waiver, as this clause does not protect against claims of breach of warranty when the warranty's inaccuracy is evident in the contract. Reformation of the Mortgage Loan Purchase Agreement (MLPA) is justified due to a scrivener’s error that was apparent to all parties involved. Under New York law, contracts can be reformed for mistakes in drafting, provided there is clear and convincing evidence of the error. Evidence presented—including testimony from Sovereign employee James McClernan and documentation showing the omission of second mortgage data—supports the assertion that the mistake was clerical and unintentional by both Morgan Stanley and the defendant. Consequently, as Morgan Stanley’s assignee, the plaintiff inherits the same defense against any claims of breach of warranty.

Regarding Rep 10, the plaintiff alleges a breach due to extending loans on properties with second mortgages, but this claim is dependent on the previously mentioned undisclosed second mortgages. Without a successful claim concerning the second mortgages, the Rep 10 claim cannot stand alone. The court concludes that the plaintiff's claims are dismissed for the reasons stated, granting the defendant’s motion to dismiss and denying the plaintiff’s motions to amend. The court notes that the plaintiff did not cite any laws or industry standards against the common practice in question, and the existence of at least one second mortgage was disclosed, waiving any alleged breach. The court refers to Sovereign as Santander Bank, N.A. for context.

Twelve Mortgage Loans, totaling about 9.0% of the Initial Pool Balance, have subordinate second lien mortgages or lines of credit. These disclosures were included in a preliminary COM dated May 24, 2007, and reflected in the COM disk. The Mortgage Loan Schedule attached to the MLPA and PSA includes a footnote not found in the COM version. Specific loans mentioned include the Eneo Loan ($1,330,000), Linden Loan ($4,880,000), Caroline Arms Loan ($5,500,000), Magnolia Terrace Loan ($2,750,000), Grand Loan ($1,200,000), and Marina Palms Loan ($17,480,000). 

Section 6.5 of the MLPA outlines the seller's obligations upon notice of a breach that materially affects the value of a Mortgage Loan, allowing for a 90-day period to cure the breach, repurchase the affected Mortgage Loan, or substitute it with a Qualified Substitute Mortgage Loan. The PSA stipulates that substitutions cannot occur after the second anniversary of the Closing Date. The Servicer, Special Servicer, or Trustee must notify relevant parties of any breach, with the understanding that failure to notify does not waive obligations.

Despite the defendant incorporating prior briefs, they cannot escape the notice requirement for breach claims. On August 20, 2014, after oral arguments, the plaintiff sent a notice letter regarding additional breaches not previously mentioned, which the court declined to consider due to timing and the requirement for prior notice. The absence of evidence for intentional omission regarding the second mortgage information was noted. The defendant did not breach representations 18 or 10, leading to the dismissal of the current and proposed claims based on the alleged breach.