Professor Miller Submits Amicus Curiae Brief in Residential Mortgage-Backed Securities Case

Professor Robert T. Miller has submitted an amicus curiae brief in a New York case arising out of the events that triggered the financial crisis of 2007-2008.

The case is ACE vs. DB Structured Products and is one of several similar cases pending in New York courts in which billions of dollars are at stake.

In 2006, DB Structured Products (DBSP) was in the business of securitizing residential mortgage loans, that is, packaging such loans into residential mortgage-backed securities (RMBSs) that were ultimately sold to financial institutions around the world. When the housing bubble burst and real estate prices fell, RMBSs generally lost a large fraction of their value. Most institutions holding the RMBSs sold the securities at significant losses, often to hedge funds that specialize in buying distressed debt.

The prices of RMBSs have recovered substantially since 2008, and the hedge funds that bought the securities have made significant profits. But now some of these funds are suing the banks and other financial institutions that originally created and sold the securities. “They made some excellent investments, buying when prices were irrationally low following the panic of 2008,” Professor Miller said, “and now they are hoping to get an even greater return by litigating against the original sellers of the securities.”

In the transaction underlying ACE v. DB Structured Products, as in such transactions generally, DBSP made various representations and warranties to the buyers about the quality of the mortgage loans being sold, including the standards according to which they were underwritten, their loan-to-value ratios, and so on. DBSP also promised that, if any of these representations and warranties turned out to be false with respect to a particular loan, DBSP would repurchase the non-conforming loan at face value.

The plaintiff alleges that a large percentage of the loans did not conform to the representations and warranties, and DBSP denies this. At this stage of the litigation, however, the issue is whether the plaintiffs can still sue on this claim at all.

DBSP argues that, if the representations and warranties were breached, then that breach occurred at the time the loans were first sold in 2006, and since New York law has a six-year statute of limitations for contract claims, the statutory period ran out in 2012. The plaintiff argues that the period began to run not at the time the representations and warranties were breached, but only when, much later, the plaintiff demanded that DBSP repurchase the allegedly non-conforming loans and DBSP refused.

Professor Miller is interested in the case because much of his scholarship concerns the allocation of risk between sophisticated parties entering into complex commercial agreements. “The agreements underlying these transactions,” he said, “are just the kinds of agreements I teach and write about.”

When, in the original agreement, DBSP represented and warranted to the purchasers that the mortgage loans had certain qualities, Professor Miller says, DBSP was agreeing to bear the risk that the loans may not actually have those qualities. “The issue,” he explained, “is how long DBSP agreed to bear that risk—for six years, or until sometime in the indeterminate future when the purchasers may claim that the representations and warranties were breached and demand that DBSP repurchase the loans.” On that issue, he said, “there are the strongest economic arguments for thinking that DBSP was bearing the risk only for the statutory period of six years beginning at the time the agreement was made.”

Professor Miller also calls the court’s attention to the fact that, within the securitization market, there is a menu of standard provisions that the parties can choose to include or not to include in their agreement. The key provision at issue in ACE vs. DB Structured Products is a “Sole Remedy Provision”; some other agreements include an additional provision called a “Claims Accrual Provision.” Professor Miller argues that, in deciding this case, the court ought not to prejudge the issue of whether, in an agreement that also includes a Claims Accrual Provision, the outcome may be different.

“In interpreting the Sole Remedy Provision,” Professor Miller said, “the court should not decide what effect a Claims Accrual Provision would have because that issue is not before the court, the parties to this case have not fully briefed that issue, and anything the court said about the Claims Accrual Provision could adversely affect the contract rights of persons not parties to the case.”

Professor Miller’s brief is available here.

UPDATE: On December 19, 2013, the New York Supreme Court, Appellate Division, First Department, unanimously ruled in favor of DBSP, holding that the statutory period began to run at the time the alleged breaches of representations and warranties occurred, i.e., the date that the contract was made. The court’s opinion can be read here.