Last week, U.S. District Judge Katherine B. Forrest of the Southern District of New York reinstated a failure-to-notify claim brought by plaintiff Deutsche Bank National Trust Company (the trustee) against defendant Morgan Stanley Mortgage Capital Holdings LLC (“Morgan Stanley”). This notification claim is distinct from the trustee’s claim for breach of contract—based on Morgan Stanley’s alleged breaches of the agreements governing the residential mortgage-backed security (“RMBS”) transaction—and concerns Morgan Stanley’s failure to inform the trustee about alleged misrepresentations made by Morgan Stanley about the mortgage loans which served as the underlying collateral for the securities issued by the Morgan Stanley Structured Trust I 2007-1 (“the trust”).

The trustee’s suit, initially brought in April 2014, claims that Morgan Stanley, as sponsor of the trust, misrepresented the quality of the mortgage loans it sold into the trust, inducing investors to purchase approximately $735 million in RMBS. Because of the resulting borrower defaults that occurred in the wake of the 2007-2008 financial crisis, the trustee alleges investors suffered more than $306 million in losses and Morgan Stanley breached the representations and warranties it made on the underlying mortgage loans and failed to cure or repurchase the loans as contractually required.

In a 2015 decision, U.S. District Judge Laura Taylor Swain dismissed the trustee’s failure-to-notify claim based on a series of prior New York decisions holding that contractual remedy provisions—including notification provisions in the RMBS context—are not bases for independent causes of action but rather are intended to be solely remedial in nature and exercised prior to bringing suit. That is, only the underlying breaches of representations and warranties could provide a basis for suit. The case was subsequently transferred to Judge Forrest in September 2017.

In her opinion reviving the notification claim, Judge Forrest noted that since 2015, “multiple New York appellate courts have held that notice provisions, unlike cure/repurchase obligations, do provide a basis for separate breach of contract claims.” Judge Forrest noted three First Department Appellate Division cases providing unequivocal support for this holding. See Nomura Home Equity Loan, Inc. v. Nomura Credit & Capital, Inc., 143. A.D.3d 1 (1st Dep’t 2015) (docket number 650337/13); Morgan Stanley Mortg. Loan Tr. 2006-13ARX v. Morgan Stanley Mortg. Capital Holdings LLC, 151 A.D.3d 72 (1st Dep’t 2016) (docket number 653429/12); and Bank of New York Mellon v. WMC Mortg., LLC, 151 A.D.3d 72 (1st Dep’t 2017) (docket number 653831/13).

Accordingly, Judge Forrest held “this Court is convinced that subsequent developments in the law have rendered Judge Swain’s decision to dismiss the Notice Claim incorrect.”

Morgan Stanley has moved for reconsideration of the court’s decision. Morgan Stanley previously moved for summary judgment in May 2017, challenging the sufficiency of the trustee’s decision to use a sample of loans to prove breaches throughout the entire trust. The summary judgment motion, also pending before the court, is unaffected by the reinstatement of the failure-to-notify claim.

The case is Deutsche Bank National Trust Co. v. Morgan Stanley Mortgage Capital Holdings LLC, case number 1:14-cv-03020, in the U.S. District Court for the Southern District of New York.

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