RMBS Suit Against Morgan Stanley Gets Resurrected On Appeal

December 30, 2017 by Ruby Keys

In late summer of this year, a New York appellate court revived the breach of contract and negligence suit filed against Morgan Stanley. U.S. Bank National Association, who was acting as a trustee for investors in residential mortgage-backed securities (RMBS), first introduced the suit in 2012. U.S. Bank alleged that Morgan Stanley breached its contractual duty to notify the trustee of the defective loans which resulted in alleged losses of $140 million from the sale of the allegedly defective loans.

In issuing its opinion, the court stated that the lower court erred in their 2014 decision to dismiss the case, holding that the alleged failure by a seller to notify securitization counterparties of material breaches it discovers in the underlying loans constitutes an independently breached contractual obligation that allows plaintiff to pursue separate damages. The court also reversed the dismissal of the plaintiff’s gross negligence claims noting that the facts alleged in the amended complaint were sufficient to constitute a claim for gross negligence.

According to the complaint, as part of a larger securitization deal, Mortgage Stanley Mortgage Loan Trust 2006-13ARX (“Trust”), the trust holding the underlying loans, purchased over $609 million in debt from 1,873 residential mortgage loans. The RMBS pool was then offered out to investors as certificates by the Trust, which used the proceeds to pay for the underlying loans. In the agreement, Morgan Stanley was required to confirm to the trustee that the loans did not contain any default, breach or violation, and none were not in danger of being accelerated or impending foreclosure. However, it is alleged that Morgan Stanley knowingly included at least 371 loans that violated one or more of the agreed upon eligibility terms which resulted in breaches that hurt the value of the loans and the interests of the investors. It is further alleged that when the Trust notified Morgan Stanley of the violations, Morgan Stanley failed to honor its promise to repurchase the defaulted loans.

Based on these allegations and citing to a similar case, Nomura Home Equity Loan Inc. vs. Nomura Credit & Capital Inc., among others, the appellate court stated that the allegations were sufficient to support plaintiff claims for failure to notify and gross negligence at the pleading stage.

The case is Morgan Stanley Mtge. Loan Trust 2006-13ARX v. Morgan Stanley Mtge. Capital Holdings LLC, case number 2016 NY Slip Op 05781, in the New York Supreme Court, Appellate Division, First Department.

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