Chris Lazarini Analyzes Trustee Duties Under Event of Default

March 25, 2019
Securities Online Litigation Alert

Bass, Berry & Sims attorney Chris Lazarini analyzed a case brought by plaintiffs against Bank of New York Melon (BNYM) alleging that the firm breached its trustee duty to act prudently after the event of default. The court affirmed the trial court’s ruling, finding that BNYM’s duties were divided into two parts – duties existing before an event of default and duties existing after an event of default – and that BNYM did not breach any duties.  The court held that BNYM acted prudently to secure repayment of the underlying obligation.

Chris provided the analysis for Securities Online Litigation Alert (SOLA). The full text of the analysis is below and used with permission from the publication. If you would like to receive additional content from the SOLA, please visit the SOLA website to sign up for the newsletter.

The Western and Southern Life Ins. Co. vs. Bank of New York Mellon, No. C-170476 (Ohio App., 1Dist., 2/8/19)

*Unlike common law trusts where a trustee must act solely in the interests of the beneficiaries, an indenture trustee’s duties are strictly defined by and limited to the terms of the trust agreement.

**Under New York law, the pre-default duties of an indenture trustee are limited to duties imposed by the indenture; however, after an event of default, the trustee’s obligations become more like an ordinary fiduciary and the trustee must act prudently to secure repayment of the underlying obligation.

Plaintiffs purchased $538 million in RMBS trust certificates. The underlying mortgages were originated, pooled, and serviced by Countrywide entities, with Bank of New York Melon (BNYM) serving as trustee under the Pooling Services Agreement (“PSA”). Plaintiffs filed this appeal after the trial court, at the conclusion of a bench trial, found that BNYM did not breach its obligations under the PSA and denied Plaintiffs’ $100 million breach of contract claim. Plaintiffs argued that the trial court erred in finding BNYM did not have a duty to enforce Countrywide’s obligation to repurchase or replace non-conforming loans. Plaintiffs also argued that the trial court erred in finding BNYM did not breach its duty to act prudently after an event of default. Affirming, the Court examines the PSA and finds BNYM’s duties are divided into two parts; duties existing before an event of default and duties existing after an event of default.

The Court explains that prior to an event of default (which events are defined in the PSA), BNYM’s duties are limited to those set out in the PSA, whereas, after an event of default, BNYM’s duties are elevated to a prudent man standard. Rejecting Plaintiffs’ first argument, the Court finds the PSA obligates Countrywide to repurchase or replace non-conforming loans, but does not assign to any party the duty to enforce Countrywide’s obligation. Specifically, the Court finds the PSA gave BNYM the right to enforce Countrywide’s repurchase or replace obligation, but did not obligate it to do so. If the trustee’s duties included the obligation to require Countrywide to act, the Court concludes, that duty would have been specifically stated in the PSA.

The Court rejects Plaintiffs’ argument that BNYM breached its duty to notify other parties to the PSA of Countrywide’s failure to repurchase or replace loans. Under the PSA, the duty to notify only arose if BNYM actually knew of a breach of a representation or warranty regarding specific loans. The evidence at trial was insufficient to trigger this duty, the Court explains, because it showed that, while BNYM may have had general information about defaulting loans, there was no evidence to show it knew of specific breaches of representations and warranties related to specific loans.

The Court similarly overrules Plaintiffs’ second assignment of error. Plaintiffs argued there was an event of default, because the master servicer was not providing complete mortgage files and that triggered BNYM’s duty to act prudently in protecting certificate holders. The Court disagrees, finding an event of default did not occur, because written notice of the incomplete mortgage files was not sent to the master servicer or BNYM. Absent an event of default, the Court concludes, BNYM’s duties were not elevated.