April 6, 2018
This decision by the New York Supreme Court, Appellate Division, First Department,1 provides guidance on the interpretation of “no action” provisions in a pooling and servicing agreement (“PSA”) underlying the issuance of asset-backed certificates. (A copy of the decision is accessible here.) It emphasizes the importance of holder strict compliance with the pre-conditions to suing under a “no action” clause, and, particularly, providing proper notice of default before demand is made on the trustee to sue.
The plaintiff owned more than 25% of a class of certificates issued by the relevant trust. Its complaint alleged that the Master Servicer and the Special Servicer had obtained only one appraisal for a defaulted mortgage loan, which reflected a value less than the amount outstanding on the loan secured by the mortgage. They then permitted the trust to sell the loan and mortgage in a way that realized even less than the appraised value. But within weeks of the sale, the property owner refinanced the property for substantially more than the amount outstanding on the mortgage loan, allegedly resulting in a loss to the trust of at least $16.5 million.
The plaintiff sent a letter to the trustee under the PSA notifying the trustee that the Master Servicer and Special Servicer had breached their duties under the PSA, outlining the foregoing facts, and demanding that the trustee commence an action against them, for which it offered indemnity. The trustee declined to sue, and, after sixty days, the certificate holder commenced its derivative action against the two servicers.
The servicer defendants moved to dismiss on the ground that the certificate holder lacked standing to sue due to its non-compliance with the “no action” clause of the PSA. That clause permitted an action by a certificate holder only if four preconditions were met: (1) the plaintiff must have provided the “Trustee and the Paying Agent a written notice of default hereunder, and of the continuance thereof, as herein before provided”; (2) plaintiff must have been a holder of at least 25% of a class of certificates: (3) plaintiff must have made a written request of the trustee to institute an action and must have offered the trustee reasonable indemnity against the cost and expense to be incurred in pursuing the action; and (4) prior to plaintiff's institution of suit, 60 days must have passed during which the trustee has refused to institute such an action.
The trial court granted the motion to dismiss with prejudice. On appeal, the Appellate Division affirmed. There was no question that the plaintiff had satisfied the last three of the four preconditions of the “no action” clause. The only question was whether it had satisfied the first condition of having provided the trustee and paying agent with “written notice of default hereunder... as herein before provided”. The defendants asserted that this condition had not been satisfied because the phrase “default hereunder … as herein before provided” necessarily referred to an “Event of Default” defined under the “Default” section of the PSA. Under that section, “Event of Default” was defined to include a number of defaults by various parties and included any “failure on the part of the Master Servicer or Special Servicer …duly to observe or perform in any material respect any of its … covenants or obligations contained in this Agreement which continues unremedied for a period of 30 days … after the date on which written notice of such failure, requiring the same to be remedied shall have been given… to [such servicer].” Although the complaint set out that the plaintiff, in the demand to sue, had notified the trustee of the alleged “failures” by the servicers, the complaint did not allege that a 30 day notice of failure had ever been given to either servicer, and there was no evidence in the record of any such 30 day notice having been given to the servicers. It did not appear that the servicers had even been copied on the letter to the trustee and paying agent demanding suit.
On appeal, the parties argued as to whether the reference in the “no action” section to a “default” was a reference to an “Event of Default” as defined in the PSA and whether the “no action” provision was ambiguous on the point. The parties also addressed a number of cases in New York and other jurisdictions dealing with the meaning of the terms “default” and “Event of Default”.
Ultimately, the Appellate Division concluded as a matter of law that the only thing the phrase “default hereunder … as herein before provided” could have referred to was an “Event of Default” as defined in the PSA. The alleged failures of the servicers here would only become an “Event of Default” if they continued unremedied for 30 days after notice of such failures had been given to such servicers. In effect, the Appellate Division found that the reference to a “default hereunder … as herein before provided” was to the occurrence of an “Event of Default” rather than to the underlying action or failure of the servicers which would become an actionable “Event of Default” only after notice and failure to cure. Since no “Event of Default” had occurred due to the certificate holder’s failure to send the 30 day notice to the servicers, the trustee had no basis for suit, and the precondition for the certificate holder to sue had not been satisfied.
1Alden Global Value Recovery Master Fund, L.P. v. KeyBank, N.A., 2018 NY Slip Op 02241 (1st Dep’t 2018).