Secondary Loan Market Reassured by Recent Ruling of New York's Highest Court

A recent decision from New York's highest court will have a significant impact on both investors and institutions facing litigation stemming from the commercial mortgaged-backed securities market and should provide assurances to purchasers in the distressed debt and secondary loan market. The case, Trust for the Certificate Holders of the Merrill Lynch Mortgage Investors, Inc. Mortgage Pass-Through Certificates v. Love Funding Corp. ("Love Funding"),¹ addresses rights under a New York law that codifies an "ancient and medieval..."² English law called champerty.

Under New York Judiciary Law § 489(1) no person or entity shall "solicit, buy or take an assignment of ... any claim or demand, with the intent and for the purpose of bringing an action or proceeding thereon." At its inception, champerty was used to prevent lawyers from filing suit or trading causes of action merely for the purpose of generating fees and costs for themselves by litigating those claims. More recently, champerty has been asserted as a defense to litigation brought by purchasers of debt who seek to enforce the underlying loan agreements and guarantees or who seek enforcement against loan originators for representations made under their loan purchase and sale agreements.

Specifically, the dispute in Love Funding centered on a discovery by a trust for Merrill Lynch investors (the "Trust") which held a securitized pool mortgage loans. When the Trust discovered that there were problems with several of the loans in the pool, the Trust sued UBS AG, successor in interest to Paine Webber, which had securitized the loans. UBS AG and the Trust settled their dispute concerning all but one of the loans. As part of the settlement agreement, UBS AG agreed to assign its right to seek indemnification from Love Funding Corp., the originator and assignor of the loan. The Trust then sued Love Funding Corp. in the Southern District of New York for breach of representations made in the mortgage loan purchase agreement and recovery of the loan balance. The district court held that because the primary purpose of UBS AG's assignment was to allow the Trust to litigate the claim against Love Funding Corp. for recovery of the loan, the suit was in violation of New York's law prohibiting champerty. The Trust appealed the decision to the Second Circuit Court of Appeals which referred the issue to the New York Court of Appeals, the state's highest court. The New York Court of Appeals has clarified New York's champerty law, limiting its application and avoiding certain chaos in New York's secondary debt market.

The New York Court of Appeals held that since the Trust held a pre-existing proprietary interest in the loan, meaning that the Trust would "directly suffer the damages of any default on that loan," the Trust's pursuit of its claim against Love Funding Corp. did not violate New York's champerty law. The Court clarified the law saying "the champerty statute does not apply when the purpose of an assignment is the collection of a legitimate claim. What the statute prohibits...is the purchase of claims with the intent and for the purpose of bringing an action that...may involve parties in costs and annoyance, where such claims would not be prosecuted if not stirred up...in [an] effort to secure costs."³

Significantly, the holding in Love Funding provides a requisite amount of certainty and stability to investors, financial services firms and institutions trading in and dealing with assigned debt and mortgage-backed securities under New York law. The Court was careful to limit the scope of New York's champerty law to its historical confines, which in turn will allow the secondary debt market to continue to function with liquidity and reason.

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¹ -- N.E.2d --, 2009 WL 3294928 (Oct. 15, 2009 N.Y.), 2009 N.Y. Slip Op. 07323.
² Id . at *7 (internal citations omitted).
³Love Funding, 2009 WL 3294928 at *12 (internal citations omitted).