As we explained in our case summary, the question in this case was whether the trustee of a residential mortgage-backed security (RMBS) trust can bypass a contractual “sole-remedy” clause by showing that the RMBS sponsor was grossly negligent. The Court (Fahey, J.) held that it could not and that the sole-remedy clause at issue in this case barred the trustees’ claims. Judge Rivera dissented; Chief Judge DiFiore and Judge Garcia recused.
RMBS deals typically involve a sole-remedy provision limiting the options available to an investor (or the deal trustee) in the event of an alleged contract breach. Those sole-remedy provisions typically provide that, in the event that there is a breach of the warranties or representations about any loan in the RMBS mortgage pool, the sole remedy available is to direct the sponsor cure the breach or repurchase the noncompliant loan.
The RMBS deal in this case involved one of these sole-remedy provisions, and the trustee sought to avoid it and sue for contract damages instead, as well as punitive damages and attorneys’ fees. The trustee alleged widespread loan-level breaches throughout the pool that were the result, it alleged, of gross negligence by the deal’s sponsor. The trustee argued that the cure-or-repurchase remedy would be ineffectual under the circumstances, and the sole-remedy clause should be void pursuant to the public policy against allowing a party to exculpate its liability for gross negligence. The First Department agreed with the trustee and refused to dismiss the action, holding that discovery was required to ascertain whether the sole-remedy clause was ineffectual and thus unenforceable.
The Court of Appeals reversed. First, the majority held that the public policy rule prohibiting parties from immunizing themselves from liability for their own gross negligence applied only to “exculpatory or nominal damages clauses.” The gross-negligence rule, the majority explained, did not apply to contract provisions that merely restricted “the remedies available to the non-breaching party.” This limitation on “the scope of the gross negligence public policy exception to exculpatory and nominal damages clauses,” however, was applicable only in “pure breach of contract” cases and only ones “where a defendant’s conduct does not give rise to separate liability in tort.”
Next, the majority held that the sole-remedy provision at issue in this case was not an exculpatory or nominal damages clause that would trigger the gross-negligence rule. On this point, the majority acknowledged that it was an open question whether contract damages would be available for a party whose sole remedies were impossible. But defendant had conceded that contract damages would be available under those circumstances. And defendant had also conceded that it would be liable for the repurchase price of a loan, even if repurchase was impossible. In the majority’s view, these concessions meant that the sole-remedy provision in this case “cannot be said to be exculpatory or illusory.”
The majority also held that, “as a general matter,” a sole-remedy provision is not intended to operate as an exculpatory clause. This finding was necessary, the majority explained, to prevent that question from having to “depend upon a legal ruling this Court may make in some unrelated litigation at some unspecified point in the future.” Such uncertainty would “leave RMBS litigation in limbo indefinitely” and would be “destabilizing to the uniformity and predictability” of New York contract law.
Finally, the majority dismissed the trustee’s claim for punitive damages and attorneys’ fees. Punitive damages were not available, the majority explained, because the trustee alleged contract breaches, not independently tortious conduct. And there was no “unmistakably clear” contract language in the deal documents requiring the parties to pay attorneys’ fees.
The dissent disagreed with the majority on nearly every point (they agreed about attorneys’ fees). For one, the dissent would have applied the gross-negligence rule outside the context of exculpatory and nominal damages clauses. The policy justifying the exception, the dissent explained, fully justified applying it where parties agree to damages that are not nominal, but nevertheless “fail to compensate for gross negligence.” And even if the gross-negligence rule was limited in pure contract cases, the dissent did not agree that this was a pure contract case: in the dissent’s view, the trustee’s claims implicated the sponsor’s independent tort duty of care to the investing public that separately warranted limiting the sponsor’s ability to insulate itself from liability for its own gross negligence. And for the dissent, this independent tort duty would also have justified the trustee’s claim for punitive damages.