Lasalle Bank Nat. Ass'n v. Nomura Asset Capital

• Decision Date: 14 September 2005
• Docket Number: Docket No. 04-5488-CV.
• Citation: 424 F.3d 195
• Parties: LaSALLE BANK NATIONAL ASSOCIATION, as Trustee for Certificate-holders of Asset Securitization Corporation Commercial Mortgage Pass-Through Certificates, Series 1997-D5 by and through Lend Lease Asset Management, L.P., (Successor in Interest to Ameresco Management, Inc.), formerly known as LaSalle National Bank, Plaintiff-Appellant, v. NOMURA ASSET CAPITAL CORPORATION and Asset Securitization Corporation, Defendants-Appellees.
• Court: U.S. Court of Appeals — Second Circuit

424 F.3d 195

LaSALLE BANK NATIONAL ASSOCIATION, as Trustee for Certificate-holders of Asset Securitization Corporation Commercial Mortgage Pass-Through Certificates, Series 1997-D5 by and through Lend Lease Asset Management, L.P., (Successor in Interest to Ameresco Management, Inc.), formerly known as LaSalle National Bank, Plaintiff-Appellant, v. NOMURA ASSET CAPITAL CORPORATION and Asset Securitization Corporation, Defendants-Appellees.

Docket No. 04-5488-CV.

United States Court of Appeals, Second Circuit.

Argued: June 9, 2005.

Decided: September 14, 2005.

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Gregory G. Garre, Hogan & Hartson LLP, Washington, DC (Ira M. Feinberg, Hogan & Hartson LLP, New York, NY, Lorane F. Hebert, Hogan & Hartson LLP, Washington, D.C., Gary Cruciani, David Sochia, McKool Smith, PC, Dallas, TX, of counsel), for Plaintiff-Appellant.

Daniel C. Malone, Dechert LLP, New York, N.Y. (Nory Miller, Dechert LLP, Philadelphia, PA, James E. Tolan, Dechert LLP, New York, NY, of counsel), for Defendants-Appellees.

Before: JACOBS, SACK, and RAGGI, Circuit Judges.

SACK, Circuit Judge.

This appeal¹ turns in large part on the meaning of several standard warranties contained in contracts for the sale and securitization of commercial mortgage loans. Plaintiff LaSalle Bank National Association ("LaSalle") brought this action in its capacity as trustee of a $1.8 billion fund of pooled mortgage loans on behalf of investors holding bonds representing interests in the fund. LaSalle alleges that defendant Nomura Asset Capital Corp. ("Nomura"), which originated or purchased from other originators each of the 156 mortgage loans in the fund, breached several warranties concerning the nature and issuance of those loans that are contained in a contract governing the sale of the mortgages to a Nomura affiliate, the Asset Securitization Corp. ("ASC"). LaSalle further alleges that ASC breached warranties contained in a second contract governing the mortgages' securitization, in which it provides assurances regarding the nature of the loans and the truth and accuracy of Nomura's representations under the contract between Nomura and ASC.

The district court (Naomi Reice Buchwald, Judge), rejecting LaSalle's claims, denied its motion for summary judgment, and granted the defendants' cross-motion for summary judgment. LaSalle Bank Nat'l Ass'n v. Nomura Asset Capital Corp., No. 00 Civ. 8720, 2004 WL 2072501, at *1, 2004 U.S. Dist. LEXIS 18599, at *1 (S.D.N.Y. Sept. 14, 2004). Analyzing the two contracts together, the court concluded that one of the warranties contained in the first contract — the so-called "eighty percent" warranty assuring, inter alia, that the fair market value of the real property securing each loan "was at least equal to 80% of the principal amount" of the loan — had "no greater effect" than another of the warranties in that contract — the so-called "qualified mortgage" warranty assuring that each loan qualified for special tax treatment because, under Treasury Department regulations, it was "principally secured by an interest in real property." LaSalle, 2004 WL 2072501 at *6, *8. The court determined that the defendants had, in turn, satisfied the qualified mortgage warranty by virtue of a "safe harbor" provision in the applicable Treasury regulations because they "reasonabl[y] believ[ed]" that the loans were eighty percent secured by real property. Id. at *8. And the court concluded that even if the defendants were not protected by the safe harbor provision, they "cure[d]" any breach by providing the plaintiff with a legal opinion letter affirming that the qualified mortgage warranty had been satisfied. Id. at *8 n. 12. The court also rejected the plaintiff's contention that the defendants violated a separate "underwriting" or "origination" warranty providing that the loans were issued "in accordance with customary industry standards." Id. at *10.

We agree with the district court that even viewed in the light most favorable to the plaintiff, the evidence is insufficient to establish that the defendants breached the origination warranty. We disagree, however, with the court's conclusion that the eighty percent warranty and the qualified mortgage warranty were redundant. We also do not think that the safe harbor provision — the application of which was precluded by the terms of the mortgage sale contract, and which, in any event, does not apply to mortgage originators — covered, and therefore protected the defendants, or that the defendants properly cured any breach. Accordingly, we affirm the judgment of the district court with respect to the origination warranty but vacate the judgment with respect to the defendants' satisfaction of the eighty percent warranty and the qualified mortgage warranty, and remand the case for further proceedings.

BACKGROUND

Although this dispute implicates the multi-billion dollar market for a complex and often risky class of investments known as commercial mortgage-backed securities, it revolves around a single, ill-fated mortgage on a now-defunct Chicago-area hospital. The $50 million loan, issued on August 28, 1997, to an entity called HPCH, LLC (the "Doctors Hospital Loan"), was secured, at least in part, by the hospital's aging building and surrounding land. The building and land were, in turn, leased to Doctors Hospital of Hyde Park, Inc. ("DHHP" or "Doctors Hospital"), a company controlled by Dr. James Desnick, a local ophthalmologist and businessman² who also controlled HPCH. The Doctors Hospital Loan was underwritten by Nomura, a major participant in the mortgage-backed securities market, which in October 1997 sold it, along with 155 other commercial mortgages, to an affiliate, ASC.³ ASC, in turn, packaged the mortgages into a single, $1.8 billion fund, the Series 1997-D5 Trust (the "D5 Trust"), appointed LaSalle as the fund's trustee, and sold stakes in the fund to investors. It is these stakes — the "bonds" or "certificates" — that are ordinarily referred to as commercial mortgage-backed securities ("CMBS").

In April 2000, less than three years after the creation of the D5 Trust and the issuance of the related bonds, Doctors Hospital closed its doors and filed for Chapter 11 bankruptcy protection. The following month, the bankruptcy court in which the case was pending authorized the hospital to reject the unexpired portion of its lease on the hospital property, and in June 2000, HPCH defaulted on the loan. The bankruptcy and subsequent default precipitated a flurry of recriminations among the parties to the D5 transaction including, on the one side, LaSalle and the holders of the D5 bonds, and on the other, Nomura and ASC. These disputes ultimately led to the filing of the instant lawsuit.

Underlying this suit are two contracts: the Mortgage Loan Purchase and Sale Agreement ("MLPSA") between Nomura and ASC, and the Pooling and Servicing Agreement ("PSA") among ASC, LaSalle, and several other entities hired to service the mortgages in the D5 Trust. We examine the relevant provisions of each of those contracts in turn. We begin, however, with a brief review of some of the actions Nomura took before issuing the Doctors Hospital Loan and selling it to ASC for inclusion in the D5 Trust.

The Doctors Hospital Loan

Nomura completed the Doctors Hospital Loan after obtaining a third-party appraisal of "the market value of the going-concern known as Doctor's [sic] Hospital of Hyde Park, as of August 1, 1997." See Letter from David S. Felsenthal, Managing Director, Valuation Counselors, to Geoff Smith, Analyst, Nomura Commercial Real Estate Finance 2 (Aug. 28, 1997). The appraisal employed three "valuation approaches." See Valuation Counselors, An Appraisal of Doctor's Hosp. of Hyde Park Chicago, Ill. for Nomura Commercial Real Estate Finance as of Aug. 1, 1997, at 42 (Aug. 28, 1997) ("Valuation Counselors appraisal" or "the appraisal"). Under the "cost approach," which assesses "the market value of the land, as vacant, to which the depreciated replacement cost of the improvements and equipment is added," the appraisal estimated the hospital's value at $40.6 million. Id. at 43, 57. Under the "sales comparison" approach, which represents "the cost of acquiring an equally desirable substitute property," the appraisal placed the hospital's value at $64 million. Id. at 42, 70. And under the "income capitalization approach," which "convert[s] anticipated benefits, i.e., cash flows and reversions, into property value," the appraisal determined the hospital's value to be $68 million. Id. at 42, 91. The appraisal concluded that "buyers of this property type typically do not rely upon the Cost Approach when making purchase decisions," but that the approach can nonetheless be "useful for allocation purposes." Id. at 92. At the same time, it reported that "buyers of hospitals typically base their purchase decisions on the facility's ability to generate cash flow and income," such that the income capitalization approach offered "the best indicator of value" for the Doctors Hospital property. Id. at 93. Accordingly, the appraisal concluded that the "market value" of the property, including land, improvements, equipment, and intangibles, was $68 million. Id. The appraisal allocated $3 million of this amount to the hospital's "land," approximately $28 million to building and site "improvements," and the rest to "equipment" and "intangibles." Id.

In addition to obtaining the appraisal, Nomura retained the accounting firm then known as Coopers & Lybrand L.L.P. to evaluate regulatory issues confronting the hospital as well as its cash flow prospects. The accounting firm's report, dated September 1997, purported "not [to] indicate in any way projected financial results of DHHP or the financial feasibility of the transaction upon the Borrower," but nonetheless concluded that "[i]f DHHP is able to achieve profit margins that yield results similar to the adjusted...