Cent. Mortgage Co. v. Morgan Stanley Mortgage Capital Holdings Llc As Successor-In-Interest To Morgan Stanley Mortgage Capital Inc.

• Decision Date: 18 August 2011
• Docket Number: No. 595,2010.,595
• Citation: 27 A.3d 531
• Parties: CENTRAL MORTGAGE COMPANY, Plaintiff Below Appellant,v.MORGAN STANLEY MORTGAGE CAPITAL HOLDINGS LLC as Successor-in-interest to Morgan Stanley Mortgage Capital, Inc., Defendant Below Appellee.
• Court: Supreme Court of Delaware

27 A.3d 531

CENTRAL MORTGAGE COMPANY, Plaintiff Below Appellant,

v.MORGAN STANLEY MORTGAGE CAPITAL HOLDINGS LLC as Successor-in-interest to Morgan Stanley Mortgage Capital, Inc., Defendant Below Appellee.

No. 595

2010.

Supreme Court of Delaware.

Submitted: May 25, 2011.Decided: Aug. 18, 2011.

Court Below Court of Chancery of the State of Delaware, C.A. No. 5140.Upon appeal from the Court of Chancery. REVERSED and REMANDED.R. Judson Scaggs, Jr. and John Eakins, Morris, Nichols, Arsht & Tunnell LLP, Wilmington, Delaware. Of Counsel: Nicholas J. Boyle (argued), Richard Olderman and Daniel M. Dockery, Williams & Connolly LLP, Washington, DC for appellant.Steven J. Fineman and Rudolf Koch, Richards, Layton & Finger, P.A., Wilmington, Delaware. Of Counsel: Jeffrey Q. Smith (argued), Laila Abou–Rahme, and Cynthia A. Hanawalt, Bingham McCutchen LLP, New York, N.Y. for appellee.Before STEELE, Chief Justice, HOLLAND, BERGER, JACOBS and RIDGELY, Justices constituting the Court en Banc.STEELE, Chief Justice:

Central Mortgage Company sued Morgan Stanley after mortgages for which CMC purchased servicing rights from Morgan Stanley began to fall delinquent during the early financial crisis in 2007. CMC made a variety of claims, and the Vice Chancellor ¹ dismissed all of those claims with prejudice, except for its breach of contract claims which he dismissed without prejudice. CMC now appeals the dismissal of its breach of contract and implied covenant of good faith and fair dealing claims. We reverse.

I. FACTS AND PROCEDURAL HISTORY

Morgan Stanley is in the business of purchasing residential mortgage loans from originators, pooling them, and selling these pools to investors either securitized or in bulk. It regularly sells servicing rights for these loans to third party servicers. Loan servicers generally handle the operational aspects of mortgage lending, which include billing, collecting payments from mortgagors, and remitting payments to mortgagees. Generally, servicers retain a small percentage of payments collected as compensation. CMC is a servicer of residential mortgage loans.

In March 2005, Morgan Stanley offered about $1 billion in mortgage servicing rights for a servicer to purchase on a regular basis in the forthcoming months and years. These rights pertained to pooled mortgage loans that Morgan Stanley planned to sell to both Fannie Mae and Freddie Mac (collectively, the Agencies) as well as private investors. The offering materials explained that Morgan Stanley did not originate the loans and that all the loans were “Alt–A” in quality—lower quality than prime loans, but higher quality than subprime loans. CMC bid on the servicing rights, and Morgan Stanley accepted CMC's bid in July 2005.

On July 25, 2005, Morgan Stanley and CMC signed a Master Agreement which, in 66 pages and 15 exhibits, established the framework for a series of future transactions between the parties. Specifically, the Master Agreement gave CMC the opportunity, but not the obligation, to purchase servicing rights on specific pools of loans. In the Master Agreement, the parties agreed that New York law would govern the contract and Delaware courts would have exclusive jurisdiction over disputes.

If CMC decided to buy servicing rights with respect to loans Morgan Stanley sold to the Agencies, the Master Agreement required CMC to service those loans in strict compliance with Agency guidelines. The Master Agreement contained an integration clause specifying that it, along with the documents for each future transaction between the parties, constituted the parties' entire agreement. The Master Agreement also provided that the parties could only amend it in a signed writing. In the Master Agreement, Morgan Stanley made representations and warranties to CMC, and it assigned to CMC all representations and warranties that the originators of the subject loans had made to Morgan Stanley. The Master Agreement also provided a notice provision in section 10.13. Specifically, the notice provision provided:

Upon discovery by either [Morgan Stanley] or [CMC] of a breach of any of the foregoing representations and warranties, the party discovering such breach shall give prompt written notice to the other party. Within 60 days of the earlier of either discovery by or notice to [Morgan Stanley] of any such breach of a representation or warrant which materially and adversely affects the ownership interest of [CMC] in the Servicing Rights related to any Mortgage Loan, [Morgan Stanley] shall use its best efforts to promptly cure such breach in all material respects and, if such breach cannot be cured, [Morgan Stanley] shall, at [CMC's] option, repurchase the Servicing Rights affected by such breach at the Purchase Price.

The Master Agreement also contained a clause explaining that except as otherwise set forth, no remedy was exclusive of any other available remedy. Finally, the Master Agreement contained a clause explaining that the parties could only waive a breach with written notice and the consent of all parties.

In February 2006, CMC visited Morgan Stanley's due diligence facilities. CMC alleges that during this visit Morgan Stanley assured CMC that it was performing due diligence on residential mortgage loans in accordance with the Agencies' guidelines. Importantly, Morgan Stanley told CMC that the Agencies will not purchase loans from Morgan Stanley or other sellers unless the Agencies have reviewed and approved the underwriting criteria and the available information on the loans. Because the Agencies review and approve Morgan Stanley's underwriting guidelines before purchasing its loans, the Agencies issue guidance regarding their underwriting expectations. Allegedly, Morgan Stanley took great pains during CMC's visit to convince CMC that it paid close attention to this Agency guidance.

On March 16, 2006, CMC made its first purchase of servicing rights on pooled loans Morgan Stanley sold to the Agencies. CMC then made five separate additional purchases of servicing rights between January 31, 2007 and August 2007 for pooled loans Morgan Stanley sold to the Agencies. For each of the six separate purchase transactions, CMC and Morgan Stanley signed transaction specific documentation, which included a commitment letter, a purchase agreement, a sale of servicing rights agreement, and a “Form 981” or “Form 629” (together, the Agency Transfer Agreements) regarding the transfer of the servicing rights.² The Agency Transfer Agreements provided that CMC, as transferee of the servicing rights, “acknowledge[d], covenant[ed] and warrant [ed] that it shall be responsible for all representations, covenants, and warranties concerning the eligibility of Mortgages for purchase by” the relevant Agency as provided in that Agency's guidelines. Under these Agency Transfer Agreements and Agency guidelines, Morgan Stanley and CMC became jointly and severally liable to the Agencies for all the responsibilities, duties, and selling warranties associated with the mortgages.

In early 2007, CMC began to notice that the loans it had purchased from Morgan Stanley were not performing at the level the parties had expected. CMC raised this concern with Morgan Stanley, and in response, Morgan Stanley allegedly admitted to a technical oversight and its failure to properly diligence the loans at issue. Morgan Stanley agreed to reduce the price of the servicing rights by 2% and to otherwise “take care” of CMC. The parties also negotiated a written amendment to the Master Agreement, which the parties signed and dated retroactively to apply from January 2007 forward. The amendment required Morgan Stanley to repurchase servicing rights at CMC's option for any mortgage loans that, starting in January 2007, fell delinquent by 90 or more days within the first 12 months after their sale date. Also, in that amendment, CMC and Morgan Stanley “in all respects ratified and confirmed” all the other terms, provisions, and conditions of the Master Agreement.

In early 2008, the Agencies began sending repurchase and make whole demands to CMC, as servicer of the loans, because many of the mortgages allegedly did not satisfy Agency guidelines. The Agency Transfer Agreements obligated CMC either to repurchase the loans or to pay the make whole amounts. Initially, CMC merely forwarded the repurchase or make whole requests to Morgan Stanley, which then either repurchased the loans from CMC or reimbursed CMC for make whole payments 47 times in 2008 and early 2009.

At some point, Morgan Stanley stopped repurchasing from, and reimbursing, CMC. CMC alleges that it gave Morgan Stanley notice that Morgan Stanley had breached its agreements with CMC by failing to take back the loans the Agencies had returned to CMC but that Morgan Stanley declined to cure. Instead, CMC itself either repurchased the loans from the Agencies or paid make whole payments with respect to about 50 loans after March 2009 that Morgan Stanley did not repurchase or reimburse. When CMC filed this Court of Chancery action on December 14, 2009, 140 additional Agency repurchase or reimbursement demands were pending.

In its complaint, CMC asserted 10 claims for relief against Morgan Stanley. Specifically, CMC claimed that Morgan Stanley breached the Master Agreement, breached the representations and warranties it made in the Master Agreement and the other transaction specific documents, repudiated the Master Agreement, breached the implied covenant of good faith and fair dealing, unjustly enriched itself, has an implied duty to indemnify CMC requiring it to reimburse CMC for repurchases and make whole payments, and negligently misrepresented the characteristics of the loans it sold the Agencies. CMC also argued that the court should rescind the Master Agreement because of CMC's unilateral mistake regarding the nature of the loans for which CMC purchased servicing rights. Finally, CMC alleged that Morgan Stanley should be...