Ellington Credit Fund, Ltd. v. Select Portfolio Servicing, Inc., 08 Civ. 2437 (RJS).

CourtUnited States District Courts. 2nd Circuit. United States District Courts. 2nd Circuit. Southern District of New York
Writing for the CourtRICHARD J. SULLIVAN
Citation837 F.Supp.2d 162
PartiesELLINGTON CREDIT FUND, LTD., et al., Plaintiffs, v. SELECT PORTFOLIO SERVICING, INC., et al., Defendants.
Docket NumberNo. 08 Civ. 2437 (RJS).,08 Civ. 2437 (RJS).
Decision Date05 December 2011

837 F.Supp.2d 162

ELLINGTON CREDIT FUND, LTD., et al., Plaintiffs,

No. 08 Civ. 2437 (RJS).

United States District Court,
S.D. New York.

Dec. 5, 2011.

[837 F.Supp.2d 175]

Kell Corrigan Mercer, M. Daniel Guerra, and Stephen Wayne Lemmon of Brown McCarroll, LLP, Austin, TX, Patricia Baron Tomasco of Munsch Hardt Kopf & Harr, P.C., Austin, TX, and David J. Grais, Leanne Marie Wilson, and Owen L. Cyrulnik of Grais & Ellsworth, LLP, New York, NY, for Plaintiffs Ellington Credit Fund, Ltd and ECF Special Securities, LLC.

Elizabeth K. Duffy, Benjamin David Foster, C. Don Clayton, Joseph Nicholas Froehlich, and Thomas G. Yoxall of Locke Lord Bissell & Liddell, LLP, New York, NY, for Defendants Select Portfolio Servicing, Inc., Mountain West Reality Corp., Residential Real Estate Service, Inc., Alta Real Estate Services, Inc., Pelatis Insurance Agency Corp.

Amelia Berg, Paul S. Francis, and Marc Dennis Powers of Baker & Hostetler, New York, NY, for Defendant Manufacturers and Traders Trust Company.


RICHARD J. SULLIVAN, District Judge.

Plaintiffs Ellington Credit Fund, Ltd., and ECF Special Securities, LLC—two hedge funds that invested in a series of mortgage-backed securities—bring this diversity action against Defendants Manufacturers and Traders Trust Company (“M & T”), Select Portfolio Servicing, Inc. (“SPS”), and various affiliated entities of SPS (“SPS Affiliates”). Plaintiffs allege that Defendants breached various contractual, fiduciary, and common law obligations by mismanaging the mortgages held by the securitization trusts, engaging in self-dealing, and misrepresenting their deficient oversight of these assets. Before the Court are Defendants' motions to dismiss the First Amended Complaint pursuant to Rules 12(b)(1) and 12(b)(6) of the Federal Rules of Civil Procedure. For the reasons set forth below, the motions are granted in part and denied in part.

I. Background
A. Facts 1
1. The Securitizations

Beginning in 1997 and continuing through 1998, ContiFinancial Corporation, ContiWest Corporation, and their affiliates

[837 F.Supp.2d 176]

and subsidiaries (collectively “Conti”) sponsored a series of twenty-one real estate mortgage investment conduit (“REMIC”) securitization trusts. (FAC ¶¶ 13, 19.) A REMIC trust consists of a pool of mortgages—in this case, loans originated by Conti ( id., ¶ 12)—the beneficial ownership of which has been sold to various investors in the form of certificates representing their undivided ownership interest in the total pool. The purchasers of these certificates (referred to as “owners” or “certificateholders”) are entitled to a share of the principal and interest received by the trusts from the mortgage loans. ( Id. ¶¶ 12, 14.) The certificates in this case were structured in various classes of interests, ranging from senior certificates, which offered the highest priority of repayment, down to “residual” or “Class R” certificates, which were entitled to essentially any leftover proceeds, and were the first to absorb any losses from defaults on the underlying home mortgages. ( Id. ¶ 12.) Conti initially held the Class R certificates of the securitizations, but it declared bankruptcy in May 2000, and in December 2004, Plaintiffs acquired many of the Class R certificates from Conti's bankruptcy estate. ( Id. ¶ 58.)

Each trust was governed by a Pooling and Servicing Agreement (“PSA”) between Conti as Servicer (as well as other affiliates not relevant here) and M & T as Trustee.2 The PSA established the responsibilities of the Servicer, who was required to collect payments due under the loans, enforce the terms of the mortgages, maintain and market properties for foreclosure, and remit the loan payments and proceeds to the Trustee. (FAC ¶ 14.) Likewise, the PSA set out the duties of the Trustee, who was charged with holding the mortgages in trust for the benefit of the certificateholders and distributing the proceeds to them. ( Id.) Although the various certificateholders did not execute the PSA, it also set out their rights and powers and recognized them as the beneficiaries of the agreement. ( See PSA § 11.09.)

On May 17, 2000, following Conti's bankruptcy filing, SPS assumed Conti's servicing obligations subject to the PSA.3 (FAC ¶ 31.) On the same date, Conti, M & T, and MBIA Insurance Corporation—which insured the performance of certain categories of senior certificates—entered into a Side Servicing Agreement that amended ten of the twenty-one PSAs to include additional servicing standards. ( Id. ¶ 32 & n. 3.)

2. SPS's Misconduct

According to the Complaint, SPS subsequently engaged in various dishonest and illegal practices while servicing the mortgage loans. ( Id. ¶ 36.) Specifically, the Complaint alleges that SPS “manufactured defaults” in order to charge mortgage borrowers illegitimate fees for property inspections, home insurance policies, legal services, and late payments, among others. ( Id.) Pursuant to the PSA, the Servicer was responsible for initial payment of “all [of its] ‘out-of-pocket’ costs and expenses incurred in the performance of its servicing obligations,” referred to as “servicing advances.” (PSA § 8.09(b).) However, because SPS was entitled to reimbursement for its servicing advances from either (1) the monthly cash flow collected from the borrowers, or (2) the liquidation proceeds

[837 F.Supp.2d 177]

of a loan in foreclosure, SPS and its various “dummy subsidiaries” allegedly performed unnecessary or fictional services to inflate the fees and costs subject to reimbursement. (FAC ¶ 36.) These practices increased the amount of unpaid balances remaining on mortgage loans following foreclosure—called “deficiency balances”—and reduced the proceeds available to the trusts and certificateholders. ( Id. ¶¶ 36–37.)

In the fall of 2002, the Federal Trade Commission (“FTC”) began an investigation of SPS's servicing practices. ( Id. ¶ 43.) At the same time, mortgage loan borrowers brought several class actions against SPS that were consolidated into a single class action in Federal Court in the District of Massachusetts under the caption Curry v. Fairbanks Capital Corporation, No. 03–10895–DPW. ( Id.) The class actions alleged that SPS engaged in predatory practices, including failing to post payments, not accepting partial payments, improperly imposing force-placed insurance,4 and “placing borrowers in default based on manufactured circumstances.” ( Id.) In November 2003, SPS agreed to a consent judgment with the FTC and settled the Curry class action. ( Id. ¶ 44.) According to the Complaint, SPS was able to settle, in part, by voluntarily agreeing to curtail certain legitimate collection practices that were required by the PSA. ( Id. ¶ 45.) For example, SPS agreed not to foreclose on defaulted loans until 92 days after default, even though the Fannie Mae Guidelines, which were incorporated by reference in the PSA, instructed servicers to initiate foreclosure only 60 days after default. ( Id.) Plaintiffs claim that these settlements severely restricted SPS's ability to collect on the mortgages. As a result, collection rates plummeted, diminishing the assets of the securitizations. ( Id. ¶ 54.)

Plaintiffs further allege that SPS made fraudulent misrepresentations to induce them to exercise certain redemption rights, or “clean-up calls,” in three of the twenty-one trusts in 2005. ( Id. ¶¶ 58–60.) Under the PSA, Class R certificateholders were permitted to purchase all of the assets of a trust from the other classes of certificateholders and terminate the trust. ( Id. ¶ 58.) In exercising a clean-up call, however, Class R certificateholders were required to pay any unreimbursed, or “trapped,” servicing advances to the Servicer. ( Id.) Upon taking control of the mortgage loans following termination of the trusts, the certificateholders were free to appoint a different loan servicer or retain the existing servicer. ( Id.) In February 2005, Plaintiffs exercised the clean-up call provision for the 1998–2 and 1998–3 Trusts, and did the same in October 2005 for the 1997–3 Trust.5 ( Id. ¶ 60.) Thereafter, Plaintiffs paid SPS approximately $37 million for trapped servicing advances and then chose to retain SPS to continue servicing the loans. ( Id. ¶¶ 59–60, 134.) Plaintiffs were allegedly induced to make these clean-up calls by various false representations made by SPS regarding the legitimacy of its servicing advances and the potential recovery rates for outstanding deficiency balances on the loans. ( Id. ¶¶ 59–60, 133–135.) Subsequently, Plaintiffs learned that many of the deficiency

[837 F.Supp.2d 178]

balances on the loans were uncollectible from the mortgage borrowers, allegedly as a result of SPS's neglect and poor servicing practices. ( Id. ¶ 63.)

3. The SPS Affiliates' Misconduct

Defendants Mountain West Realty Corporation (“Mountain West”), Residential Real Estate Services, Inc. (“Residential”), Alta Real Estate Services, Inc. (“Alta”), and Pelatis Insurance Agency Corporation (“Pelatis”) (collectively, the “SPS Affiliates”) are all companies organized and controlled by SPS, based out of SPS's office in Salt Lake City, Utah, that were allegedly complicit in SPS's wrongful conduct. ( Id. ¶¶ 6–9, 38–42, 64–91.) According to the Complaint, the SPS Affiliates participated in schemes with SPS to charge unearned fees to the securitizations and homeowners, but performed no actual services that can be verified or valued. ( Id. ¶ 39.)

For example, Plaintiffs allege that SPS required real estate brokers responsible for selling the trusts' foreclosed properties to pay 25% of their sales commission to either SPS or Mountain West as a referral fee, despite the fact that Mountain West performed little or no work in connection with the sales. ( Id. ¶¶ 39 & n. 4, 67) Similarly, the Complaint alleges that SPS and Pelatis engaged in a scheme that funneled commissions for mandatory lender-placed home insurance to...

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