Nomura Asset Capital Corp. v. Cadwalader, Wickersham & Taft LLP

• Decision Date: 22 October 2015
• Docket Number: No. 122.,122.
• Citation: 2015 N.Y. Slip Op. 07693,19 N.Y.S.3d 488,26 N.Y.3d 40,41 N.E.3d 353
• Parties: NOMURA ASSET CAPITAL CORPORATION et al., Respondents–Appellants, v. CADWALADER, WICKERSHAM & TAFT LLP, Appellant–Respondent.
• Court: New York Court of Appeals Court of Appeals

26 N.Y.3d 40

41 N.E.3d 353

19 N.Y.S.3d 488

2015 N.Y. Slip Op. 07693

NOMURA ASSET CAPITAL CORPORATION et al., Respondents–Appellants

v.CADWALADER, WICKERSHAM & TAFT LLP, Appellant–Respondent.

No. 122.

Court of Appeals of New York.

Oct. 22, 2015.

Cravath, Swaine & Moore, LLP, New York City (David R. Marriott of counsel), for appellant-respondent.

Hinman Straub P.C., Albany (James T. Potter of counsel), and Constantine Cannon LLP, New York City (Amianna Stovall and Joel A. Chernov of counsel), for respondents-appellants.

OPINION OF THE COURT

RIVERA

, J.

On these cross appeals from an order granting partial summary judgment in a legal malpractice action, we conclude that no triable issues of fact exist with respect to the first cause of action, which alleges that counsel failed to properly advise and conduct requisite due diligence in a mortgage securitization matter. Therefore, we modify the Appellate Division order, grant summary judgment to dismiss the first cause of action in its entirety, and otherwise affirm.

I.

At times relevant to this appeal, plaintiffs, Nomura Asset Capital Corporation and Asset Securitization Corporation (Nomura), and defendant, the law firm of Cadwalader, Wickersham & Taft LLP, were working in the mortgage securitization field. In this industry, an investment bank sources and funds mortgages on properties with the objective of aggregating the mortgages into securitization pools. The loans are then sold to a trust, which issues securities in the form of certificates to investors. The certificates entitle the holders to a portion of the revenue stream produced by payments made by the mortgage borrowers.¹

Nomura established a commercial mortgage-backed securities business,² and engaged Cadwalader to advise and confirm that Nomura's securitized commercial mortgage loans qualified

as real estate mortgage investment conduit (REMIC) trusts.³ Over the course of several years, Cadwalader's work on Nomura REMIC securitizations garnered immense profits for Nomura and significant legal fees for Cadwalader. However, the professional relationship soured when a 1997 REMIC securitization, known as the series 1997–D5 securitization (D5 securitization), embroiled Nomura in federal litigation and demands for a buyback of a defaulted loan. In an attempt to recoup its losses associated with the federal lawsuit, Nomura commenced the underlying legal malpractice action against Cadwalader, alleging that Cadwalader failed to provide appropriate legal advice and perform necessary due diligence concerning the REMIC eligibility of the D5 securitization.

Now, almost two decades since the events leading to the original securitization, and almost 10 years since Nomura filed this action, the case has reached this Court, and we are presented with the question whether Cadwalader is entitled to summary judgment as to all or part of the first cause of action. For the reasons set forth below, we conclude that Cadwalader has established, as a matter of law, that summary judgment and dismissal of the legal malpractice cause of action are merited in this case.

II.

We begin our analysis with a discussion of the relevant legal requirements for REMIC qualification of the D5 securitization, and the events leading up to Cadwalader's opinion as to the REMIC eligibility of the mortgage loan at the center of the parties' dispute. The D5 securitization consists of 156 loans, secured by first liens on 220 commercial and multifamily properties. For these mortgage loans to be pooled in a REMIC-qualified trust they had to be in compliance with certain federal Internal Revenue Code requirements, including that substantially all of the assets be “qualified mortgages and permitted investments” within the meaning of the Code (26 USC § 860D

[a][4] ).

Under the Internal Revenue Code, a “qualified mortgage” is “principally secured by an interest in real property” (26 USC § 860G

[a][3][A] ), which in accordance with federal tax regulations,

requires that “the fair market value of the interest in real property securing” the mortgage is “at least equal to 80 percent of the adjusted issue price” of the loan, as of the loan origination date or when the REMIC sponsor contributes the loan to the trust (26 CFR 1.860G–2

[a][1][i]; [5] ). This is known as the “80% test.”

Although pursuant to the federal regulations the 80% test is based on a value-to-loan ratio (VTL) (see 26 CFR 1.860G–2

[a][1][i]; [5] ), the parties agree that mortgage lenders, such as Nomura, typically utilize a loan-to-value ratio (LTV) for underwriting purposes, and that Nomura understood that an 80% VTL is equal to a 125% LTV.⁴ However, the LTV is based on the overall value of property, whereas the regulations define REMIC real property as “land or improvements thereon, such as buildings or other inherently permanent structures” (26 CFR 1.856–3 [d] ). It does not include personal property (id. ).

One of the mortgages included in the D5 trust was a $50 million loan secured by the Doctor's Hospital of Hyde Park (hospital), an acute care facility located in Chicago. In order to be REMIC-qualified and in compliance with the warranties set forth in the pooling service agreement (PSA) and mortgage loan purchase and sale agreement (MLPSA), the real property value for the hospital had to be appraised at a minimum of $40 million.⁵ Nomura's appraiser estimated the hospital property's market value at $68 million, based on a valuation of $3 million for the land, $27,960,000 for improvements, $9,640,000 for equipment, and $27,400,000 for intangibles. Although not set forth in the appraisal, a property valued at $68 million with a $50 million mortgage has an LTV of 73%, and therefore appears to be REMIC-qualified.

The final appraisal was determined after a reconciliation of three valuation approaches: “income capitalization,” “sales comparison,” and “cost.” The “income capitalization approach” resulted in an estimated valuation of the hospital property at $68 million, based on a 21.5% capitalization rate of the

hospital's net operating income ($14,547,499), determined by gross annual income, minus operating expenses. The “sales comparison” resulted in an estimated value of $64 million, based on the cost of acquiring an equally desirable substitute property. The “cost approach” estimated the property at $40.6 million, based on the value of the land as vacant ($3 million), replacement costs of buildings ($27,761,163), and depreciation of improvements and equipment ($180,000 and $9,640,000, respectively).

The appraisal lacked a detailed breakdown of the hospital equipment included in the property valuation, and instead applied figures for similar acute care hospitals. However, because not all types of equipment count for REMIC purposes, the lack of detail arguably left unclear whether the appraisal could provide a reasonable basis for determining REMIC qualification. Although the land, building, and improvements, valued by the appraiser at $30,960,000, would count under the REMIC standards, they failed to meet the $40 million minimum required under the 80% test. Nevertheless, Nomura relied on this appraisal, as written.

It is undisputed that prior to the closing on the D5 securitization, Nomura did not provide, Cadwalader did not request, and no one at Cadwalader ever reviewed or even saw the actual appraisal for the hospital, or, for that matter, for any other D5 securitization mortgage loan. Nomura did fax to an associate at Cadwalader, approximately 24 days before the D5 closing, a freestanding asset description report prepared by Nomura's bankers for credit purposes, titled “Doctor's Hospital of Hyde Park ... Deal Highlights” (highlights document). The highlights document stated that the $50 million loan was secured by “the land, building, and operations of the property” and that the collateral was the hospital's “land, building and property management (operations).” It set forth an LTV at 73.5%. It also listed the appraiser's reconciled valuation of $68 million, as well as the three valuation approaches.

In preparation for the closing, Cadwalader provided an opinion letter to Nomura stating that the D5 series was REMIC-qualified. Cadwalader stated that its legal conclusion was based on the information contained in the PSA, MLPSA, prospectus, and two supplements. The letter also specifically stated that “as to any facts material to such opinions ... not known to” Cadwalader, it relied on “statements, certificates and representations” of Nomura officers and representatives. There was no mention of the highlights document.

Cadwalader also drafted the D5 securitization's PSA and MLPSA. The PSA and the MLPSA stated specifically that Nomura warranted that each mortgage loan is a “qualified mortgage” within the meaning of the Internal Revenue Code, and that the loans in the trust were secured by mortgages on real property with a fair market value of at least 80% of the principal amount of the loan, as measured at the origination or closing date. In other words, that the mortgage loans in the D5 securitization complied with the 80% test.

III.

Approximately three years after the closing, the hospital went bankrupt and defaulted on its loan. Thereafter, the D5 securitization trustee notified Nomura that the hospital property was insolvent and that Nomura was in breach of the PSA and MLPSA warranties because the hospital's property value was below the 80% REMIC minimum. Nomura refused to repurchase the loans and submitted letters from Cadwalader and the appraiser stating that the hospital had an overall REMIC-qualified market value of $45,080,000.

Unpersuaded by these representations, the trustee commenced a federal action against Nomura in the District Court for the Southern District of New York, for the alleged breach of the PSA and MLPSA. The District Court granted Nomura summary judgment, concluding that based on Cadwalader's opinion letter, Nomura reasonably believed the property met the 80% REMIC test (see ...