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Residential Funding Company, LLC v. Stearns Lending, Inc.

United States District Court, D. Minnesota

August 22, 2014

Residential Funding Company, LLC, Plaintiff,
v.
Stearns Lending, Inc., Defendant.

Donald G. Heeman, Esq., Jessica J. Nelson, Esq., Felhaber Larson, Minneapolis, MN; Peter E. Calamari, Esq., David Elsberg, Esq., Isaac Nesser, Esq., Quinn Emanuel Urquhart & Sullivan, LLP, New York, NY; and Jeffrey A. Lipps, Esq., Carpenter Lipps & Leland LLP, Columbus, OH, on behalf of Plaintiff.

Andre T. Hanson, Esq., Allison Lange Garrison, Esq., Robert J. Pratte, Esq., and Margaret Rudolph, Esq., Fulbright & Jaworski LLP, Minneapolis, MN, on behalf of Defendant.

MEMORANDUM OPINION AND ORDER

ANN D. MONTGOMERY, District Judge.

I. INTRODUCTION

This matter is before the undersigned United States District Judge for a ruling on Defendant Stearns Lending, Inc.'s ("Stearns") Motion to Dismiss the complaint filed against it by Plaintiff Residential Funding Company, LLC ("RFC"). In light of this court's ruling in similar cases RFC initiated against other defendants, the parties agreed to cancel the scheduled hearing and submit the issue to the Court based on the parties' briefs.[1] See Letter to Distr. Judge, Aug. 19, 2014 [Docket No. 52]. For the reasons stated below, Defendant's motion is denied.

II. BACKGROUND

Before it declared bankruptcy in May 2012, RFC was "in the business" of buying and securitizing residential mortgage loans. RFC purchased these mortgage loans from various "correspondent lenders, " including Stearns, who had primary responsibility for underwriting the loans. RFC then "pooled" loans with similar characteristics together, and sold the bundled loans into securitization trusts. The loans served as collateral for the trusts' securitized investments (commonly referred to as "residential mortgage-backed securities" or "RMBSs"). RFC sold the RMBSs to investors, and it also occasionally sold pooled loans to "whole loan" investors. Am. Compl. [Docket No. 30] ¶¶ 21-22.

Stearns is a California corporation with its principal place of business in Santa Ana, California. Over the course of their relationship, RFC purchased "over 300" mortgage loans from Stearns, with an original principal balance in excess of $80 million. Id . ¶¶ 4, 14. Stearns sold its first mortgage loan to RFC in 1998, and the last in 2007. Id . Ex. C.

Stearns sold mortgage loans to RFC in accordance with a Client Contract, which in turn incorporated a "Client Guide." Id . Exs. A-B. RFC contends the applicable Client Contract and Client Guide have the same material terms concerning loan quality. Id . ¶ 18. Through the Client Guide, Stearns made numerous representations and warranties to RFC regarding the residential loans it sold. Among other representations, Stearns agreed it had: verified the accuracy of the information used by borrowers to obtain the loans; ensured the proper completion and execution of loan forms; complied with applicable laws; determined that no default or other breach of loan terms had occurred in any loan; confirmed the market value of the mortgaged property; and not sold any "high-risk" loans to RFC. Id . ¶ 24. Stearns further stated that none of loans sold were based on borrower or lender misrepresentations or fraud. Id.

The Client Guide provides RFC with broad remedies. The Client Guide states that any failure by Stearns to comply with the representations and warranties made will result in an "Event of Default." Similarly, any failure by a borrower, appraiser, broker, or other intermediary to provide accurate information is an "Event of Default, " regardless of whether Stearns knew of the misrepresentation. Id . ¶¶ 26-27. RFC reserved the sole right to declare an Event of Default, upon which RFC could require the lender to repurchase or replace the loan. Id . ¶¶ 29-30. The Client Guide also granted RFC indemnification for any liability resulting from a lender's breach. Stearns agreed to indemnify RFC for all losses, damages, or other costs resulting from any breach of contract, breach of warranty, or misrepresentation. Id . ¶ 33.

Many of the loans sold by Stearns to RFC defaulted or became delinquent. These loan defaults, in turn, led to significant investor losses. In selling the RMBSs to investors, RFC made required disclosures to the Securities and Exchange Commission (SEC) and also made representations and warranties to investors. When the RMBSs failed, investors, insurers, and other interested parties filed lawsuits against RFC for selling faulty investments. RFC alleges it was exposed to "billions of dollars" in liability. Id . ¶¶ 37-39, 45. In the ensuing litigation, investors and their insurers discovered that many of the loans underlying their investments had significant underwriting problems. See, e.g., id. ¶¶ 59, 62, 64. The paperwork for many loans was either incomplete or included inaccurate information about key aspects of the loans, such as borrower income, loan-to-value ratios, and property values. The loans also defaulted at higher than normal rates. See id. ¶¶ 40, 62.

In May 2012, RFC declared bankruptcy in the Bankruptcy Court for the Southern District of New York. The dozens of lawsuits against RFC involved a balance of more than $100 billion in original loan principal. And because RFC extended a promise to repurchase faulty loans and investments as part of its offerings, RFC had already spent millions of dollars repurchasing investments and loans. Id . ¶ 69. After RFC declared bankruptcy, investors and other interested parties filed hundreds of proofs of claim. Id . ¶ 71. Ultimately, the bankruptcy court approved a global settlement of over $10 billion to resolve the claims against RFC. The settlement assigned the rights and interests of RFC to the ResCap Liquidating Trust. Id . ¶¶ 14, 75.

After the bankruptcy settlement took effect in December 2013, RFC filed dozens of actions against the lenders from whom it had purchased residential mortgage loans, including Stearns. RFC has alleged a breach of the Client Contract and ...


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