Three recent corporate trust decisions provide insight into issues of jurisdiction, standing of indirect holders and the authority of limited direct certificateholders to direct trustees. The U.S. Supreme Court has left alone a ruling allowing a state to exercise in rem jurisdiction over trust assets. Meanwhile, New York state court held that indirect holders of certificates through CDO investments do not have standing to participate in an Article 77 proceeding and a state court in Minnesota held that holders of minimal trust assets cannot direct the trustee to undertake expensive, time-consuming litigation.
Minnesota Court’s In Rem Jurisdiction Over Out-of-State Trust Assets Stands
The U.S. Supreme Court will not consider the constitutionality of a Minnesota court’s exercise of in rem jurisdiction over trust assets that are not located in Minnesota. On October 7, 2019, the Supreme Court denied Ambac Assurance Corporation’s Petition for Certiorari in the case of Ambac Assurance Corporation v. U.S. Bank National Association, which we discussed in a previous update. This leaves in place a Minnesota Court of Appeals decision upholding the exercise of in rem jurisdiction where sufficient “contacts” between the Trust property and the state of Minnesota satisfied due process requirements.
Indirect Holders May Not Have Standing in Article 77 Proceedings
In an appeal in the Article 77 proceeding In re Wells Fargo Bank, et al., Petitioners, the New York Supreme Court unanimously affirmed an order by Justice Marcy Friedman dismissing Nover Ventures LLC as a respondent with respect to trusts in which Nover does not hold a certificate.
Nover appeared in the Article 77 proceeding to, among other things, assert positions as an interested party with respect to trusts in which it held interests through collateralized debt obligation (CDO) holdings. The trial court determined that Nover lacked standing to do so and that its indirect interests must be represented by the CDO trustees.
The Appellate Division affirmed, noting that “[e]ven upon the broad construction required of article 77 of the CPLR, ‘cover[ing] any matter of interest to trustees, beneficiaries or adverse claimants concerning the trust’ . . . the court correctly limited Nover's interest as a respondent to the trusts in which Nover was the named certificateholder.” Nover’s CDO holdings, by contrast, were insufficient to confer standing to participate in the proceeding because the CDOs transfer all right, title and interest in CDO holdings to the trustee rather than CDO investors. Therefore, “the court correctly concluded that the trustees of those CDOs, which held certificates in the Settlement Trusts, could participate in the article 77 proceeding, but not individual CDO investors.”
Minimal Trust Holdings Are Insufficient to Order Litigation on Behalf of Trust
A Minnesota court held that a certificateholder’s minimal trust holdings (less than 1% of the trust certificates as a whole) were insufficient to justify mandating that the Trustee utilize the trust funds to pursue expensive and potentially risky litigation at the direction of the holder. The case was In the Matter of Merrill Lynch First Franklin Mortgage Loan Trust, Mortgage Loan Asset-Backed Certificates, Series 2007-5.
West Park Fund LLC, a certificateholder in the Residential Mortgage-Backed Securities trust, filed a petition seeking to require the Trustee to commence litigation for breaches of representations and warranties by First Franklin Corporation. West Park alleged in its petition that the trust suffered approximately $312 million in collateral losses since origination and that much of the principal balance of the certificates has been written down as a result. It alleged that the losses were attributable largely to mortgage loans sold to the trust by First Franklin and that the trust therefore possessed legal claims against First Franklin related to breaches of representations and warranties.
After a hearing, the Court denied the Petition, holding that nothing in the applicable Pooling and Servicing Agreement (PSA) obligated the Trustee to commence litigation against First Franklin. The court noted that the Trustee had authority under the PSA to investigate breaches of representations and warranties but had not received any request that satisfied the PSA provisions. It also determined that no certificateholder had provided adequate direction and indemnity needed to commence litigation.
Considering whether West Park could provide such direction, the Court primarily looked at the nature and magnitude of West Park’s interest in the trust as it related to diverting significant trust cashflows to pursue litigation. The Court found that West Park’s holdings in the trust had a certificate principal balance of less than 0.22% of the trust.
The Court determined that the “Petitioner's extremely limited interest in the trust is insufficient to justify mandating that the Trustee utilize the Trust funds to pursue the expensive and potentially risky requested litigation.” In addition to not being explicitly contemplated by the terms of the PSA, West Park’s potential gain from the litigation was minimal relative to the litigation costs. Therefore, the Court concluded it would be “inappropriate to now order the Trustee to engage in the contemplated litigation and fund it with Trust assets because Petitioner's direct interest in this matter appears small and remote.”