In recognition of the Independence Day holiday in the U.S., and in what is now something of an annual tradition, I am reprising here my 2012 essay about Time and Summer, which can be found here. Have a great Fourth of July holiday. Thank you to all of my loyal readers.
The first half of 2015 was an active period for new securities class action lawsuit filings. The filings through the year’s first six months suggest we are on pace for the highest annual number of new filings since 2011. The heightened levels of lawsuits involving non-U.S. companies and IPO companies contributed to the uptick in securities suit filings in the year’s first half. Continue Reading
In a recent post in which I discussed the “basic value proposition” of D&O insurance, I noted that among the five indispensable elements required in order for coverage under a D&O insurance policy to exist is the requirement that a Claim for an alleged Wrongful Act against an Insured Person acting in an Insured Capacity. The prerequisite that the Insured Person must have been acting in an Insured Capacity at the time of the alleged Wrongful Act arises from the fact that individuals act in a number of different capacities; it is only conduct undertaken in their capacity as an officer or director of the insured company for which the insurance policy provides coverage.
A June 22, 2015 decision by the Eleventh Circuit, applying Georgia law, provides a good illustration of how an individual might be acting in multiple capacities, and underscores the fact that the insurance under a D&O policy is only available when the insured was acting in his or her capacity as a director or officer of the insured company. The case presents some interesting policy wording lessons. A copy of the Eleventh Circuit’s opinion can be found here. Continue Reading
One of the standard features of D&O insurance policy is the fraud exclusion, which these days typically provides that the exclusion is triggered only after a “final” judicial determination that the precluded conduct has occurred. But what is it that makes a determination “final”?
On June 23, 2015, in a decision that has a number of important implications, the New York (New York County) Supreme Court, Appellate Division, First Department, applying New York law, held that the imposition of a post-conviction criminal sentencing constitutes a “final judgment” that not only triggered the fraud exclusion in a D&O insurance policy but also required the convicted individual to reimburse the carrier for amounts it had already paid – even though the individual’s appeal of his criminal conviction was pending.
As I noted in a recent post (here), on June 11, 2015, the Delaware legislature passed legislation prohibiting fee-shifting bylaws for Delaware stock corporations. On June 24, 2015, Delaware’s governor signed the statute into law, as discussed here. As I noted in my blog post about the legislation, though the statute has been passed, a number of questions remain about fee-shifting bylaws, including in particular what the legislation’s impact might be for bylaws purporting to shift fees in connection with federal securities litigation. As discussed here, according to Columbia Law School Professor John Coffee, as a result of the statute’s wording, there may be unanswered questions whether the statute prohibits bylaws shifting fees in connection with securities litigation.
In the following guest post, Neil J. Cohen, Publisher, Bank and Corporate Governance Law Reporter, takes the position that there may be arguments that the new legislation is broad enough to preclude bylaws that purport to shift fees in connection with federal securities litigation. (Please note that Neil wrote and submitted his article before the Governor has sighed the statute into law.) The “Note” at the beginning of the guest post is part of Neil’s article.
I would like to thank Neil for his willingness to publish his article on this site. I welcome guest post submissions from responsible authors on topics of interest to readers of this site. Please contact me directly if you would like to submit an article. Here is Neil’s guest post.
Note: The following article discusses a Delaware bill, passed by both the Senate and House, which prohibits a Board of Directors of a stock company from implementing fee-shifting provisions for “internal corporate claims.” The author asserts that securities fraud suits can fit within that category. The article is part of a Round Table on the Delaware legislation that includes Professors J. Robert Brown and John C. Coffee. The June, 2015 issue of the Bank and Corporate Governance Law Reporter containing the entire Round Table can be downloaded here.
The Governor of Delaware is expected to sign a bill, passed by the House and Senate, which prohibit fee-shifting provisions for “internal corporate claims”. The bill also contains a prohibition of bylaws or charter provisions that designate a forum other than Delaware as the exclusive forum. That provision would prevent corporations from choosing forums that allow fee-shifting provisions.
The legislators resisted a lobbing effort by the Chamber of Commerce’s Institute for Legal Reform to insert a provision expanding the Court of Chancery’s discretionary authority to shift to include cases that “plainly should not have been brought but that do not satisfy the extremely narrow ‘bad faith’ or ‘frivolousness’ exceptions”.
Assuming the Governor signs the bill, what is the outlook for fee-shifting provisions affecting securities fraud litigation? Will plaintiffs file for a declaratory judgment in Chancery Court or in District Court to strike the fee-shifting provisions as facially invalid under the new Delaware law? If so, the specific questions are likely to be whether the general bylaw authority under Section 109 of the law allows such provisions and, if so, whether Section 115, dealing with “internal corporate claims,” exempts them. If they are not exempt plaintiffs will be forced to overcome a high standard of proof to demonstrate they are invalid as applied. In the author’s opinion the best argument that the fee-shifting provisions are invalid is because they are exempt as “internal corporate claims” under Section 115 of the new law. Continue Reading
With this blog post, The D&O Diary is proud to launch its new look website. I hope readers will find the cleaner, more open page design easier to read, and that the relocation of the search box and the alterations to other website functions will make the site easier for readers to use.
Though the website redesign represents a pretty significant change to The D&O Diary’s look, the bigger and more important changes to the site are actually behind the scenes.
The primary purpose for the redesign was to implement what is known as responsive web design, which should allow the website to be viewed across a wide range of devices without any loss of design integrity or functionality. In other words, the website should look about the same and function about the same regardless of whether you are viewing it on your phone, on your tablet, or on your computer.
The launch of this redesign is the culmination of several months of planning and implementation. I hope that readers like the changes, and in particular I hope that readers like being able to have the same experience when viewing the site, regardless of the device on which it is accessed. I welcome readers’ comments about the changes.
Along with the design changes, the feed URL for those who access the site using an RSS feed has been changed. Those readers who want to continue to subscribe via RSS should make sure to subscribe at the new feed URL http://www.dandodiary.com/feed
The D&O Diary was in Palo Alto, California this week for the annual Directors’ College at the Stanford Law School (depicted to the left). The keynote speaker on Tuesday morning was SEC Commissioner Daniel M. Gallagher, who recently announced that he will be stepping down from the Commission when his successor has been confirmed. As was the case with many of the panels at the conference, the focus of Gallagher’s speech was on the questions and concerns involving activist shareholders. The text of Gallagher’s June 23, 2015 speech can be found here.
Gallagher began his speech by rhetorically posing the question of whether shareholder activism is good or bad, a question that he contends is all too often answered based on a “binary view of the world” in which shareholder activism is viewed either as all good or all bad. For Gallagher, this view “is convenient, but it is also far too simplistic.” The question that needs to be answered in determining whether a specific instance of shareholder activism is either good or bad is whether or not it is aimed at creating long-term shareholder wealth and whether or not that effort is successful.
As for whether or not the SEC should be in the business of determining which activism is good and which is not, he said that “it doesn’t, and shouldn’t.” It is the SEC’s role to “create a level playing field, chiefly through disclosure”; it is up to the states to determine the substantive rights of shareholders. As for the SEC, while it has been a faithful groundskeeper over the years, the prudent division of responsibilities between the agency and the states has been eroded over the years as a result of marketplace changes and due to “our own overzealous implementation of legislative enactments.”
Shareholder activism is one of the areas where Gallagher sees the balance of responsibilities as having changed. In discussing this topic, Gallagher drew a distinction between shareholder proposal activism and hedge fund activism. With respect to shareholder proposal activism, Gallagher asserted that the current SEC process for administering the process is broken, both for shareholder activists and for the companies that they target. Specifically, Gallagher said, “the SEC’s shareholder proposal rule, Rule 14a-8, is being abused by special interest groups to advance idiosyncratic goals that may directly conflict with the interests of most shareholders.”
Gallagher would prefer to see the SEC get out of the business of policing shareholder proposals, and leave the entire issue to the respective states under their governing corporate laws. In the interim, which awaiting these types of changes, he would like to see the current Commission “no action” letter process, which is administered at the staff level, to be “jettisoned” and converted into a process involving Commission advisory opinions, in which the Commission itself would issue opinions on major policy issues. The buck, Gallagher said, should stop with the political appointees at the Commission.
Hedge fund activism, by contrast to shareholder proposal activism, Gallagher said, is at least driven by profit motivation, but “the key question here is whether activist hedge funds drive long-term value creation, or whether short-term gains to activism are at the expense of long-term corporate growth.” Gallagher noted the debate within the academic and legal communities about the value of shareholder activism but expressed his doubt that answers to the value of activism can be found in econometrics.
The SEC’s role with respect to activist investors begins with its administration of the Section 13 reporting obligations that are triggered when an investor’s ownership share exceeds the 5% threshold. Gallagher observed that in the current trading environment an activist investor can quickly accumulate a 5% stake in a particular company, often using trading mechanisms and ownership structures. However, even with a 5% stake, 95% of the ownership remains elsewhere and the activists are still subject to the requirements of the other investors.
The question then, according to Gallagher, is “how the other investors are conducting themselves vis-à-vis activists, and whether the SEC has done enough to ensure the integrity of this process.” In particular, Gallagher noted, institutional investors could make or break activist interventions, but they “paying insufficient attention to their fiduciary obligations to their clients when they determine whether to support a particular activist’s activity.” All too often the funds are simply deferring to the proxy advisory firms. The states and SEC are not doing enough to police the funds. The funds are “fiduciaries, they are in the markets we oversee, dealing with SEC registrants, and they should be held accountable for their activities.”
Gallagher said that better policing of advisors and funds is “hard, and it is controversial, ” but it “falls to the SEC and the states to figure out how to empower the individuals and give them the information they need to hold their advisers to account, and to take action against the institutional scofflaws.”
Gallagher then turned to the topic of proxy advisory firms. He said that too many institutional investors simply rely on the proxy advisory firms. He said that the proxy advisory firms have done too little to address concerns about their sometimes shoddy research. The proxy advisory firms’ lack of progress could and probably should result in further action on the SEC’s part.
He then turned to corporate boards and management, which obviously have a critical role in the activist debate. In discussing the role of boards and management, Gallagher observed that there are two models of shareholder involvement, the first of which is based on a model of pure democracy in which the corporation is directly controlled by shareholder voting, by contrast to the republic model in which the shareholders elect the directors and the directors control the company. Which of these two models is to be preferred is a matter of state law. Gallagher said that the SEC action increasingly has disrespected that distinction and has become biased toward direct shareholder democracy. Gallagher said the SEC’s rules should be flexible enough to accommodate both approaches.
The pressure toward more shareholder democracy comes when boards are perceived as falling short. There may be, Gallagher noted, company boards that have become stale or too chummy with management, but a vigorous board that drives change “moots” the need for direct shareholder democracy. Boards that are out in front and engaged with shareholders by “communicating your company’s strategy and how the board is overseeing management’s execution of that strategy to investors, and in turn hearing what’s on your investors’ minds, can help demonstrate to the SEC that boards are a tool for investor protection, not an impediment to it.” This approach can also allow companies to get out in front of activist investors.
All of these constituencies can coexist on a level playing field, with activists putting pressure on companies that fall short. The problem, Gallagher said, is that the activist campaigns can involve short-term goals rather than a long-term focus. In the current low interest rate environment, activism has become popular, motivated by the desire for returns. In this environment, investors become focused on the short term, and so too are managers as they seek to stave off activists. The SEC, Gallagher said, has played a role, as its corporate governance rules are contributors to the short-termism. There is, Gallagher says, “enough blame to go around.”
Gallagher said that the pendulum may have started to shift as a bi-partisan view is emerging that the pervasive short-termism is destructive of long-term shareholder value. But as of yet there are no bi-partisan consensus on what to do about it. There are a number of ideas and proposals circulating. Gallagher referred approvingly to the proposals of Harvard Law School Professor Guhan Subramanian in his March 2015 Harvard Business Review article “Corporate Governance 2.0” (here), in which Subramanian suggested that using principles drawn from basic negotiation theory that concerned parties should engage in a process to re-conceptualize overall corporate governance, to develop an alternative to the activists’ incremental approach to corporate change.
Gallagher said that he hoped that the SEC “give life” to Professor Subramanian’s proposal and host a roundtable “where representatives from interested groups can sit down and try out this approach.” The agency is uniquely situated to provide a neutral forum could lead to the outline of a consensus. He noted that while it is this type of roundtable meeting unlikely to take place before his departure as Commissioner he hoped that his colleagues will “take up this banner and run with it if they so choose.”
I am grateful to have had the opportunity while at the conference to participate on a panel on the topic of Indemnification and D&O Insurance, with my good friends Priya Cherian Huskins of Woodruff-Sawyer and Jim Kramer of the Orrick law firm, as pictured below.
The conference overall was great. It is always interesting to hearing the perspective and questions of the directors themselves. Congratulations to Stanford Law Professors Joseph Grundfest and Joe Siciliano and to the Directors’ College staff for another successful conference.
Stanford University is so beautiful, it is a pleasure just to be there (note the circle of students enjoying the tree shade):
At Dinner in Palo Alto with my good friends Winnie Van (ABD) and Mike Hoy (Socius):
Scenes from Glen Canyon Park, San Francisco:
A view of the San Francisco Skyline, from Billy Goat Hill in Glen Park, San Francisco:
After claimants filed shareholders’ data breach-related derivative suits against the boards of Target (here) and Wyndham Worldwide (here), a number of commentators (including me) asked whether we could see a wave of cybersecurity related D&O lawsuits. Interestingly, since these two lawsuits were filed more than a year ago, there have been no further lawsuits of this type filed, even though there have been a number of very high profile data breaches since that time – including, for instance, those involving Home Depot, Sony Pictures Entertainment, Anthem (not to mention the massive breach last week involving U.S. government personnel records).
The absence of new data breach-related D&O lawsuit filings for over a year and the October 2014 dismissal of the Wyndham lawsuit (here) made a number of observers (including me) wonder whether the anticipated wave of D&O litigation might not materialize after all. (Although there are a number of commentators have continued to suggest that we should just be patient, the lawsuits will arrive sooner or later).
Though there have not been any further liability lawsuits filed, there have been developments that suggest we might soon see a lawsuit arising out of the Home Depot data breach. As discussed in a June 15, 2015 Law 360 article (here, subscription required), a plaintiff shareholder has filed an action in Delaware Chancery Court seeking to review Home Depot’s books and records related to the massive data breach the company sustained last year. (I do not have a copy of the plaintiff’s books and records complaint; if any reader can provide me with a copy, I will add a link to the complaint to this post. UPDATE: Thanks to the helpful response of a loyal reader, the complaint can be found here. )
The plaintiff reportedly seeks to inspect the records to determine whether the company’s directors and officers breached their fiduciary duties by failing to adequately protect customer credit card information on its data systems despite the many high profile cybersecurity problems that other retailers had previously experienced. The plaintiff apparently sent the company a request under Section 220 of the Delaware Corporations Code in September 2014. Two months later, in response to the request, the company produced over 500 pages of documents, but in her recent complaint, the plaintiff complained that this production was incomplete and that many of the documents were redacted. The company and the plaintiff’s attorney apparently had been in negotiations to arrange for the plaintiff’s counsel to review the redacted documents but apparently frustrated by the process the plaintiff filed the recent Delaware Chancery Court action to compel inspection.
The Law 360 article includes a statement from a Home Depot representative with respect to the books and records action that “we look forward to resolving the matter.”
The parties may (or may not) be able to work out the issues surrounding the books and records inspection, but it seems likely that in any event, the sequence of events eventually will lead to the filing of a liability lawsuit against Home Depot and its executives. Among other things, the plaintiff alleges in her books and records suit that “There is a credible basis to believe that officers and directors of Home Depot were aware of the risks that the company faced from a cyberattack but in breach of their fiduciary duties the board has failed in its responsibilities to implement systems and internal controls to properly protect the company from this threat,” and that “[T]he allegations of lax cybersecurity at the company, the pending government investigations, together with numerous lawsuits claiming misconduct at Home Depot, provide a credible basis from which mismanagement at the company can be inferred.”
It is clearly not too much of a stretch to suggest that the books and records action is merely prefatory to a later liability lawsuit that will be filed eventually. To be sure, there is always the chance that the lawsuit may not materialize, but just as the battle does not always go to the strong nor the race to the swift, that’s the way you bet. I am not a betting man, but if I were I would be that sooner or later we will see a D&O lawsuit related to the Home Depot data breach. Either way it will be interesting to watch and see what happens because it could tell us something about whether the much anticipated data breach-related D&O litigation will arise.
For an earlier post discussing the possible reasons why we have not seen data breach securities class action litigation so far and whether or not we may see these kinds of securities suits in the future, refer here.
The D&O Diary was on assignment in São Paulo last week, for meetings and for a little bit of a look around. I had never before been to Brazil, or for that matter, to South America. São Paulo turned out to be a bit of a revelation. For one thing, São Paulo, the financial capital of Brazil, is huge; with a population of about 21 million, São Paulo is the world’s 10th largest city. For another thing, in the middle of June when I arrived, São Paulo was entering the Southern Hemisphere winter. My June visit to the city came just before the Southern Hemisphere winter solstice. Many of the stores and shops were having festival de inverno sales while I was visiting.
Because the city is located at 23 degrees southern latitude — by way of comparison, Key West is at 24 degrees northern latitude — São Paulo winter does not involve frigid temperatures. In fact, on the day I arrived it was quite warm and sunny. Unfortunately for me, the sunshine did not last. Though I visited São Paulo during the dry season and in the midst of a record drought, it absolutely poured rain the first full day I was there, and much of the remainder of my visit was cooler and cloudy, as many of my pictures show.
Because São Paulo is so massive, it encompasses a multitude of different districts and neighborhoods. My hotel was located on a leafy, tree-lined street a block away from the Avienda Paulista (pictured right), a 1.7 mile thoroughfare lined with the headquarters of a large number of financial institutions, as well as an extensive shopping area and Latin America’s most comprehensive fine-art museum, Museu de Arte de Sao Paulo (MASP). The street also runs a strikingly philosophical course between two stations on Sao Paulo’s subway, the Metrô, from Paraíso (Paradise) to Consolação (Consolation).
The Metrô itself is quite impressive. It is clean, quiet, easy to use, and inexpensive (at current exchange rates, a single ride costs the equivalent of slightly more than one U.S. dollar). The Metrô can be quite busy at peak times (as shown in the first picture below) but it does make it possible to avoid the city’s congested roads (reflected in the second picture below). The Metrô also makes it possible to easily visit many of the city’s other districts and neighborhoods, including in particular Centro Histórico de São Paulo (or “Centro” for short), which, as the name implies, is the city’s historic center.
The city grew so quickly in the late 20th century that few vestiges of the city’s earlier history remain, and almost all of the city’s most historical buildings are located in the Centro. The photo at the top of the post depicts the Cathedral da Sé, an early 20th neo-Gothic revival structure that is in many ways the city’s heart. (However, given the general tenor of the crowd that inhabits the Praça de Sé in front of the Cathedral, I would suggest that most American tourists might want to allow pictures of the Cathedral to suffice). A warren of pedestrianized streets full of shops and cafes connects the Cathedral to the rest of the Centro.
The next pictures taken in the Centro, respectively, show the Teatro Municipal; the interior of the Mercado Municpal Paulistano; and the Estacão da Luz.
Though densely populated and urban, São Paulo has some magnificent parks. Right near my hotel was the Parque Tenente Siqueira Campos, universally referred to as the Parque Trianon, a little jewel of a park located directly across the street from the MASP. The Park, dense with native Brazilian plants and trees, some of which are said to be over 300 years old, is a reminder of the tropical rain forest that once covered much of the Brazilian coast.
To the south (from my hotel) was another beautiful park, the Parque Ibirapuera , which has the same urban oasis feel as Central Park. At 545 acres, Ibirapuera is one of the largest urban parks in South America, though it is smaller than New York’s 778 acre version. The view across one of the park’s large lakes is shown below. The park is laced with paths and trails.
In addition, there are several smaller (and a little bit more ragged) parks in the city center, including the Parque da Luz (which is pictured first below, and is just across from the Luz rail station pictured above), and the Parque da República, located adjacent to the Centro district.
There are many great reasons to visit Sao Paulo, but possibly the best is the food, which is absolutely phenomenal. I had several great meals while I was there, including in particular a memorable lunch on the day of my arrival, with my São Paulo hosts, Glaucia Smithson (of Zurich) and Marcus Smithson (of Generali), at the Jardineira Grill, a Brazilian barbeque in the Vila Olimpia neighborhood. The restaurant is a churrascaria, with waiters move around the restaurant with skewers, slicing various types of grilled meat directly onto each customer’s plate. In the picture below, I am seated at the table and awaiting the first round of grilled meat, with Marcus on the left in the picture and Celso Soares (of Zurich) to my right. (Glaucia, who snapped this shot for us with my camera is, alas, not in this picture. Sorry Glaucia!)
I also had a great dinner with several industry colleagues at the Hotel Unique Skye Bar and Restaurant, the highlight of which was a wonderful dish of Filhote, an Amazon river fish. We toasted our gathering with a Caipirinha — the Brazilian drink made with cachaça (distilled spirits made from sugar cane juice), sugar, and lime — which has to be the best cocktail on the planet. But perhaps the most authentic and memorable meal I enjoyed in Sao Paulo was the bowl of feijoado, a traditional stew of black beans, beef and pork served with rice and cabbage, which I enjoyed for lunch Wednesday afternoon (the dish traditionally is served on Wednesdays and Saturdays for reasons no one could explain to me), as depicted in the picture below (the beans are in the bowl). When I tell you this meal stayed with me, you will I understand I mean that in more than one sense. I didn’t require any dinner that evening.
When I left Ohio to travel to São Paulo, the early summer sunset back home was well after 9 p.m. During my Sao Paulo visit, however, in the Southern Hemisphere early winter, the sun set was before 5:30 p.m. The abrupt shift in daylight hours was quite a shock to my system. My first evening in Sao Paulo, I found myself wandering in the unexpected early evening darkness in the streets near my hotel, feeling adrift and alone in the middle of a huge foreign (and now quite dark) city. Even though it was just after 6, I was about to call it quits and head back to my room when I came upon a street of lively cafes and bars, including one open air sports bar with outdoor seating and huge big screen TVs on the veranda. Purely coincidentally, as I walked up, the Copa America qualifying match between Brazil and Peru had just begun. I made my way into the crowded bar, ordered uma cerveja, and tried to blend into the crowd as they vocally registered every dribble, pass, shot, and goal in the game. (Only my closest family members would truly appreciate how, for me, stumbling upon the bar and the game was about as perfect of a development as could possibly have happened in the entire universe.)
During my visit to São Paulo, I was very self-conscious of my poor command of the Portuguese language. I know only a few phrases, so out of sheer self-defense, I kept my most useful Portuguese phrase at the ready – that is, não falo Português (I don’t speak Portuguese). As I was watching the Copa America game, a young man standing nearby started to speak to me, and more out of instinct than anything else, I quickly said to him, não falo Português. He looked at me sideways and said “Why in the world are you telling me you don’t speak Portuguese? Dude, I just spoke to you in English. I know you are American, you are the most American-looking person who has ever been in this place.” I recovered myself quickly, and introduced myself. It turns out that my new friend Luis had lived in Tampa for many years. He spoke perfect English. I bought him uma cerveja and we had a great conversation during the rest of the game.
As great as it was to become acquainted with São Paulo, the primary purpose of my visit was to attend and to participate as a speaker in the 3rd Encontro Internacional de Linhas Financeiras (International Financial Lines Conference) of Federação Nacional de Seguros Gerais (FenSeg, the Brazilian national insurance association). It was my honor to participate in a panel with Marcus and Celso, to discuss the recent developments in the Brazilian D&O marketplace in the context of historical developments in the U.S. and U.K. D&O marketplace. It was a lively panel and a fascinating conference. The best part of all was to meet for the first time so many industry colleagues in Brazil and to find out how many of them read The D&O Diary. I have posted more pictures of the event below.
Here is a picture of Marcus, Celso, and me after our session.
Christopher Kramer (Zurich), me, and Victor Trapp (AON)
Christopher Kramer (Zurich), me, and Flavio Sá (AIG):
I wanted to be sure and include this picture (below) of Raquel Canossa da Silveira and Marco Antonio Mendes Miranda, both of AON in São Paulo. They had approached me during the lunch break to tell me how, as relatively new participants in the financial lines insurance market, they have found my blog to be an invaluable training source. Every now and then my energy for blogging starts to flag, but then when I meet some younger people in our industry like Raquel and Marco and they tell me how much they value the blog, I am completely rejuvenated. Isn’t it great that I sit in suburban Cleveland and write my little blog posts, put them out on the Internet, and then somehow my articles wind up getting read literally all over the world? It never ceases to amaze me.
I would like to thank Celso for inviting me to participate in the conference, for Glaucia for helping to make my participation happen in the first place, and to Glaucia and Marcus for being such good hosts during my visit to São Paulo.
More Pictures of São Paulo:
Here is the view looking south from my hotel room. This gives you a sense of how massive and sprawling São Paulo is. But do you see what is wrong with this picture, which was taken around Noon on the day of my departure? It is the sun – it isn’t in the picture. In the Southern Hemisphere, the afternoon sun is in the Northern sky, not (as is the case in the Northern Hemisphere) in the Southern sky. I suffered from massive solar disorientation throughout the visit, or at least I did when the sun was shining.
In a city as populous as São Paulo, even the pedestrianized streets are crowded.
A street fair on Avienda Paulista, near the Parque Trianon, the day I arrived.
Anhangabaú Square, in the Center City
As a final note, I feel I should acknowledge that while this most recent trip did take me below the equator during the Southern Hemisphere winter, I did have get the chance this past February to enjoy late summer in the Southern Hemisphere, in Australia (here) and New Zealand (here).
On June 11, 2015, in a closely watched case, the New York Court of Appeals, New York’s highest court, decided when the statute of limitations begins to run for claimants alleging breaches of the representations and warranties provisions in residential mortgage backed securities.
As Robert Fumerton and Alexander Drylewski of the Skadden, Arps, Slate Meagher & Flom law firm discussed in a prior guest post on this blog at the time of the oral argument in the case, the range of possible outcomes inthe case included an interpretation of the statute of limitations that could have led to a new wave of RMBS repurchase litigation that otherwise would be time-barred.
However, as discussed below, the Court rejected these more expansive possibilities. In the following guest post, the two Skadden attorneys discuss the June 11 decision of the New York Court of Appeals and examine the ruling’s implications. A version of this article previously appeared on Law 360 (here, subscription required).
A copy of the New York Court of Appeals June 11 decision can be found here.
I would like to thank Robert and Alexander for their willingness to publish their article as a guest post on this site. I welcome guest posts from responsible authors on topics of interest to readers of this blog. Please contact me directly if you would like to submit a guest post. Here is Robert and Alexander’s guest post.
On June 11, 2015, New York’s Court of Appeals unanimously affirmed the Appellate Division, First Department’s decision in ACE Securities Corp. v. DB Structured Products, Inc. and held that New York’s six-year statute of limitations for breach of contract claims begins to run on the date that the RMBS defendant’s contractual representations and warranties were first made, not on the date of its refusal to comply with the parties’ agreed-upon remedy provision.
“Finality, Certainty and Predictability”
In a highly-anticipated opinion, the Court reaffirmed New York’s emphasis on the “objectives of finality, certainty and predictability that New York’s contract law endorses.” Among the key aspects of the decision was the Court’s conclusion that a defendant’s failure to comply with a contractual remedy provision is “not a separate and continuing promise of future performance” sufficient to defer accrual of the statute of limitations for breach of contract claims.
The Court stressed that “[a]lthough parties may contractually agree to undertake a separate obligation, the breach of which does not arise until some future date, the repurchase obligation undertaken by [defendant] does not fit this description.” The Court recognized that the representations at issue involved “certain facts about the loans’ characteristics as of” the date of the contract – “not a promise of the loans’ future performance” – and that “loans may default 10 or 20 years after they have been issued for reasons entirely unrelated to the sponsor’s representations and warranties.”
The Court also concluded that “[t]he Trust suffered a legal wrong at the moment [defendant] allegedly breached the representations and warranties.” Because the defendant’s obligation to repurchase was only a remedy for underlying breaches of representations, and not a substantive element of any breach claim, the Court reasoned that the remedial obligation was “a procedural prerequisite to suit” that did not delay accrual of the limitations period.
“Day 1 Breaches”
The Court’s decision was well reasoned. Indeed, the defendant’s representations and warranties were either true or false on the first day of the transaction – i.e., the date that they were made. As a result, any alleged breaches could only occur on Day 1 and the statute of limitations for breach of contract must expire six years from that date. RMBS representations and warranties typically relate to the characteristics of the mortgage loans, including the loan-to-value ratios and occupancy status of the underlying properties, as well as whether the loans complied with the applicable originator underwriting guidelines. These are static characteristics that cannot be altered or change in the future. Significantly, at oral argument, the trustee had no answer to the most critical question raised by the Court – namely, whether it could provide any example of a breach of representation or warranty that could occur after the transaction closed. The only specific example that the trustee offered was a situation where the borrower’s employment status was misstated on the loan application and later discovered to be false. But this is precisely the type of representation that is either true or false on Day 1 – a borrower’s employment status at the time of closing cannot later become false through subsequent events.
Rather than provide concrete examples of breaches that could occur after closing, the trustee emphasized that RMBS investors had no duty to conduct due diligence on the loans at issue and thus could not have discovered the breaches on Day 1. But this argument is, in essence, an attempt to import a “discovery rule” into New York’s statute of limitations. As the Court’s decision makes clear, New York case law is well-settled that the limitations period for breach of contract claims begins to run on the date of breach regardless of whether or when the plaintiff may have discovered the breach.
This principle is also reflected in N.Y. CPLR 206(a), which states that where a demand is necessary in order to institute a breach of contract suit, “the time within which the action must be commenced shall be computed from the time when the right to make the demand is complete” – not the time when demand is actually made. Indeed, in any breach of contract case, the parties understand that there is a risk that they will not discover any breach until more than six years after the date of contract. By focusing on the investors’ inability to discover potentially breaching loans, the trustee framed its position before the Court as contrary to long-standing New York law regarding statute of limitations accrual.
Preventing Open-Ended or Subjective Liability
The Court’s decision reinforces New York’s commitment to promoting certainty, predictability and finality in contractual matters by strictly applying the statute of limitations. Indeed, a contrary ruling would have twisted an agreed-upon remedy clause into a liability-enhancing provision, exposing RMBS defendants to nearly open-ended liability predicated on the plaintiff’s unilateral decision regarding when to make demand for repurchase. The Court’s application of a bright-line statute of limitations protects defendants’ reasonable expectations; at the same time, parties may bargain for additional contractual language giving rise to a separate and continuing obligation to repurchase. Such language – if sufficiently explicit – could protect investors for the life of the loans. As the Court recognized, “even though the result may at times be harsh and manifestly unfair, . . . a contrary rule would be entirely dependent on the subjective equitable variations of different Judges and courts instead of the objective, reliable, predictable and relatively definitive rules that have long governed this aspect of commercial repose.” Definitive rules like those endorsed by the Court can only help future commercial actors to reliably and efficiently structure their private affairs.
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— By Robert Fumerton and Alexander Drylewski, Skadden, Arps, Slate, Meagher & Flom LLP
Robert Fumerton is a partner and Alexander Drylewski is an associate at Skadden, Arps, Slate Meagher & Flom’s New York office.