Deutsche Bank. Credit: Michael A. Scarcella/ ALM

The New York Court of Appeals is likely to decide next month whether companies may include a contract provision that extends or delays the start of the statute of limitations for a breach of that contract.

The court heard arguments this week in the case, which was brought by Deutsche Bank against Quicken Loans over a set of allegedly fraudulent residential mortgage-backed securities sold immediately preceding the financial crisis between December 2006 and May 2007.

In its agreements to sell the loans, Quicken made certain representations and warranties about the quality and risk level of the securities and included a provision to either cure a breach of those warranties, buy back the loans, or replace them with another loan if a breach is found.

But the contract included another provision that Quicken argued this week should not be enforced. The provision delayed the accrual of a breach-of-contract claim on those loans until three conditions were met. There had to be a discovery of the breach, a failure by Quicken to rectify the breach, and a demand by the loan buyer for Quicken to comply with the contract.

That provision also, in theory, was supposed to delay the statute of limitations on a breach-of-contract claim until all of those conditions were met, rather than when the loans were sold. The statute of limitations for such claims is limited to six years.

So, for example, the contract would suggest that the statute of limitations would not start until 2010 if the three conditions were met that year rather than when they were sold in 2006.

The Federal Home Loan Mortgage Corp., or Freddie Mac, was one of the loans’ buyers between December 2006 and May 2007. In 2013, a review found that many of the loans Freddie Mac invested in breached the agreement with Quicken.

Deutsche Bank is the trustee for Freddie Mac’s loan trust. When Deutsche Bank found out about the alleged breaches, it started a breach-of-contract action against Quicken in August 2013, more than six years after the sale of the loans, which happened sometime before June 2007.

Both Manhattan Supreme Court Justice Marcy Friedman and the Appellate Division, First Department granted a motion to dismiss from Quicken, saying the part of the contract that attempted to delay or extend the beginning of  the statute of limitations was unenforceable. Both courts decided that the statute of limitations could only begin when the loans were sold, not when the three conditions were met in the agreement.

Howard Sidman, a partner at Jones Day in Manhattan, represents Quicken. He argued that, in this case, the statute of limitations could not be delayed because if any breach of warranty had occurred, it would have happened when the loans were sold, not when a demand to cure the breach happened.

Judge Jenny Rivera asked Sidman in an exchange why the parties involved would not be able to set a different condition for when a breach occurs, and therefore start the statute of limitations later.

“Why aren’t they correct that what the parties agreed to was the way they craft what is truly a breach?” Rivera said. “[That] the breach is the promise to do something when that happens?”

“That could have been what they contracted to, but that’s not what they contracted to here,” Sidman said. “The provision itself refers to a breach of a representation in warranty and the notice of demand requirement that follows from that breach all presuppose that breach in the first place.”

In other words, when Deutsche Bank demanded that the breach be cured, it was admitting that the breach happened at the point of sale, which was past the statute of limitations, Sidman argued.

Zachary Rosenbaum, a partner at Lowenstein Sandler, represented Deutsche Bank. He was asked by Judge Eugene Fahey why they should allow the accrual provision of the contract when it could set a precedent for future contracts to delay the start of a statute of limitations.

“If you have the authority to do this, how are we not left with a situation where parties can always contract to extend the statute of limitations and in essence we’ve created a contractual discovery rule?” Fahey said. 

“I would submit that in every contract it is a bundle of rights and obligations,” Rosenbaum said. “So, virtually in every contract, the parties are setting forth when the obligations come due.”

Rosenbaum argued that there is not an overriding policy reason or statute that would prohibit parties to enter into a contract with an accrual provision, such as seen between Quicken and its investors. He said the contract made clear that the cause of action in this case did not occur until the conditions of the contract were met.

“The breach of the contract occurs when the conditions, the elements of the accrual clause, are complete,” Rosenbaum said. “It is not seeking or requiring a remedy for a pre-existing wrong because by design these parties agreed that the contractual wrong occurs when the demand is made for compliance by the purchaser, in this case, the trustee.”

The Court of Appeals is expected to issue a decision in the case in October.

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