2nd Circuit Vacates Dismissal of RMBS Suit and Remands for Demand Futility Analysis

A three-judge panel for the U.S. Court of Appeals for the Second Circuit recently vacated a district court’s dismissal of an investor’s suit against the trustee of certain residential mortgage-backed securities trusts in which the investor holds certificates.

The investor alleges that the trustee had a duty to protect the trusts from any contractual breaches and that its failure to carry out that duty caused the investor to lose hundreds of millions of dollars in its investments.  The district court dismissed the suit after finding that certain pre-suit demand requirements contained in “no action clauses” in the trusts’ governing documents had not been met because the investor failed to make a pre-suit demand to certain third-party servicers.  The Second Circuit panel noted that the no-action clause in this case required investors to make pre-suit demands on third-party servicers, as well as the trustee, and held that the “demand futility” exception that excuses investors from complying with no action clauses where doing so would amount to asking the trustee to sue itself also applies to servicers and other similar third parties “where these parties are sufficiently conflicted” by having “close relationships” with the trustees.

The Second Circuit panel remanded the case to the district court to determine whether the third-party servicers are “sufficiently conflicted” such that making a pre-suit demand on them would be as futile as if they were the trustee themselves.  If so, such conflict would excuse the investor from compliance with the no-action clauses and potentially allow its suit to move forward.