On December 22, 2020, Davis Polk secured a victory for Morgan Stanley Mortgage Capital Holdings LLC (“Morgan Stanley”) in its appeal before the New York Court of Appeals stemming from a residential mortgage-backed securities lawsuit. The decision forecloses plaintiff’s attempts to render a contractual “sole remedy” clause unenforceable – while establishing an important new precedent governing New York contract law – and also dismisses plaintiff’s claims for punitive damages and attorneys’ fees.

The lawsuit is one of many brought in the wake of the 2008 housing crisis. Davis Polk has represented and continues to represent Morgan Stanley entities in other residential mortgage-backed securities lawsuits in relation to different securitizations. In this complaint, the plaintiff Deutsche Bank National Trust Company, acting in its capacity as Trustee of the Morgan Stanley Asset Capital I Inc. Trust 2007-NC4, alleged that numerous mortgage loans backing the securitization were in breach of Morgan Stanley’s representations and warranties. Based on those alleged breaches, the Trustee sought general contract damages, punitive damages and attorneys’ fees despite a contractual “sole remedy” provision that limited the Trustee’s remedy to cure of the breach or repurchase of the breaching loan. The Trustee argued that the “sole remedy” clause should be rendered unenforceable as a result of Morgan Stanley’s alleged gross negligence.

On appeal, Davis Polk argued that the public policy against contractual provisions that insulate a party from liability for gross negligence did not apply to the “sole remedy” clause, even if it made it more difficult for plaintiffs to prove their case, because that policy only applied to provisions that eliminated liability altogether or limited it to a nominal sum. Davis Polk also argued that the allegations of “grossly negligent” breaches of representations and warranties failed to allege the type of tortious conduct necessary to either plead gross negligence or seek punitive damages.

The Court of Appeals agreed. In a decision largely tracking Davis Polk’s arguments, the Court of Appeals concluded that, in pure breach of contract actions, the gross negligence exception only applies to provisions that eliminate liability or limit liability to a nominal sum and that the “sole remedy” clause was neither. The Court of Appeals also concluded that the plaintiff had failed to allege tortious activity, as required to seek punitive damages, and that the contract did not reflect an “unmistakable intent” to abrogate the American Rule that each party in litigation bears its own attorneys’ fees. The decision reverses an order of the Appellate Division, First Department, and reinstates the dismissal of the same claims that Davis Polk had obtained from the Supreme Court for New York County in 2015. 

The Davis Polk team on the appeal included partner Brian S. Weinstein (who argued the appeal), counsel Matthew Cormack, associates Craig Cagney, Matthew R. Brock, Dylan S. Rubin, Lesley Chen, Alexandra Goldman and Grace Lee, and former associate Anat Jordana Schraub. All members of the Davis Polk team are based in the New York office.