In Central Mortgage Company v. Morgan Stanley Mortgage Capital Holdings LLC, C.A. No. 5140-VCS, (Del. Ch. Aug. 19, 2010), read opinion here, the Court granted defendant’s Rule 12(b)(6) motion to dismiss a complaint, under New York law, concerning mortgage failures and underperforming loans arising out of the ongoing financial crisis. This summary was prepared by Kevin F. Brady of Connolly Bove Lodge & Hutz LLP.

Defendant Morgan Stanley is in the business of purchasing loans from originators, pooling the loans and selling the pool to investors either as securitized transactions or in bulk. Central Mortgage Company (“CMC”) is a servicer of residential mortgage loans which means that CMC sends bills to and collects payments from the mortgagor and remits those payments to the mortgagee. In March 2005, Morgan Stanley offered for sale approximately $1 billion in mortgage servicing rights for mortgages it later planned to sell to Fannie Mae and Freddie Mac (the “Agencies”).

Morgan Stanley and CMC entered into an agreement to service the pools of mortgage loans that Morgan Stanley had sold or would sell in the future to the Agencies and private investors (the “master agreement.”). However, when the mortgages became delinquent, the Agencies demanded that CMC repurchase the underperforming loans. CMC in turn requested that Morgan Stanley take responsibility for the mortgages which it did initially by repurchasing or repaying CMC for approximately 50 of those delinquent loans. Thereafter, Morgan Stanley refused to repurchase or pay CMC for any more mortgages. CMC filed suit asserting claims for breach of contract, repudiation, breach of an implied covenant of good faith and fair dealing, rescission, mistake, unjust enrichment, breach of an implied duty to indemnify, negligent misrepresentation, and promissory estoppel.

In Count I, CMC alleged that Morgan Stanley breached the master agreement by selling CMC servicing rights for loans that did not comply with Agency guidelines. In Count II, CMC alleged that Morgan Stanley breached certain representations and warranties in the master agreement. Morgan Stanley argued that CMC had failed to comply with the provision in the master agreement which outlined the steps that must be followed to remedy a party’s breach of contract, by giving the prompt written notice of the breach and an opportunity to cure. The Court agreed with Morgan Stanley finding that “CMC never gave Morgan Stanley an express indication explaining what provisions of the master agreement were breached before CMC filed its complaint.” The Court did note, however, that “[g]iven the allegations in the complaint, it is possible that CMC has viable breach of contract claims, and perhaps even claims that could lead to the rescission of the [m]aster [a]greement. But, in order to pursue those claims, CMC must first follow the remedy set forth in the master agreement.” As a result, the Court dismissed Counts I and II of the complaint without prejudice to allow CMC to provide proper notice and replead those claims if it chose to do so “once the contractual remedy process has been pursued in good faith.”

In Count III, CMC claimed that Morgan Stanley repudiated the master agreement by, among other things, declining to make additional repurchases or reimbursements of the Agency loans. The Court noted that under New York law, a party claiming repudiation has the burden of showing an unequivocal manifestation of the other party’s intention not to perform the entire contract. Because CMC alleged that Morgan Stanley refused to repurchase only some but not all of the loans that were returned by the Agencies, the Court dismissed Count III.

CMC also argued that Morgan Stanley had breached an implied covenant of good faith and fair dealing (Count IV), that Morgan Stanley had an implied duty to indemnify CMC (Count V), and that Morgan Stanley would be unjustly enriched (Count X) if it was not required to repurchase the underperforming loans from the Agencies. The Court disagreed, finding that all of these “implied” claims failed because there was an enforceable agreement that governed the relationship between the parties on these issues.

CMC brought a claim for negligent misrepresentation (Count VII) alleging that Morgan Stanley breached its duty to make accurate representations about the loans for which CMC purchased servicing rights. However, as the Court stated, under New York law, there can be no action for negligent misrepresentation without a “special relationship of trust and confidence” between the parties. Because the Court found that CMC had alleged no facts supporting an inference that there was a special relationship of trust and confidence between the parties beyond their business relationship, CMC’s negligent misrepresentation claim was dismissed with prejudice.

In Count VI, CMC sought to rescind the parties’ agreements arguing that it mistakenly believed that the master agreement and individual transfer agreements concerned only valuable, Agency guideline compliant loans, and that it paid a premium for Agency-compliant loans based on that belief. The Court disagreed stating that under New York law, a contract may generally be rescinded for unilateral mistake where the mistake is “coupled with some fraud” and no fraud was alleged. In addition, CMC only complained about 140 loans out of the thousands of loans to which it purchased the Servicing Rights.

Finally, in Count VIII, CMC alleged that Morgan Stanley was estopped from denying the enforceability of an oral promise it made and, in Count IX, CMC argued that it relied on Morgan Stanley’s oral representation that the loans sold to the Agencies complied with the Agency guidelines, so Morgan Stanley is estopped from denying the enforceability of that promise. The Court found that the master agreement contained an enforceable integration clause that precluded oral modifications to the contract. As a result, the Court dismissed Counts VIII and IX with prejudice.