New York’s First Department Appellate Division recently reversed a lower court’s granting of a motion to dismiss and held that the beneficiaries of a real estate mortgage investment conduit (“REMIC”) trust may bring a breach of contract claim against the trustee when the trustee purchased the assets for a below-market price and then resold them to a third party for profit. See Cece & Co. v. U.S. Bank Nat. Ass’n, 2017 WL 3253370 (1st Dept. Aug. 1, 2017). There, plaintiffs are the holders of residual interests in the REMIC trusts at issue. Under the Trust Agreements, the trustee had the right to terminate the trusts once the principal balance of the trust declined to less than 1% the original principal balance. At this point, the trustee had the right to purchase all of the remaining trust assets or sell them to a third party, at which point it had to use the proceeds to pay off any expenses and make required payments to regular security holders.

According to plaintiffs’ allegations, the trustee purchased the assets for itself, “fully aware that the market price greatly exceeded” the price it paid, and then “flipped” the assets to a third party for an alleged profit of over $10 million. The trustee did not deny purchasing the assets for a below-market price, but argued that it was authorized to do so by the Trust Agreements as long as it paid at least the “termination price” for the assets. The termination price is an amount sufficient to satisfy any required payments to the trust’s regular security holders—i.e., not the plaintiff residual security holders, who would have been entitled to excess proceeds. The trial court agreed with the trustee that it was authorized to do this and dismissed the complaint.

On appeal, the First Department reversed the dismissal with regard to the breach of contract claim. Under New York law, an indenture trustee—such as a REMIC trustee—does not have a fiduciary relationship with the beneficiaries, but nonetheless owes a duty of care to not “profit at the possible expense of [the] beneficiary.” Moreover, according to the Trust Agreements, the trustee was required to “hold all trust assets for the exclusive use and benefit of all present and future holders.” The Court further held that the Trust Agreements’ requirement that the assets must be purchased “at a price equal to the Termination Price” only reflects a threshold price, not a cap. To purchase the assets for a below-market termination price, as the trustee allegedly did here, would prohibit any residual security holders from ever seeing a return on their investment, and “[s]uch interpretation of the Trust Agreements is untenable and inconsistent with the trustee's general contractual duties to act on behalf of all security holders.” Accordingly, plaintiffs were allowed to proceed with their breach of contract claims.