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Challenging New Breaches of a Contract Without Running Afoul of the Statute of Limitations

August 22, 2012
Morris James LLP
Delaware Business Court Insider

When does amendment of a complaint to assert a new breach of contract claim relate back to the date of the original complaint asserting different breaches of the same contract? The Court of Chancery recently addressed this issue in Central Mortgage v. Morgan Stanley Mortgage Capital Holdings LLC, C.A. No. 5140-CS (Del. Ch.).

This litigation arose from a 2005 contract between plaintiff Central Mortgage and defendant Morgan Stanley for the purchase of servicing rights for mortgage loans that Morgan Stanley intended to sell to government agencies and private investors. Under the master agreement, Central Mortgage obtained the right, but not the obligation, to purchase servicing rights for specific pools of loans. Central Mortgage had access to the loan files before purchasing service rights to each loan pool so it could review the loans. Morgan Stanley represented that information set forth in a mortgage loan schedule it made available to Central Mortgage along with accompanying data files was complete and accurate. Morgan Stanley also represented that it did not commit fraud with regard to the loans and, to the best of its knowledge, neither did the originator or borrower. If Central Mortgage learned that Morgan Stanley breached any of its representations or warranties, it had to provide prompt written notice of such a breach. Morgan Stanley then had the opportunity to cure. If the breach was not curable, Central Mortgage could opt to require Morgan Stanley to repurchase the servicing rights affected by the breach for a set price.

From October 2005 through August 2007, the parties entered into 26 different servicing transactions under the master agreement for more than 20,000 loans. Many loans for which Central Mortgage acquired the servicing rights fell into delinquency and the government agencies exercised their right to put certain of those loans to Central Mortgage for repurchase. Claiming that the putback of the loans to Central Mortgage was due to Morgan Stanley's breaches of representation and warrants relating to the truth and accuracy of information contained in the mortgage loan schedule and accompanying data files, Central Mortgage demanded that Morgan Stanley repurchase the loans returned to Central Mortgage. After repurchasing some of the loans, Morgan Stanley stopped doing so in March 2009.

Central Mortgage first sued Morgan Stanley on December 14, 2009, alleging that Morgan Stanley breached the master agreement for 47 agency loans that were returned to Central Mortgage and that Morgan Stanley refused to repurchase (original loans). The Court of Chancery granted Morgan Stanley's motion to dismiss Central Mortgage's claims for breach of contract and breach of the implied covenant of good faith and fair dealing for failure to state a claim. After the Supreme Court reversed the dismissal of these claims on the grounds that Central Mortgage had satisfied the liberal pleading standard for stating a claim, Central Mortgage filed an amended complaint on November 4, 2011. In the amended complaint, Central Mortgage added breach of contract and implied covenant claims for an additional 218 agency loans that had been put back by government agencies (new agency loans). Central Mortgage also added claims attacking 12,000 private loans (together with the new agency loans, "new loans"). Morgan Stanley moved to dismiss the new loans claims, which arose from servicing rights contracts entered into between October 2005 and August 2007, on the grounds that they were barred by Delaware's three-year statute of limitations. In opposing Morgan Stanley's motion to dismiss, Central Mortgage argued that the new loans claims related back to the date of the original complaint (December 2009).

The Court of Chancery began its analysis by noting that as a court of equity it analyzes whether a claim is time-barred under the doctrine of laches. Usually, the Court of Chancery applies the relevant statute of limitations by analogy. The court next determined that Delaware's three-year statute of limitations for contract claims applied, rather than New York's six-year statute of limitations. Under Delaware's borrowing statute, the court will apply the shorter of the statutes of limitations where the case is brought versus the statute of limitations where the case arose. Delaware's statute of limitations for contract claims is shorter than New York's, so the court applied Delaware's three-year statute of limitations.

As the court emphasized, Delaware's statute of limitations for contract claims begins to run on the date of the breach. Because the servicing rights contracts were entered into between October 2005 and August 2007, Central Mortgage had until October 2008 through August 2010 to file litigation regarding the new loans. Central Mortgage did not file the amended complaint until November 4, 2011, which was more than four years after purchase of the servicing rights for the last new loans. Unless the new loans claims in the amended complaint related back to the original complaint, those claims were time-barred.

Under Court of Chancery Rule 15(c), an amendment of a complaint dates back to the date of the original complaint when the claim asserted in the amended complaint arises out of the conduct, transaction or occurrence set forth in the original pleading. The court stated that the determinative factor is whether the defendant should have notice from the original pleading that the plaintiff might assert a new claim. Central Mortgage claimed it satisfied Rule 15(c) because the claims relating to the new loans were based on the same master agreement and conduct of the parties set forth in the original complaint. Morgan Stanley argued that Rule 15(c) was not satisfied because the new loans claims were based on independent breaches of the master agreement and the original complaint did not give it fair notice of the new loans claims.

The court held that the new loans claims did not satisfy Rule 15(c), did not relate back to the original complaint and were therefore time-barred. According to the court, each sale of loan servicing rights was a separate and independent transaction. The new loans involved separate and independent transactions that were not alleged in the original complaint and therefore did not date back to the original complaint. The court also held that even if the loans might have been part of the same loan pool, each alleged breach of representation by Morgan Stanley for each individual loan constituted a separate transaction. As the court stated, a separate, independent breach of a contract provision does not arise out of the same conduct as a prior, unrelated breach of the same contract.

Further, the court noted that Central Mortgage's theory was inconsistent with the terms of the master agreement. The master agreement required Central Mortgage to provide notice of a breach of representation or warranty on a loan-specific basis so that Morgan Stanley had the opportunity to cure on a loan-specific basis. Under Central Mortgage's theory as characterized by the court, notice of a breach of one loan would be notice of breaches of the remaining 20,000 plus loans. The court expressed concerns regarding the public policy implications if such a theory were accepted. In addition, the court pointed out that Central Mortgage had disclaimed the private loans as the subject matter of the litigation in the original complaint and at oral argument on the motion to dismiss the original complaint. In light of those disclaimers, the court questioned how Morgan Stanley could have notice of the private loans claims from the original complaint. Finally, the court rejected Central Mortgage's arguments that the statute of limitations was tolled.

Litigators should keep this decision in mind when they are preparing a breach of contract claim and there is the possibility of additional breaches of the same contract. If those additional breaches are not pled in the original complaint or before the running of the statute of limitations, then those claims may not relate back to the original contract and may be time-barred.