New York's economic loss rule, which acts as a check on asserting tort claims for purely economic damages, has long confounded practitioners. The rule, intended to preserve the distinction between contract and tort law and to protect defendants from disproportionate damages, has its most straightforward application in products liability and construction cases, but has been applied in a broad array of cases. The resulting body of case law is both complicated and confusing. In his recent decision in Ambac Assurance v. U.S. Bank National Association, 2018 WL 3212456 (S.D.N.Y. June 29, 2018), Judge William H. Pauley III attempts to make sense of the economic loss rule in the context of litigation arising out the collapse of the residential mortgage-backed securities (RMBS) market, exploring a split in authority within the Southern District of New York on the question of whether a plaintiff in an RMBS case seeking recovery for purely economic loss may assert claims for breach of fiduciary duty as well as for breach of contract. We discuss that decision below.

'Ambac v. U.S. Bank'

In broad strokes, the litigation before Judge Pauley involved claims by Ambac, as the insurer for a series of RMBS trusts, against U.S. Bank, the trustee of those trusts, for failing to take various actions against the originator of the underlying mortgages (Countrywide Home Loans, Inc. (Countrywide)) or the sponsor (Greenwich Capital Financial Products, Inc. (Greenwich)) who pooled and then transferred those loans ultimately to the trusts. During the loan securitization process, Countrywide made various representations and warranties to Greenwich about the quality of the underlying loans, backed by Countrywide's obligation to cure or repurchase any beaching loan. Greenwich assigned those rights to U.S. Bank as trustee, which took on the obligation to enforce those rights for the benefit of the trust beneficiaries, and assumed certain contractual, common law and statutory obligations to protect trust assets.

As the insurer of the trusts, Ambac was an express trust beneficiary, and asserted claims for breach of contract and breach of fiduciary duty (as well as certain statutory breaches) against U.S. Bank for violation of those obligations. The essence of those claims was that because of its own shortcomings in originating, underwriting and servicing residential mortgage loans, U.S. Bank as trustee of the RMBS trusts composed of Countrywide loans, failed to enforce Countrywide's obligations in order to avoid scrutiny of its own practices and to maintain good relationships with its own counterparties. Ambac asserted that U.S. Bank's abdication of its responsibilities depleted the trust assets and deprived the trusts of recoveries resulting in Ambac paying more than $300 million in insurance claims.

U.S. Bank moved both to stay Ambac's claims under the Colorado River abstention doctrine based on what it claimed were parallel state proceedings, and alternatively to dismiss certain claims as time-barred, and on the merits, including under the economic loss rule. Judge Pauley rejected U.S. Bank's abstention argument, finding that the state proceedings in favor of which U.S. Bank sought the stay were not sufficiently parallel, despite significant overlap of issues, because Ambac was not a party to either action.