Prior to Default, RMBS Trustees Owe Note Holders Extracontractual Duty to Perform Basic Functions

On July 5, 2016, the First Department issued a decision in Commerce Bank v. Bank of N.Y. Mellon, 2016 NY Slip Op. 05339, holding that prior to a default under a pooling and servicing agreement, an RMBS trustee owed note holders extra-contractual duties.

In Commerce Bank, the First Department considered a number of issues on appeal from a decision on a motion to dismiss a lawsuit against an RMBS trustee. One issue was whether an RMBS trustee had extra-contractual fiduciary duties. The court held that it did, stating that in AG Capital Funding Partners, L.P. v State St. Bank & Trust Co., "the Court of Appeals agreed with other courts that had held that prior to default, indenture trustees owe note holders an extracontractual duty to perform basic, nondiscretionary, ministerial functions." However, the court went on to hold that it was not a breach of this duty to fail "monitor other parties," because "[a] failure to monitor other parties plainly does not involve the performance of basic non-discretionary ministerial tasks."

The court held that an RMBS trustee also has a "pre-default duty to avoid conflicts of interest," but that in that case, the plaintiff had failed to allege a conflict of interest, holding that "[t]he existence of a conflict of interest can not be inferred solely from a relationship between an issuer and an indenture trustee that is mutually beneficial and increasingly lucrative." (Internal citations omitted).