Crisis Construction in Contract Boilerplate

By Strauss, Emily | Law and Contemporary Problems, Fall 2019 | Go to article overview

Crisis Construction in Contract Boilerplate


Strauss, Emily, Law and Contemporary Problems


I

INTRODUCTION

Why might judges interpret a boilerplate contractual clause to reach a result clearly at odds with its plain language? Though courts don't acknowledge it, one reason might be the economy. Boilerplate provisions are pervasive and enforcing some common clauses as written might cause additional upheaval during an economic crisis. Under such circumstances, particularly where other government interventions to shore up the market are exhausted, courts may step in to help restore investor confidence.

In the past, a number of scholars have argued that this is an important function of lawmakers generally. Under this theory, because the economy operates differently in times of crisis, specifically when interest rates near zero, the law should function differently as well. (1) In normal economic times, policymakers can decrease interest rates to stimulate demand and spur a stagnating economy by incentivizing people to spend rather than save. However, when interest rates near zero, as they did during the Great Depression and the Great Recession, this tool is unavailable. Under these circumstances, the theory goes, the law should be adjusted to produce decisions that restore confidence and activity in the market.

In this Article, I argue that courts have in fact done this. In the aftermath of the financial crisis, residential mortgage backed securities (RMBS) trusts, which held pools of loans and issued securities to investors, sued securities sponsors en masse on contracts warranting the quality of the mortgages sold to the trusts. These contracts almost universally contained provisions requiring sponsors to repurchase individual noncompliant loans. Significantly, this was the "sole remedy" for bad loans available to the trusts under the contractual language. (2) Due to the sheer volume of bad loans in these pools following the mortgage crisis, however, it was prohibitively expensive and cumbersome for trustees to enforce repurchase of these loans on an individual basis. The clause therefore benefited sponsors, who argued that it must be enforced as written. Recent scholarship has explained how enforcing these provisions would effectively leave trustees without a meaningful remedy for the vast pools of fraudulent or otherwise noncompliant loans that they had bought. (3)

Despite the unambiguous language of the sole remedy provision, in the aftermath of the crisis court after court held that trustees and other parties to these contracts could claim damages by sampling the loan pools and calculating breach and damages based on the sample, rather than forcing repurchase loan-by-loan. (4) Although this approach was facially inconsistent with the plain text of the sole remedy provision, these decisions gave trustees, and through them investors, the leverage to salvage millions--even billions--of dollars in settlements from the sponsors and originators who had made the shoddy loans. These decisions are generally not paragons of clarity. They did not rely on classic contract doctrines; initially, they relied on dubiously applied precedent, or on no reasoning at all. However, as these cases permitting sampling accumulated, later opinions came to rely on each other, creating a judicial echo chamber; for a time, judges cited the general consensus permitting sampling, even though it was contrary to the contractual language.

I argue that these decisions were an exercise in "crisis construction." This term refers to the act of interpreting a contract in light of the general economic turmoil existing at the time. Although the decisions permitting sampling generally do not include transparent reasoning, it appears that bolstering investor confidence--and thus stabilizing demand for mortgage-backed securities (MBSs), which was virtually paralyzed at the time--was a key consideration in disregarding the loan-by-loan repurchase requirement. The timing of these decisions suggests that a broader assessment of economic conditions motivated the decisions relaxing the requirement of loan-by-loan proof in the years immediately following the crisis. …

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