I Meant it at the Time: Second Circuit Reverses $1.2BN FIRREA Judgment

It's hornbook law that a later intentional breach of contract, alone, doesn't equal promissory fraud.

Holding it therefore cannot establish mail or wire fraud, the Second Circuit reversed the Government's $1.2 Billion FIRREA judgment against Countrywide, Bank of America and others, with instructions to dismiss the case. The case started as a qui tam action alleging that Countrywide's "high-speed swim lane" process delivered substandard mortgage loans to GSEs (Fannie, Freddie) during performance of master mortgage-loan sales agreements ("MLSAs") executed earlier. The evidence at trial indicated adequate performance earlier in the contract term and the Government adduced no evidence of intent not to perform at the time of contract performance. The FIRREA action (12 U.S.C. § 1833a) rests on predicate offenses of mail and wire fraud (18 U.S.C. § 1341, 1343). Mail and wire fraud, in turn incorporate common-law standards, such that a later "willful" (intentional) breach of contract (e.g. of reps and warranties of "product" standards) are not sufficient to establish promissory fraud, where the agreement originally was entered with the intent to perform.

As explained below, where allegedly fraudulent misrepresentations are promises made in a contract, a party claiming fraud must prove fraudulent intent at the time of contract execution; evidence of a subsequent, willful breach cannot sustain the claim.

Op. at 14 (citing hornbook law, including Cardozo in Ultramares Corp. v. Touche, 255 N.Y. 170, 187 (1931); see also RESTATEMENT (FIRST) OF TORTS § § 526, 531 (1938)). The Court distinguished the Government's "repeated certification" cases:

These cases are distinguishable, however, in that none recognize a contract breach, by itself, to constitute fraud. Rather, in each, the defendants made affirmative fraudulent misrepresentations to their contractual counterparties in the course of performance or to feign performance under the contract. See, e.g., United States v. Naiman, 211 F.3d 40, 44, 49 (2d Cir. 2000) (submitting false certifications of compliance required by contracts with the government).

Op. at 13 (or otherwise involving fraudulent statements outside the four corners of the contract, Op. at 21, n. 12). And the Court held that was especially true where the parties themselves had bargained for a contractually-determined remedy for subsequently breached performance obligations, as here with the MLSA repurchase obligation. Op. at 22, n. 13. The opinion is United States ex rel. O'Donnell v. Countrywide Home Loans, Inc., Nos. 15-496, 15-499 (2nd Cir. May 23, 2016).

Thomas K. Potter, III (tpotter@burr.com) is a partner in the Securities Litigation Practice Group at Burr & Forman, LLP. Tom is licensed in Tennessee, Texas and Louisiana. He has over 30 years' experience representing financial institutions in litigation, regulatory and compliance matters. See attorney profile. © 2016 by Thomas K. Potter, III (all rights reserved).

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