Sunsets and Loan Repurchase Provisions

When reviewing a 75+ page consumer loan sale agreement, you slow-pedal some provisions and fast-pedal others. You’re more focused on the recourse sections — repurchase and indemnification — because that’s where the action and exposure can be down the line. You home in on interrelated provisions, such as the loan-level representations and warranties, the definition of “repurchase price,” and the limitation on liability section. There are other important sections, including nonsolicitation and termination in a servicing retained deal. Naturally, to do your job right, you review the whole agreement.

In a moment of accidental poetry, this writer found himself reviewing a repurchase sunset clause in a loan sale agreement at sundown the other day. Yes, really, a sunset clause at sunset — perhaps a sign that a client alert on repurchases is in order?¹

Loan-Level Reps 

Sellers make a series of loan-level representations and warranties in loan sale agreements that the recourse remedies feed off of. There can be over 60 such reps in a residential mortgage loan sale agreement — such as that the loan was originated in compliance with law, the loan was made in accordance with the underwriting guidelines, the mortgage is an enforceable first lien, the mortgaged property is free from toxic or hazardous substances, or the one often cited in repurchase demands as grounds for putback, the too narrowly captioned “fraud” rep:

No Fraud: No error, omission, misrepresentation, negligence, fraud, or similar occurrence with respect to the mortgage loan has taken place on the part of any person, including the seller and the borrower.

This rep covers much more ground than fraud, including the open terrain of any mistake, omission, or “similar occurrence” (what this means is up for grabs). For example, omitting a single immaterial debt of the borrower in their debt-to-income (DTI) ratio calculation either by lender processing oversight or borrower reporting omission could very well be argued to be a breach of this rep. 

Customary Repurchase Provision

The repurchase remedy feeds off the loan-level reps in that a breach of a rep by the seller can trigger a repurchase right on the subject loan for the purchaser. Condensed, the normal formulation of a repurchase provision is: 

The seller must repurchase from the purchaser any loan for which the seller has breached any of its loan-level representations and warranties and such breach materially and adversely affects the value of the loan, if the breach is not cured within 45 days of the purchaser’s notice of the breach to the seller. 

The linchpin of the repurchase remedy is the MAE: The breach must materially and adversely affect the value of the loan to give rise to the repurchase right. The burden is on the purchaser making a repurchase demand to prove the causal connection between the breach and its material and adverse effect on the value of the loan. In the DTI example above, say the DTI ratio was a quarter point off because a debt was not included in the calculation, but the corrected ratio was still beneath the underwriting guideline DTI standard for origination or purchase — we would argue for the seller that the breach does not materially and adversely affect the value of the loan, and, therefore, repurchase is unwarranted.

Every once in a long while, we see a flat repurchase provision without an MAE in a purchaser’s form loan sale agreement. In those few cases, when on the seller side, consider adding the MAE to your mark. It shouldn’t be a controversial change because it’s customary to have an MAE there. If you don’t, that quarter-point difference in the DTI and other foot faults could give rise to a repurchase right. 

Purchasers Tightening the Repurchase Screws

Some purchasers look to include a number of additional clauses to the repurchase provision to add might to their repurchase right. Below are some examples.

Knowledge qualifier scrape. This is a clause that wipes out the effect of knowledge qualifiers that have been inserted on loan-level reps for purposes of repurchase. The consequence of a clause like this is that the seller would not be able to shield itself from a breach for which the seller did not know of its underlying issue. This makes sense for reps that the seller should know of their accuracy (e.g., origination and servicing compliance with law), but not so much for underlying issues that sellers could not have any knowledge of (e.g., toxic waste that is 20 feet under the surface in the backyard of the mortgaged property). Sellers that add a lot of knowledge qualifiers to the reps, particularly to those that sellers should know of the underlying issue or are in the best position to detect, are more likely to see purchasers counter with a knowledge qualifier scrape.

Deemed MAEs. Purchasers can have an uphill climb in a repurchase dispute because they shoulder the burden of proving the MAE. Some purchasers try to turn this handicap on its head by seeking to insert a clause providing that breaches of certain listed loan-level reps are deemed MAEs and that the seller can’t argue that the breach didn’t materially and adversely affect the value of the loan and repurchase is not in order. If there’s a breach of one of the listed reps, the seller automatically has to repurchase the subject loan. Purchasers with these deemed MAE clauses in their form loan sale agreements often try to include the fraud rep on their list of rep breaches that are deemed MAEs. Obviously, this doesn’t make sense in foot-fault breach scenarios like the quarter-point DTI illustration above. It’s hard to argue that some reps aren’t good candidates for such lists, such as, in the case of a mortgage loan sale, that the mortgage is an enforceable first lien. If the purchaser paid for a first-lien mortgage loan but it turns out that the loan is a second lien, certainly, the purchaser materially overpaid for the loan. Sellers should slow-pedal review of deemed MAE clauses and their listed reps. 

Purchaser has final say on satisfactory cure. Sellers usually are given 30 to 60 days to cure a breach and only have to repurchase the subject loan if the breach is not cured within the cure period. Purchasers will sometimes seek to revise the cure clause such that the cure must be completed to the purchaser’s satisfaction. Because a lot can be on the line, it’s uncommon to have one-party sole-discretion elements like this in recourse provisions. 

Arbitration. Some purchasers may seek arbitration clauses to govern repurchase disputes, believing that arbitration can bring faster, more favorable resolution to repurchase disagreements. Arbitration can move quicker than court litigation, which can be delayed by crowded dockets and procedural motions. The parties may select arbiters with subject matter expertise who are well-versed in assessing MAEs in this specific context. 

Sellers Loosening Them Up

There are many things sellers may advance in their loan sale agreement marks to loosen the repurchase screws. Below are some examples.

Remedy sunset! The biggest one is to have the repurchase right “sunset” after a prescribed period of time, meaning the purchaser can’t demand repurchase after the time period expires. The GSEs provide precedent for repurchase sunsets with their qualified 36-month sunset periods that came on line in 2013. The policy behind sunset clauses from a proponent’s perspective is that at some point, there has to be ownership risk and, considering the substantial breadth of the current market set of loan-level reps, repurchase is being used more as a loss allocation tool, not a quality tool. The agreement that was the inspiration of this Flash had a six-month sunset period! That agreement was for the sale of CRA loans, though. Generally, six months is off-market, but that or even less time can be appropriate in some cases for specialty sales like “scratch and dent” loan sales.

Repurchase price premium sunset. The repurchase price is often defined in the loan sale agreement as the product of the outstanding principal balance at the time of repurchase and the premium paid at the time of sale. So, if the purchaser paid a premium of 200 basis points for the loan and the loan had an outstanding balance of $500,000 at the time of repurchase, the repurchase price would be $510,000 ($500,000 times 1.02). You often see sellers advance that the premium part of the repurchase price calculation should drop off after a set period of time, resulting in a repurchase price at par after that time. The policy is that at some point, the purchaser has earned back the premium it paid. If agreed to, the most frequent drop-off period we see is 12 to 18 months. 

Reasoned push-backs. Sellers should develop loan repurchase policies and procedures. Repurchase demands from purchasers usually include only identification of the rep breached and often don’t comprehensively substantiate how the breach materially and adversely affects the value of the loan. An important part of those policies and procedures should be guidance regarding when to notify the purchaser that its demand is incomplete and that the purchaser must adequately show that the alleged breach materially and adversely affects the value of the loan to implicate repurchase. As we’ve said a number of times, the purchaser carries the burden of demonstrating the MAE. How to handle the back and forth on repurchase demands is beyond the scope of this Flash, but, fundamentally, operational time should be spent on this because significant amounts of money could be at stake.

Softening certain reps. The usual set of loan-level reps is very broad. From a seller’s perspective, there may be risk trimming that can be done to some reps, particularly if the loans won’t be securitized. For example, the omission prong in the fraud rep set out above is extremely broad and susceptible to deletion in a seller’s mark because it’s not tied to a specific activity or market standard, leaving open for argument whether what was “omitted” is customary in the loan origination process. 

The point about sellers potentially having more leeway on their repurchase provision revisions for loans that will not be securitized should be underscored. There are market conventions (e.g., rating agency standards) that securitization participants are pressured to follow. As we all know, the more leverage you have, the more leeway you get.

Goodwin’s Fintech Team

Our Fintech team counsels fintech companies, banks, investors, and other participants in the fintech and consumer financial services spaces on regulatory, transactional, enforcement and litigation matters. An important part of our practice is handling commercial disputes for our clients, including defending or prosecuting loan repurchase demands. Our team is led by partners Crystal Kaldjob, Kim Holzel, Alex Callen, Sammy Tang, and Mike Whalen. The team is highly ranked by Chambers and Legal500.