The FDIC Suffers a Setback in Case Against Lender Processing Services and LSI Appraisal
As reported in prior posts, the FDIC, as receiver for failed lender Washington Mutual, sued appraisal management company LSI Appraisal and its corporate parent Lender Processing Services for breach of contract and gross negligence on May 9, 2011 (see post here), and on July 22, LSI and LPS filed a motion to dismiss. In that motion, LSI argued that the FDIC’s gross negligence claim should be dimissed based on the economic loss rule, that the FDIC’s alter ego claims against LSI’s affiliated corporate entities (including LPS) should be dismissed because the allegations were legally insufficient, and that the remaining breach of contract claim was subject to arbitration (see post about the motion here).
Whether the FDIC’s gross negligence claim remains in the case is a key issue because LSI’s contract with WaMu contains several provisions imposing a limitation or cap on the damages that might be owed by LSI. In order for LSI to have a reasonable chance of imposing such a cap, it needs to get the gross negligence claim thrown out because New York law (which applies to its contract with WaMu) generally prohibits limitations of liability for gross negligence. At the extreme, it could mean the difference between a $1 million case and $100+ million case. In my earlier post about the motion, I offered that I believed LSI’s arguments against the gross negligence claim were sound and that I believed Judge Carter would give them credence because he has dismissed similar tort claims by the FDIC against other mortgage service providers based on the rule.
Judge Carter ruled yesterday.
His ruling is a significant setback for the FDIC and its aggressively pleaded complaint. Judge Carter granted LSI’s motion to dismiss the gross negligence claim based on the economic loss rule and also granted the motion as to the alter ego claims. Subject to the filing of an amended complaint, that means Lender Processing Services itself is out of the case and that the only remaining claims against LSI are contractual. However, the Court has given the FDIC leave to file an amended complaint in which the FDIC may try to plead new allegations supporting its gross negligence and alter ego claims. The Court did rule that the contract claims were not subject to arbitration — that means the case will stay in the court system open to the public eye.
In another embarrassment for the FDIC, Judge Carter earlier ruled that he would not consider a last-ditch, untimely sur-rely filed by the FDIC after the completion of the regular motion briefing. It was in that sur-reply filed on September 6 that the FDIC offered up its argument that appraisers are the legal agents of AMCs. Thus, the Court did not rule on that argument in its order on the motion to dismiss. I expect, however, that the FDIC will renew this contention if it files an amended complaint. In typical cases, I’d usually 100% expect a plaintiff to file an amended complaint trying to salvage its dismissed claims. With the FDIC, however, the filing of an amended complaint is not a given; the FDIC sometimes quietly rolls over and does not amend when it loses an issue early. It probably does so because in these early round litigations it is methodically trying to create momentum for other claims in future lawsuits designed to maximize recoveries and does not want to create barriers to making the same claims in other cases by escalating the significance of litigation in cases where it loses on a particular point. In another case in which the FDIC lost on the economic loss rule, it quietly let that claim be dismissed without trying to amend its pleading.
If LSI and LPS ultimately succeed with keeping the gross negligence claim out based on the economic loss rule and limiting liability exposure based on contractual caps, it won’t really be a satisfying win for them in terms of principle. These are technical grounds. It’s the same thing as when an appraiser wins the rare victory against a negligence claim based on a statute of limitations — the appraiser does a victory dance, but the appraiser’s work quality is not vindicated.
A copy of the Court’s order on the motion to dismiss is available at www.appraiserlaw.com. The Court’s order in this case provides a good hint about the likely outcome of CoreLogic’s similar motion to dismiss in the FDIC’s companion case against that company. However, the contract claim against CoreLogic is potentially more significant in its likely financial outcome.