January 12, 2010 5:38 PM

Mortgage Lender Hits Latham and Manatt with Malpractice Suit

Posted by Drew Combs

Latham & Watkins and Manatt Phelps & Phillips are the targets of a malpractice lawsuit filed by ECC Capital Corp., which accuses the firms of botching a deal to sell its mortgage-origination business and a subprime-loan portfolio to Bear Stearns & Co.

The deal in question closed in 2007, but the two companies wound up battling over it in court until reaching a settlement and finalizing terms last July. Now that the legal wrangling with Bear Stearns is over, ECC Capital is going after the law firms that represented it during the transaction.

In the suit--filed on Friday in Los Angeles Superior Court--ECC Capital claims that two law firms drafted an agreement with Bear Stearns that was flawed and incomplete. Specifically, the complaint states, provisions that should have shifted the risk of early defaults in the loan portfolio to Bear Stearns were not properly drafted.

“As a result of Latham and Manatt’s incompetent draftsmanship, [Bear Stearns subsidiaries] asserted positions that would have been untenable under properly drafted transactional documents, including refusing timely to purchase over $1 billion of loans,” the complaint states. 

A Latham spokesman tells The Am Law Daily: "We are aware of the suit and as a matter of firm policy we will not comment other than to say the allegations against our firm are wholly without merit." In a statement, Manatt also described the claims as "meritless" and said the firm will aggressively defend itself.

ECC Capital's suit doesn't specify how much it seeks in damages, but says an expert estimates that the company was deprived of more than $48 million it should have gotten from Bear Stearns had the law firms handled the deal properly. The ECC complaint also says the company racked up some $4 million in legal fees in its lawsuit against Bear Stearns as a result of the firms' shoddy work. 

By way of background: Under an October 2003 deal between Bear Stearns and ECC Capital, the former agreed to provide the latter with money for making mortgage loans, with Bear Stearns then purchasing the  portfolios of mortgages from ECC Capital and securitizing them.

Two years later, a struggling ECC Capital agreed to sell its loan-origination unit to a Bear Stearns subsidiary for $26 million. According to court documents, the deal included ECC Capital originating more than $1 billion in loans between October 2006, when the sale agreement was ultimately signed, and the February 2007 closing date.

Further, court documents indicate that given the size of the loan porfolio, ECC Capital was keen to shift the risk of any early mortgage defaults to Bear Stearns. Typically, ECC Capital's complaint states, the party selling a mortgage loan agrees to repurchase that loan if the borrower defaults soon after obtaining. But ECC Capital maintains in its filing that Bear Stearns and ECC Capital negotiated an agreement that shifted the risk to Bear Stearns.

The complaint goes on to state that ECC Capital specifically informed Latham and Manatt that it was critical for the executed agreement between the two parties to clearly and unambiguously describe the transfer of risk this way. (ECC Capital first hired Latham in 2004 in connection with its initial public offering. Manatt had served as outside counsel for the company since 2003. Over the years, both firms have represented the mortgage company on various corporate matters.)

“Latham and Manatt were responsible for negotiating and drafting all relevant transactional agreements, including but not limited to, those related to the financing, purchase, and sale of over $1 billion of mortgage loans during the preclosing period,” the complaint states.

The filing cites several instances of what it describes as malpractice, including the drafting of the agreement, which, ECC Capital claims, fails to clearly stipulate that Bear Stearns would assume the risk related to early defaults as agreed.

ECC's complaint also says the firms failed to have the appropriate Bear Stearns subsidiary sign the agreement regarding the loan-portfolio purchase. As a result of this confusion, ECC claims, Bear Stearns refused to buy loans shortly after they were originated, and imposed requirements that borrowers make first payments before the loans would be purchased.

According to media reports at the time, ECC Capital actually paid Bear Stearns $7 million when the deal closed in 2007 because the $26 million sale price was offset by $33 million that, per an earlier agreement, the mortgage company owed the investment bank for advances on loans that sold for less than anticipated.

In the settlement the two parties reached last July, Bear Stearns agreed to pay ECC Capital $15 million.

Roque Santi, ECC Capital’s president and chief financial officer, did not return calls seeking comment. The company is represented by Santa Monica law firm Spolin Silverman Cohen & Bosserman, which also did not return calls seeking comment.

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