FILED: NEW YORK COUNTY CLERK 02/25/ :55 PM INDEX NO /2014 NYSCEF DOC. NO. 4 RECEIVED NYSCEF: 02/25/2015

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1 FILED: NEW YORK COUNTY CLERK 02/25/ :55 PM INDEX NO /2014 NYSCEF DOC. NO. 4 RECEIVED NYSCEF: 02/25/2015 SUPREME COURT OF THE STATE OF NEW YORK COUNTY OF NEW YORK SPECIALTY UNDERWRITING & RESIDENTIAL FINANCE TRUST, SERIES 2006-AB3 (SURF AB3), BY U.S. BANK NATIONAL ASSOCIATION, SOLELY IN ITS CAPACITY AS TRUSTEE, v. Plaintiff, MERRILL LYNCH MORTGAGE LENDING, INC., AND MERRILL LYNCH MORTGAGE INVESTORS, INC., Defendants. x : : : : : : : : : : : : : : : : : : x Index No /2014 COMPLAINT Dated: February 25, 2015 New York, New York

2 Plaintiff Specialty Underwriting & Residential Finance Trust, Series 2006-AB3 (the Trust ), by and through U.S. Bank National Association (the Trustee ), acting solely in its capacity as Trustee of the Trust, for the benefit of the Trust certificateholders and at the direction of one or more Trust certificateholders, for its Complaint against defendants Merrill Lynch Mortgage Lending, Inc. ( Merrill Lending ) and Merrill Lynch Mortgage Investors, Inc. ( Merrill Investors and, together with Merrill Lending, Defendants ), hereby alleges as follows upon personal knowledge or information and belief: NATURE AND SUMMARY OF ACTION 1. The Trustee seeks redress for breaches of representations and warranties (the Representations ) that Defendants made concerning the mortgage loans (the Mortgage Loans ) backing the SURF 2006-AB3 residential mortgage-backed securitization (the Securitization ). The Trustee also seeks redress for Defendants failure to comply with their separate obligations to promptly inform the Trustee of those breaches. 2. The Representations concerned the Mortgage Loans quality, characteristics and risk profile and, therefore, covered the integrity of the original underwriting process, the borrowers creditworthiness and ability to repay the Mortgage Loans as agreed, and the appraised value of the mortgaged properties. 3. Defendants made or otherwise assumed liability for the Representations through certain agreements underlying the Securitization. Those agreements include: (i) the Mortgage Loan Sale and Assignment Agreement dated as of September 1, 2006 (the Sale Agreement ), to which defendants Merrill Lending and Merrill Investors are parties; (ii) the Pooling and Servicing Agreement dated as of September 1, 2006 (the PSA ), to which defendant Merrill Investors, the Trustee and non-party Wilshire Credit Corporation are parties; (iii) two 1

3 Subsequent Mortgage Loan Purchase Agreements dated as of October 18, 2006 and November 14, 2006 ( Subsequent Purchase Agreements ) to which defendants Merrill Lending and Merrill Investors are parties; and (iv) two Subsequent Transfer Instruments, dated as of October 18, 2006 and November 14, 2006, to which defendant Merrill Investors and the Trustee are parties. This complaint refers to the Sale Agreement, the PSA, the Subsequent Purchase Agreements and the Subsequent Transfer Instruments collectively as the Deal Contracts. 4. In breach of the Deal Contracts, a substantial number of the Mortgage Loans did not conform to the Representations as of the date the Representations were made. These breaches materially and adversely affect the value of the related Mortgage Loans, payment charges or the interests of the certificateholders. This complaint refers to those breaches as Material Breaches and refers to the Mortgage Loans affected by those breaches as Defective Loans. 5. Pursuant to the Deal Contracts, both Defendants were obligated, upon discovering any Material Breaches, to notify the Trustee and other parties promptly in writing (the Notice Obligations ). 6. Pursuant to the Deal Contracts, both Defendants were also obligated, within 90 days after learning of any Material Breach, to: (i) cure the Material Breach in all material respects; (ii) repurchase the affected Defective Loan from the Trustee at a contractually-defined purchase price; or (iii) otherwise, under applicable law, pay damages for each Defective Loan with respect to which specific performance is impracticable, impossible or otherwise unavailable (collectively, the Repurchase Obligations ). 7. Defendants have known about the Material Breaches for years because Defendants independently discovered Material Breaches and the Trustee specifically notified 2

4 Defendants of Defective Loans. In breach of their contractual obligations, Defendants failed to comply with their Notice Obligations and their Repurchase Obligations. Defendants breaches of their applicable contractual obligations have caused the Trust to incur substantial losses. 8. One or more Trust certificateholders have directed the Trustee to pursue this action to enforce Defendants Representations and their related Repurchase Obligations. To the extent specific performance is impracticable, impossible or otherwise unavailable, the Trustee seeks damages in lieu thereof. The Trustee also seeks damages as a result of Defendants breach of their Notice Obligations and other ancillary relief set forth below. THE PARTIES 9. The Trust is a residential mortgage-backed securities trust that was created and organized under the PSA pursuant to the laws of New York. U.S. Bank National Association, which is the Trustee of the Trust, is a federally chartered, national banking association that is headquartered in Minneapolis, Minnesota, with a registered principal office in Cincinnati, Ohio. 10. Defendant Merrill Lending is a Delaware corporation with its principal place of business located in New York, New York. Merrill Lending was the sponsor of the Securitization. At the time of the Securitization, Merrill Lending was a subsidiary of Merrill Lynch & Co., which owned, directly or indirectly, at least 99% of its voting securities. In January 2009, Bank of America Corporation ( Bank of America ) acquired Merrill Lynch & Co. and its subsidiaries, including Merrill Lending. 11. Defendant Merrill Investors is a Delaware corporation with its principal place of business located in North Carolina. Merrill Investors acted as the depositor in connection with the Securitization. At the time of the Securitization, Merrill Investors was a subsidiary of Merrill Lynch & Co., which owned, directly or indirectly, at least 99% of its voting securities. Bank of America also acquired Merrill Investors through its January 2009 Merrill Lynch acquisition. 3

5 JURISDICTION AND VENUE 12. This Court has personal jurisdiction over Merrill Lending pursuant to CPLR 301 and 311 and BCL 304, 305 and Since 2001, Merrill Lending has been a registered foreign corporation that is authorized to transact business in the State of New York. It regularly does so in New York, New York, where it maintains its principal place of business. In addition, Merrill Lending has appointed a registered agent for the service of process that is located in New York, New York. Personal jurisdiction over Merrill Lending is therefore predicated upon Merrill Lending s consent, its presence within the State of New York, and its having been properly served inside the State of New York with the Summons with Notice that initiated this action. This Court also has personal jurisdiction over Merrill Lending under CPLR 301 and 302 based on Merrill Lending s conduct with respect to the specific transactions and occurrences from which this case arises. Further, upon information and belief, a substantial percentage of the Mortgage Loans purchased by Merrill Lending and sold to Merrill Investors for deposit within the Trust relate to properties located in New York. 13. This Court has personal jurisdiction over Merrill Investors pursuant to CPLR 301 and 311 and BCL 304, 305 and Since 1987, Merrill Investors has been a registered foreign corporation that is authorized to transact business in New York. It regularly does so in New York, New York. In addition, Merrill Investors has appointed a registered agent for the service of process that is located in New York, New York. Personal jurisdiction over Merrill Investors is therefore predicated upon Merrill Investors consent, its presence within the State of New York, and its having been properly served inside the State of New York with the Summons with Notice that initiated this action. This Court also has personal jurisdiction over Merrill Investors under CPLR 301 and 302 based on Merrill Investors conduct with respect to the specific transactions and occurrences from which this case arises. Further, upon 4

6 information and belief, a substantial percentage of the Mortgage Loans purchased by Merrill Investors and deposited into the Trust relate to properties located in New York. 14. Venue is proper in New York County pursuant to CPLR 503. CPLR 503 makes venue proper in any county in which any party resides. It further provides that an authorized foreign corporation is deemed to be a resident of the county in which its principal office is located. Defendant Merrill Lending is an authorized foreign corporation with a principal office that is located in New York County. FACTUAL ALLEGATIONS I. The Securitization 15. The Securitization is a typical residential mortgage-backed securities (RMBS) securitization, meaning that the investment bank pooled residential mortgages into a trust, which then issued investors securities in the form of certificates. Each certificate entitles the holder to a portion of the monthly revenue stream that flows from the borrowers mortgage payments. 16. The following chart provides a visual depiction of the Securitization: 5

7 17. Merrill Lending acquired the Mortgage Loans, which were originated primarily in 2006, from certain third-party mortgage loan originators. In the prospectus supplement through which the Securitization was marketed and sold (the Prospectus Supplement or Pro. Supp. ), Merrill Lending s affiliated underwriter, Merrill Lynch, Pierce, Fenner & Smith, Inc., represented that Merrill Lending selected and purchased the Mortgage Loans through its Specialty Underwriting and Residential Finance ( SURF ) division, employing certain underwriting standards and guidelines that SURF had established. The underwriting standards and guidelines, which are referred to in the Prospectus Supplement and herein as the SURF Underwriting Guidelines, are described in greater detail below. 18. The Trust s pool ultimately consisted of 1,934 Mortgage Loans with an aggregate principal balance of approximately $425,000,053. A. The Initial Mortgage Loans 19. Through the Sale Agreement, Merrill Lending (denominated as Seller ) sold 1,486 of the Mortgage Loans (the Initial Mortgage Loans ) to Merrill Investors (as Depositor ) to be deposited into the Trust. 20. In Section 1.04(b) of the Sale Agreement, Merrill Lending made a number of the Representations at issue here (the Merrill Lending Representations ). The Merrill Lending Representations are described below in Section II.A. 21. Through the PSA, Merrill Investors (as Depositor ) created the Trust, deposited the Initial Mortgage Loans into the Trust, and sold all of its rights, title and interests in the Initial Mortgage Loans to the Trust for the benefit of the certificateholders. (PSA, Sections 2.01, 2.03(c), 2.11.) In exchange, the Trust issued certificates to the Depositor. (PSA, Section 2.06.) 6

8 The certificates represent beneficial ownership interests in the Trust, which are backed by the Mortgage Loans After entering the PSA, the Depositor then sold the certificates to its affiliated underwriter, nonparty Merrill Lynch, Pierce, Fenner & Smith, Inc., to market and sell the certificates to investors. B. The Subsequent Mortgage Loans 23. Through the Subsequent Purchase Agreements, Merrill Lending (as Seller ) sold the balance of the Mortgage Loans (the Subsequent Mortgage Loans ) to Merrill Investors (as Purchaser ) for deposit into the Trust. 24. Section 2.01 of both Subsequent Purchase Agreements incorporated by reference and affirmed the Merrill Lending Representations with respect to the Subsequent Mortgage Loans. 25. Through the Subsequent Transfer Instruments, Merrill Investors (as Depositor ) sold to the Trust (again for the certificateholders benefit) all of its rights, title and interests in the respective Subsequent Mortgage Loans. (Subsequent Transfer Instruments, Section 1.) 26. Prior to entering each Subsequent Transfer Instrument, Merrill Lending delivered to the Trustee a letter containing certain certifications (the Officer Certificate ). 27. In Section 2(a) and Attachment A of each Subsequent Transfer Instrument, as well as in each Officer Certificate, Merrill Investors made additional Representations with respect to the Subsequent Mortgage Loans (the Merrill Investors Representations ). The Merrill Investors Representations are described in Section II.B below. 7

9 28. In the Deal Contracts, Defendants undertook Notice Obligations and Repurchase Obligations with respect to the Representations. Defendants Notice and Repurchase Obligations are further described in Section III below. II. The Representations A. The Merrill Lending Representations 29. The Merrill Lending Representations which apply to both the Initial Mortgage Loans and the Subsequent Mortgage Loans generally concern the Mortgage Loans quality, characteristics and risk profile and are critical to accurately assess the Mortgage Loans value. They are set forth in Section 1.04(b) of the Sale Agreement (which is incorporated by reference into Section 2.01 of the Subsequent Purchase Agreements with respect to the Subsequent Mortgage Loans). Paragraphs 30 through 37 below provide examples of the Merrill Lending Representations. 30. The Representation Concerning No Fraud: In Section 1.04(b)(liii) of the Sale Agreement, Merrill Lending represented as to the third-party originators: No fraud has taken place on the part of the originator or any person in connection with the origination of the Mortgage Loan. 31. The Representation Concerning No Event of Default: In Section 1.04(b)(xxvi) of the Sale Agreement, Merrill Lending represented: There is no material monetary default existing under any Mortgage or the related Mortgage Note and, to the best of the Seller s knowledge, there is no material event that, with the passage of time or with notice and the expiration of any grace or cure period, would constitute a default, breach, violation or event of acceleration under the Mortgage or the related Mortgage Note; and the Seller has not waived any default, breach, violation or event of acceleration. 8

10 32. The Representation Concerning Conformity with the Prospectus Supplement: In Section 1.04(b)(xxxi) of the Sale Agreement, Merrill Lending represented: The Mortgage Loans, individually and in the aggregate, conform in all material respects to the descriptions thereof in the Prospectus Supplement. Based on various descriptions of the Mortgage Loans in the Prospectus Supplement, this broad Representation resulted in Merrill Lending having effectively made a number of representations about the Mortgage Loans characteristics, including, for example, their loan-to-value ratio ( LTV ), their combined loan-to-value ratio ( CLTV ), their debt-to-income ratio ( DTI ), their compliance with the SURF Underwriting Guidelines, and other characteristics, as alleged below. a) LTV and CLTV: The Prospectus Supplement described all Mortgage Loans as having an LTV and CLTV of less than or equal to 100%. (See Pro. Supp., A-II- 5) 1 In other words, through the Prospectus Supplement, Merrill Lending effectively represented that no Mortgage Loan had an LTV or CLTV higher than 100%. LTV is the ratio between the mortgage amount and the lower of the purchase price or the appraised value of the property. It reflects how much a borrower has already committed to the property though a down payment or otherwise and therefore is a factor in assessing whether a borrower is likely to abandon a loan. CLTV is the same, but considers the total amount of all mortgages to which the property is subject. A lower LTV or CLTV is considered 1 Annex II of the Prospectus Supplement described the characteristics of the mortgage pool consisting of the Initial Mortgage Loans only. The Prospectus Supplement also stated that it was expected that the material characteristics of the final mortgage pool, after the addition of the Subsequent Mortgage Loans, would not materially differ. (See, e.g., Pro. Supp. at S-32.) It further stated that a form 8-K would be filed with the Securities and Exchange Commission that would describe the characteristics of the final mortgage pool. (Id. at S-60.) On November 26, 2006, Merrill Investors filed an 8-K stating that all of the Mortgage Loan in the final pool had an LTV or CLTV of less than or equal to 100%. (See 8-K, Ex at A-II-5.) 9

11 less risky because: (i) the borrower is less likely to default on the mortgage payments because he or she is more likely to view the home as a good investment (since the borrower s equity in the home will not be wiped out, or will not be wiped out as quickly, if the value of the home decreases); and (ii) the collateral for the mortgage provides more coverage for the lender if the borrower defaults. For example, if the initial value of a property is $100,000 and the loan amount is $100,000 (giving the property an LTV of 100%), the lender is more at risk if the market declines than a situation where the initial value of the property is $150,000 and the loan amount is $100,000 (giving the property an LTV of 67%). b) DTI: The Prospectus Supplement also described all Mortgage Loans as having a DTI of less than or equal to 55.42%. (Pro. Supp., A-II-6). 2 In other words, through the Prospectus Supplement, Merrill Lending represented that no Mortgage Loan had a DTI higher than 55.42%. DTI reflects the borrower s monthly debt payments in relation to the amount of the borrower s monthly income and therefore is an indicator of the borrower s ability to pay. Mortgage Loans with higher DTIs pose increased credit risk: in general, a borrower is more likely to miss mortgage payments when the margin between income and obligations is tighter. For example, if the borrower has a change in circumstances, such as an income decline or an increase in debt obligations, the borrower may have more difficulty making required payments. c) SURF Underwriting Guidelines: The Prospectus Supplement also describes the Mortgage Loans as [a]ll having been originated generally in accordance with 2 Merrill Investors November 26, 2006 Form 8-K stated that all Mortgage Loans (Initial and Subsequent) have a DTI of less than or equal to 56.69%. (See 8-K, Exhibit 99.1 at A-II-6). 10

12 SURF s Underwriting Guidelines, which are described in the Prospectus Supplement. (Prospectus Supp., S-37 ( All of the Mortgage Loans were originated generally in accordance with SURF s Underwriting Guidelines. )); (id. at S-37 S-45.) According to the Prospectus Supplement, the SURF Underwriting Guidelines were primarily intended to evaluate the prospective borrower s ability and willingness to repay the loan, determine the value and marketability of the proposed mortgaged property, and ensure the loan complies with applicable regulations. (Id. at S-37.) i. While the Prospectus Supplement indicated that there may be some exceptions to the Mortgage Loans compliance with the SURF Underwriting Guidelines, the Prospectus Supplement represented that in such exceptional cases compensating factors exist or the Mortgage Loan is considered to be in substantial compliance with the SURF Underwriting Guidelines. (Id. at S- 37.) According to the Prospectus Supplement, compensating factors include various signs of creditworthiness, such as a low LTV, a substantial level of verified reserves and/or residual income, a stable employment history, or a strong mortgage payment history. (Id.) According to the Prospectus Supplement, Exceptions are reviewed on a case-by-case basis by SURF credit management to determine eligibility and to ensure consistency. (Id.) ii. In general, the SURF Underwriting Guidelines established a number of requirements pertaining to the characteristics of a given Mortgage Loan, including its LTV, its CLTV, its DTI, the borrower s credit rating, and other characteristics. These requirements, in turn, varied depending on a number of 11

13 factors including: (a) the credit grade classification (or Credit Grade Category ) into which the given Mortgage Loan was purportedly placed based on certain risk factors established by SURF (described further below); (b) the loan amount; (c) the type of property (e.g., owner occupied versus non-owner occupied); and (d) the level of documentation provided about the borrower s income, employment history and/or assets pursuant to certain reduced documentation loan programs (e.g., full documentation, lite documentation, stated income documentation, no ratio documentation, stated income / stated asset documentation, no income / no asset documentation, and no doc documentation. ). iii. According to the Prospectus Supplement, each Mortgage Loan was placed into one of five Credit Grade Categories, labeled PA1, PA2, PA3, SA1 and SA2. Associated with each Credit Grade Category were various factor grading criteria establishing minimum credit score, maximum DTI, cash out limits, housing payment history, bankruptcy history and foreclosure history. (See id. at S-39 through S-42.) For example, to be placed in Credit Grade Category PA1, a Mortgage Loan was required to have a minimum associated credit score of 720, a maximum associated DTI of 50% (maximum of 55% with certain compensating factors), a maximum cash out limit of $250,000 for owner occupied properties ($150,000 for non-owner occupied properties), and other criteria. (Id. at S-40.) Credit Grade Category of PA3 required the Mortgage Loan to have a minimum credit score of 620, a maximum DTI of 45% (maximum of 50% with certain compensating factors), 12

14 a maximum cash out limit of $250,000 for owner occupied properties ($150,000 for non-owner occupied properties), and other criteria. (Id. at S- 41.) iv. According to the Prospectus Supplement, the SURF Underwriting Guidelines set limits on the loan-to-value/combined loan-to-value ratios that [were] allowed based on income documentation type, property type, loan amount and [Credit Grade Category]. (Prospectus Supp., S-42.) Thus, for example, for a Mortgage Loan with a Credit Grade Category of PA1, the maximum LTV and CLTV was 100%, regardless of documentation type. For a Mortgage Loan with a Credit Grade Category of PA3, the maximum LTV and CLTV for owner occupied properties with full documentation was 100%, but the maximum LTV for non-occupied properties with stated documentation loans was 90%. (See Pro. Supp., S-43.) In addition, lower maximums could apply if the particular Mortgage Loan was not covered by mortgage insurance. (Id.) v. The SURF Underwriting Guidelines also required that [p]roperties securing the mortgage loans [be] appraised by qualified independent appraisers. (Prospectus Supp., S-42.) The SURF Underwriting Guidelines further require[d] a review of the appraisal by a loan underwriter, who may request additional diligence. (Id.) vi. According to the Prospectus Supplement, the SURF Underwriting Guidelines required that all Mortgage Loans comply with all applicable federal, state and local laws. (Id. at S-37.) 13

15 33. The Representation Concerning the Mortgage Loan Schedule. In Section 1.04(b)(i) of the Sale Agreement, Merrill Lending represented: The information set forth with respect to the Mortgage Loans on the Mortgage Loan Schedule provides a true, complete, and accurate [sic] and there are no material omissions of material facts. The Mortgage Loan Schedule, in turn, provided information about each Mortgage Loan, including (i) the LTV at origination with respect to a first lien Mortgage Loan or the CLTV with respect to a second lien Mortgage Loan; (ii) whether the collateral property was owner occupied; and (iii) the credit score for each borrower. 34. The Representation Concerning the Underwriting Methodology: In Section 1.04(b)(lv) of the Sale Agreement, Merrill Lending represented: The Mortgage Loan originator s methodology employed objective criteria such as the Mortgagor s income, assets and liabilities, in making a determination as to the Mortgagor s ability [sic] make timely payments on the Mortgage Loan. 35. The Representation Concerning Compliance with Applicable Law: In Section 1.04(b)(xlvi) of the Sale Agreement, Merrill Lending represented: Each Mortgage Loan at the time it was made complied in all material respects with applicable local, state and federal laws, including, but not limited to, all applicable predatory or abusive lending laws. Likewise, in Section 1.04(b)(xlvii) of the Sale Agreement, Merrill Lending represented: All Mortgage Loans were originated in compliance with all applicable laws, including, but not limited to, all applicable anti-predatory lending laws. 36. The Representation Concerning Qualified Appraisal. In Section 1.04(b)(xxix) of the Sale Agreement, Merrill Lending represented: Prior to the approval of the Mortgage Loan application, an appraisal of the related Mortgaged Property that satisfies the standards of the 14

16 Program Documents and the standards under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 was obtained. The appraisal was signed by a qualified appraiser, and whose compensation is not affected by the approval or disapproval of the Mortgage Loan. 37. The Representation Concerning Enforceable Prepayment Charges: In Section 1.04(b)(xxxiii) of the Sale Agreement, Merrill Lending represented: Each prepayment charge is permissible and enforceable in accordance with its terms upon the Mortgagor s full and voluntary Principal Prepayment (except to the extent that: (1) the enforceability thereof may be limited by bankruptcy, insolvency, moratorium, receivership and other similar laws relating to creditors rights generally; (2) the collectability thereof may be limited due to acceleration in connection with a foreclosure or other involuntary prepayment; or (3) subsequent changes in applicable law may limit or prohibit enforceability thereof) under applicable law. B. Merrill Investors Representations 38. The Merrill Investors Representations apply to the Subsequent Mortgage Loans. They likewise generally concern the Subsequent Mortgage Loans quality, characteristics and risk profile. They too were critical for an accurate assessment of Mortgage Loan value. Merrill Investors made these Representations in Section 2(a) and Attachment A of the Subsequent Transfer Instruments as well as in both Officer Certificates, which Merrill Investors delivered to the Trustee prior to entering each Subsequent Transfer Instrument. Paragraphs 39 through 41 below provide examples of the Merrill Investors Representations. 39. The Representation In Section 2(a) of Each Subsequent Transfer Instrument, Incorporating Section 2.10(c) of the PSA. Section 2(a) of each Subsequent Transfer Instrument provides: The Depositor hereby confirms that each of the conditions precedent and the representations and warranties set forth in Section 2.03 and 2.10 of the Pooling and Servicing 15

17 Agreement are satisfied as of the date hereof with respect to the Subsequent Mortgage Loans. Section 2.10(c) of the PSA, in turn, contains a number of representations and warranties with respect to each Subsequent Mortgage Loan. a) For example, in Section 2.10(c)(iv) of the PSA, Merrill Investors represented: [T]he Subsequent Mortgage Loan will not have a Loan-to-Value Ratio greater than %. b) In Section 2.10(c)(viii) of the PSA, Merrill Investors represented: [T]he Subsequent Mortgage Loan will be underwritten in accordance with the criteria set forth under the section Underwriting Guidelines in the Prospectus Supplement. c) In Section 2.10(c)(x) of the PSA, Merrill Investors represented: [A]s of the Subsequent Transfer Date for such Subsequent Mortgage Loan,... (E) each of the representations and warranties of the Sponsor in the Sale Agreement shall be true, complete and correct with respect to such Subsequent Mortgage Loan. 40. The Representation Contained in Attachment A of Each Subsequent Transfer Instrument. Section 1(c) of each Subsequent Transfer Agreement provides: Additional terms of the sale are set forth on Attachment A hereto. Attachment A, in turn, contains a number of Representations. For example, in Section B of Attachment A of the applicable Subsequent Transfer Instrument, Merrill Investors represented: [T]he Subsequent Mortgage Loan will be underwritten in accordance with the criteria set forth under the section Underwriting Guidelines in the Prospectus Supplement. 16

18 41. The Representations Contained in Each Officer Certificate. Each Officer Certificate contained a number of Representations about the Subsequent Mortgage Loans, including: a) None of the Subsequent Mortgage Loans have a Combined Loan-to-Value Ratio greater than 100%. b) Each of the Subsequent Mortgage Loans was underwritten in accordance with the criteria set forth under the section Underwriting Guidelines in the Prospectus Supplement. c) As of the Subsequent Transfer Date, each of the representations and warranties of the Seller in the Sale Agreement is true, complete and correct with respect to each Subsequent Mortgage Loan. d) Following the purchase of the Subsequent Mortgage Loans by the Trust Fund, the Subsequent Mortgage Loans are, as of the Subsequent Cut-off Date, not materially inconsistent with the Initial Mortgage Loans. III. Defendants Notice and Repurchase Obligations, and the Trustee s Right to Enforce Them A. Merrill Lending s Notice and Repurchase Obligations 42. Merrill Lending s Notice and Repurchase Obligations with respect to the Initial Mortgage Loans are set forth in Section 1.04(b) of the Sale Agreement. Section 1.04(b) of the Sale Agreement provides: Upon discovery by any of the Seller [Merrill Lending] [or] the Depositor [Merrill Investors]... of a breach of any of the foregoing representations and warranties that adversely and materially affects the value of the related Mortgage Loan, payment charges or the interest of the Certificate Holders, the party discovering such breach shall give prompt written notice to the other parties. Within 90 days of the discovery of any such breach, the Seller shall either (a) cure such breach in all material respects, (b) repurchase such Mortgage Loan or any property acquired in respect 17

19 thereof from the Depositor at the applicable Purchase Price or (c) within the two year period following the Closing Date, substitute a Replacement Mortgage Loan for the affected Mortgage Loan. 43. The Purchase Price at which Merrill Lending agreed to repurchase any Defective Loan is defined as: an amount equal to the sum of (i) 100% of the unpaid principal balance of the Mortgage Loan as of the date of such purchase together with any unreimbursed Servicing Advances, (ii) accrued interest thereon at the applicable Mortgage Rate from (a) the date through which interest was last paid by the Mortgagor to (b) the Due Date in the month in which the Purchase Price is to be distributed to Certificateholders and (iii) any costs and damages incurred by the Issuing Entity (or the Trustee on behalf of the Issuing Entity) in connection with any violation by the affected Mortgage Loan of any anti-predatory or anti-abusive lending laws. (See Sale Agreement, Preamble (providing that all capitalized terms shall have the same meaning assigned to such terms in the PSA); PSA, Article I, Definitions.) 44. The Trustee is empowered to enforce Merrill Lending s Notice and Repurchase Obligations set forth in Section 1.04 of the Sale Agreement. As set forth in the Preamble, the Sale Agreement was entered into with the understanding that Merrill Investors would assign all of its rights and delegate all of its obligations under the Sale Agreement to the Trustee. (Sale Agreement, Preamble.) Further, each reference in the Sale Agreement to the Depositor is intended, unless otherwise specified, to mean the Depositor or the Trustee, as assignee, whichever is the owner of the Mortgage Loans from time to time. (Id.) 45. Likewise, Section 1.06 of the Sale Agreement provides: The Depositor shall have the right, upon notice to but without the consent of the Seller, to assign, in whole or in part, its interest under this Agreement with respect to the Mortgage Loans to the Trustee, and the Trustee then shall succeed to all rights of the Depositor under this Agreement. All references to the Depositor in this Agreement shall be deemed to include its assignee or designee, specifically including the Trustee. Through Section 2.01 of the PSA, Merrill Investors, as Depositor, 18

20 subsequently sold, transferred, assigned, set over and conveyed to the Trustee all the right, title and interest of the Depositor in and to the assets of the Trust Fund, including the right to enforce the Notice and Repurchase Obligations under Section 1.04(b) of the Sale Agreement. 46. Merrill Lending s Notice and Repurchase Obligations with respect to the Subsequent Mortgage Loans are set forth in Section 2.02 of the respective Subsequent Purchase Agreements. Section 2.02 of each Subsequent Purchase Agreement provides: Upon discovery by the Seller [Merrill Lending], the Purchaser [Merrill Investors] or the Trustee of a breach of any of the representations and warranties incorporated by reference in Section 2.01 hereof, irrespective of any limitation in such representation or warranty regarding the knowledge of the Seller, which materially and adversely affects the value of the Subsequent Mortgage Loans or the interests of the Purchaser or the Trustee (or which materially and adversely affects the interests of the Purchaser or the Trustee in the related Subsequent Mortgage Loan in the case of a representation and warranty relating to a particular Subsequent Mortgage Loan), the party discovering such breach shall give prompt written notice to the other parties. Within 90 days of its discovery or its receipt of notice of any such breach, the Seller shall (i) cure such breach, or (ii) substitute a Subsequent Mortgage Loan if permitted to do so by the provisions of Section 2.03 below, or (iii) if the breach relates to a particular Subsequent Mortgage Loan, repurchase such Subsequent Mortgage Loan from the Trustee or the Purchaser, as appropriate, at a price equal to the Purchase Price, or (iv) if the breach relates to a breach of a representation or warranty regarding the Subsequent Mortgage Loans as a whole, repurchase Subsequent Mortgage Loans selected by the Purchaser (or its designee) such that the representations and warranties with respect to the Subsequent Mortgage Loans as a whole are materially correct, from the Trustee or the Purchaser, as appropriate, at the Purchase Price therefor, so long as such repurchase is in accordance with the Pooling and Servicing Agreement. Any such repurchase shall be accomplished by payment to the Servicer or deposit in the Certificate Account of the Purchase Price (after deducting therefrom any amounts received in respect of such repurchased Subsequent Mortgage Loan and being held in the Certificate Account for future distribution). 47. The Trustee is likewise empowered to enforce Merrill Lending s Notice and Repurchase Obligations set forth in Section 2.02 of the Subsequent Purchase Agreements. Section 2.01 of each Subsequent Purchase Agreement provides: 19

21 The Seller [Merrill Lending] acknowledges that, pursuant to the Pooling and Servicing Agreement, the Purchaser [Merrill Investors] will assign all of its right, title and interest in and to the Subsequent Mortgage Loans and its right to exercise the remedies created by Sections 1.04 and 2.02 hereof to the Trustee for the benefit of the Certificateholders. The Seller agrees that, upon such assignment to the Trustee, the Trustee, or the Securities Administrator as its designee, may enforce directly, without joinder of the Purchaser, the repurchase obligations of the Seller set forth in Sections 1.04 and 2.02 hereof with respect to breaches of the representations and warranties set forth in Section 2.03 of the Pooling and Servicing Agreement, or with respect to documentary defects or omissions set forth in Section 2.02 of the Pooling and Servicing Agreement. As alleged, through the Subsequent Transfer Instruments, Merrill Investors, as Depositor, subsequently sold, transferred, assigned, set over and conveyed to the Trustee all of its right, title and interest in and to the respective Subsequent Mortgage Loans, including the right to enforce the Notice and Repurchase Obligations under Section 2.02 of the respective Subsequent Purchase Agreement. B. Merrill Investors Notice and Repurchase Obligations 48. Merrill Investors Notice and Repurchase Obligations with respect to the Initial Mortgage Loans are set forth in Section 2.03(c) of the PSA (which also reaffirms Merrill Lending s Notice and Repurchase Obligations with respect to the Initial Mortgage Loans). Section 2.03(c) of the PSA provides: Upon discovery by any of the Depositor [Merrill Investors]... of a breach of any of representations and warranties set forth in the Sale Agreement that adversely and materially affects the value of the related Mortgage Loan, prepayment charges or the interests of the Certificateholders, the party discovering such breach shall give prompt written notice to the other parties. Within ninety (90) days of the discovery of a breach of any representation or warranty given to the Trustee by the Depositor, the Sponsor and assigned by the Depositor to the Trustee, the Depositor, or the Sponsor shall either (a) cure such breach in all material respects, (b) repurchase such Mortgage Loan or any property acquired in respect thereof from the Trustee at the Purchase Price or (c) within the two year period following the Closing Date, substitute a Replacement Mortgage Loan for the affected Mortgage Loan. [bracketed language added.] 20

22 The definition of the Purchase Price is the same as set forth above in paragraph Merrill Investors Notice and Repurchase Obligations with respect to the Subsequent Mortgage Loans are provided through Section 2 of both Subsequent Transfer Instruments (which also reaffirms Merrill Lending s Notice and Repurchase Obligations with respect to the Subsequent Mortgage Loans). Section 2 of both Subsequent Transfer Instruments provides: (a) The Depositor [Merrill Investors] hereby confirms that each of the conditions precedent and the representations and warranties set forth in Sections 2.03 and 2.10 of the Pooling and Servicing Agreement are satisfied as of the date hereof with respect to the Subsequent Mortgage Loans. (b) All terms and conditions of the Pooling and Servicing Agreement are hereby ratified and confirmed; provided, however, that in the event of any conflict, the provisions of this Instrument shall control over the conflicting provisions of the Pooling and Servicing Agreement. The Trustee is not aware of any conflicting PSA provision with respect to the claims brought here. 50. As a party to the PSA and the Subsequent Transfer Instruments, the Trustee is empowered to enforce the Notice and Repurchase Obligations set forth in Section 2.03(c) of the PSA and provided or reaffirmed in Section 2 of the Subsequent Transfer Instruments. IV. The Substantial Number of Defective Loans in the Trust 51. Since 2012, there have been at least three reviews of the Mortgage Loans. 52. In March 2012, the Trustee received a letter from a certificateholder conveying the results of a Mortgage Loan re-underwriting analysis (the First Review ). As detailed below, the First Review showed no fewer than 475 Defective Loans with an aggregate principal balance of approximately $102,313,

23 53. In fall of 2014, the Trustee received three letters on behalf of another certificateholder (the 2014 Certificateholder Letters ) conveying the results of its review of 455 Mortgage Loans (the Second Review ). According to the 2014 Certificateholder Letters, the Second Review consisted of loan-level forensic examination of the Mortgage Loans based on tax records, credit reports, property records, address records, lien records and other publiclyavailable information. The Second Review also used, among other things, an automated valuation model ( AVM ). Based on the Second Review, the certificateholder alleged there to be no fewer than 373 Defective Loans with an aggregate principal balance of approximately $102,288, A third review has been conducted with respect to 1,195 Mortgage Loans, also based on publicly-available information and using an AVM (the Third Review ). The Third Review showed no fewer than 592 Mortgage Loans with indications of Material Breaches, having an aggregate principal balance of approximately $140,410, These Defective Loans and Mortgage Loans with evidence of Material Breaches are simply illustrative. Many Mortgage Loans suffer from more than one Material Breach. Upon information and belief, there are additional Material Breaches and Defective Loans in the Trust. A. The First Review 56. Through the First Review, 475 Defective Loans were identified. 57. Material Breaches for Misrepresentation of Income: In at least 80 Mortgage Loans, the borrower s income was materially misrepresented. Furthermore, proper due diligence at the time of origination would have put the lender on notice of those misrepresentations. The following are examples: 22

24 a) Mortgage Loan No : For this Mortgage Loan, the borrower stated employment as an owner of a flooring company earning $7,000 per month on the loan application. However, according to the borrower s 2006 tax returns located in the post-closing loan file, the borrower s actual monthly income for the year the Mortgage Loan closed was $1,491, substantially less than the amount stated on the loan application. This misrepresentation of income constituted a default under the terms of the mortgage. Further, the borrower s stated income was unreasonable and would have put a reasonably prudent underwriter on notice of a potential misrepresentation, as it is almost double the average annual salary at the 75th percentile for the owner of a flooring company in the same geographic region. b) Mortgage Loan No : For this Mortgage Loan, the borrower stated employment as a self-employed realtor earning $22,000 per month on the loan application. However, according to the Statement of Financial Affairs filed as part of the borrower s 2009 bankruptcy proceeding, the borrower s actual monthly income for the year the Mortgage Loan closed was $2,642, substantially less than the amount stated on the loan application. This misrepresentation of income constituted a default under the terms of the mortgage. Further, the borrower s stated income was unreasonable and would have put a reasonably prudent underwriter on notice of a potential misrepresentation, as it is more than double the average annual salary at the 75th percentile for a small business owner for 3 years in 2006 and in the same geographic region. Additionally, the borrower originally stated monthly income of $12,500 per month. The increase of the 23

25 stated income to $22,000 per month was a red flag that the borrower was misrepresenting their income. c) Mortgage Loan No : For this Mortgage Loan, the borrower stated employment as a taxi driver earning $6,800 per month on the loan application. However, according to the borrower s 2005 and 2007 tax returns contained in the post-closing loan file, the borrower s actual income was $989 per month in 2005 and $1,831 per month in 2007, substantially less than the amount stated on the loan application. This misrepresentation of income constituted a default under the terms of the mortgage. Further, the borrower s stated income was unreasonable and would have put a reasonably prudent underwriter on notice of a potential misrepresentation, as it was nearly 1.5 times the average salary of the 75 th percentile of taxi drivers in the same geographic region. d) Mortgage Loan : For this Mortgage Loan, the borrower stated employment as a retiree earning $7,000 per month. However, according to certain tax documentation in the loan file, the borrower s actual monthly income for the year the Mortgage Loan closed was $1,981 per month less than 30% of the income stated on the loan application. This misrepresentation of income constituted a default under the terms of the mortgage. The 80 Mortgage Loans suffering from misrepresentation of income are in breach of the Merrill Lending Representation Concerning No Event of Default and the Merrill Lending Representation Concerning No Fraud, set forth above. At least 61 of these Mortgage Loans are also in breach of the Merrill Lending Representation Concerning Conformity with the Prospectus Supplement and the Merrill Lending Representation Concerning the Underwriting Methodology. To the extent 24

26 they are Subsequent Mortgage Loans, they are also in breach of the Merrill Investors Representations, set forth above. These are Material Breaches because, among other reasons, they reveal that the borrower never had sufficient financial means to repay the loan. 58. Material Breaches for Misrepresentation of Debt Obligations: In at least 70 Mortgage Loans, the borrower s debt obligations were misrepresented. Furthermore, proper due diligence would have put the lender on notice that the borrower had not fully disclosed all debt obligations as required. The following are examples: a) Mortgage Loan : For this Mortgage Loan, a review of public records and audit credit report revealed that the borrower failed to disclose four purchase money mortgages for two separate properties that were originated three months prior to the subject closing. The borrower acquired more than $1,000,000 in additional mortgage debt as a result of these undisclosed transactions. This misrepresentation of debt obligations constituted a default under the terms of the mortgage. Further, the origination credit report reflected six credit inquiries between November 22, 2005 and February 20, These inquiries would have put a reasonably prudent underwriter on notice of the potential misrepresentation of debt obligations. There is no evidence that the underwriter requested or obtained an explanation from the borrower as to these inquires. b) Mortgage Loan No : For this Mortgage Loan, a review of public records and an audit credit report revealed that the borrower had purchased an undisclosed property less than 30 days prior to the subject closing, acquiring additional mortgage debt exceeding $200,000. This misrepresentation of debt obligations constituted a default under the terms of the mortgage. Further, the 25

27 origination credit report reflected nine credit inquiries, from May 8, 2006 through July 4, These inquiries would have put a reasonably prudent underwriter on notice of the potential misrepresentation of debt obligations. There is no evidence that the underwriter requested or obtained an explanation from the borrower as to these inquires. c) Mortgage Loan : For this Mortgage Loan, a review of public records and an audit credit report revealed that the borrower failed to disclose two mortgages totaling $220,000 in mortgage debt. This misrepresentation of debt obligations constituted a default under the terms of the mortgage. Further, the origination credit report listed two mortgage-related credit inquiries, dated from March 5, 2006 through March 17, These inquiries would have put a reasonably prudent underwriter on notice of the potential misrepresentation of debt obligations. There is no evidence that the underwriter requested or obtained an explanation from the borrower as to these inquiries. d) Mortgage Loan No : For this Mortgage Loan, a review of public records and an audit credit report revealed that the borrower failed to disclose three mortgages totaling $201,800 in undisclosed mortgage debt. This misrepresentation of debt obligations constituted a default under the terms of the mortgage. Further, the origination credit report listed several mortgage-related credit inquiries from July 5, 2006 to July 18, These inquiries would have put a reasonably prudent underwriter on notice of the potential misrepresentation of debt obligations. There is no evidence that the underwriter requested or obtained an explanation from the borrower as to these inquiries. 26

28 The 70 Mortgage Loans suffering from misrepresentation of debt obligations are in breach of the Merrill Lending Representation Concerning No Event of Default, the Merrill Lending Representation Concerning No Fraud, the Merrill Lending Representation Concerning Conformity with the Prospectus Supplement and the Merrill Lending Representation Concerning the Underwriting Methodology, set forth above. To the extent they are Subsequent Mortgage Loans, they are also in breach of the Merrill Investors Representations, set forth above. These are Material Breaches because, among other reasons, they reveal that the borrower s financial obligations were greater than represented, and accordingly, that the borrower did not have the ability to repay the loan. 59. Material Breaches for Excessive DTI: In at least 265 Mortgage Loans, the borrower s DTI was higher than the maximum allowed under the applicable guidelines, without sufficient compensating factors or substantial compliance. The following are examples: a) Mortgage Loan No : The applicable guidelines for this Mortgage Loan permitted a maximum DTI of 50% for this particular loan type. At origination, the originator calculated DTI of 30.54% based in part on the statement on the loan application that the borrower made $7,000 per month as a janitor. However, the borrower s income was misrepresented. Based on the Statement of Financial Affairs filed as part of the borrower s 2010 bankruptcy proceeding, the borrower s actual monthly income for 2006 was $388 per month. The true DTI based on the borrower s verified income was %, which far exceeds the maximum. b) Mortgage Loan No : The applicable guidelines for this Mortgage Loan permitted a maximum allowable DTI of 45% for this particular loan type. The 27