On April 26, 2023, the United States Court of Appeals for the Second Circuit affirmed the dismissal of two actions brought by issuers of collateralized debt obligations ("CDOs") against the trustee and master servicer of certain residential mortgage-backed securities ("RMBS") that served as collateral for the CDOs. Phoenix Light SF Ltd. v. Bank of New York Mellon, —F.4th—, 2023 WL 3082212 (2d Cir. 2023). The Second Circuit affirmed the district courts' holding that, even assuming plaintiffs had Article III standing, they were precluded from relitigating prudential standing because plaintiffs were previously found to lack prudential standing in a case they had brought against one of the same defendants.

Plaintiffs originally brought multiple suits against RMBS trustees in 2014. Id. at *1. One of these proceedings was dismissed in 2015 based on the district court's determination that plaintiffs lacked standing because, in issuing the CDO notes, they had conveyed all right, title, and interest in the RMBS certificates to the CDO trustees. Id. After that dismissal, the CDO trustees attempted to assign litigation rights back to plaintiffs, and plaintiffs amended their complaint accordingly. Id. The district court, however, granted summary judgment in favor of defendant, holding that the assignments were champertous and that plaintiffs lacked both Article III standing (i.e., "a concrete and particularized injury in fact, fairly traceable to the challenged actions of [defendant] and likely redressable by a favorable decision") and prudential standing (i.e., they had not "asserted their own legal rights and interests"). Id. at *2. On appeal, the Second Circuit, without deciding the Article III standing issue, affirmed the district court's grant of summary judgment on the ground that the assignments were champertous and that plaintiffs therefore lacked prudential standing. Id. Following the Second Circuit's decision, the district courts dismissed for lack of prudential standing two similar actions brought by the same plaintiffs, holding that plaintiffs were barred from relitigating the same issue and, in the alternative, that plaintiffs lacked prudential standing "under a fresh analysis." Id.

The Second Circuit first rejected plaintiffs' argument that the district courts were obligated to address whether plaintiffs had Article III standing before addressing whether they had prudential standing. Id. at *2. The Court explained that, while constitutional jurisdiction ordinarily is addressed first, courts have "leeway" to dismiss actions based on "non-jurisdictional, non-merits grounds, particularly where the constitutional-jurisdiction question is 'difficult to determine.'" Id. at *3. Moreover, the Second Circuit held for the first time, agreeing with the Ninth Circuit, that issue preclusion (also referred to as collateral estoppel) is a "non-merits threshold ground that is suitable for resolution before addressing a difficult or novel question of constitutional jurisdiction." Id. Because the Court concluded that the district courts here were faced with a "thorny Article III standing question" that was "hotly debated" by the parties, the Court concluded that the district courts were permitted to dismiss based on preclusion without addressing constitutional standing. Id.

In addition, the Court affirmed the district courts' application of issue preclusion. Specifically, the Court explained that it was undisputed that "materially identical transactions with the CDO Trustees were at issue in all the actions," and the Court did not find that the district courts "erred in determining that [p]laintiffs had a full and fair opportunity to litigate the champerty-based prudential-standing issue" in the prior action. Id. at *4. In reaching this determination, the Court rejected plaintiffs' argument that prudential standing was a "pure legal question" and therefore could not be the subject of issue preclusion; to the contrary, the Court noted that the district courts' evaluation of the champerty issue included a factual determination of "the purpose behind the plaintiffs' acquisition of rights." Id. The Court also rejected plaintiffs' arguments based on equitable considerations, concluding that (1) plaintiffs made no argument that they were unfairly treated in the prior action; (2) plaintiffs' argument that one defendant had unclean hands because it was a party to one of the assignments was irrelevant because plaintiffs themselves had "orchestrated the assignments"; and (3) even though defendant in one action had allegedly not included champerty as an affirmative defense in its answer, the district court was permitted to consider issue preclusion "in accordance with the 'strong public policy in economizing the use of judicial resources by avoiding relitigation." Id.

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