Course of Performance Controls: HAMP Deferred-Principal Repayments Treated as “Subsequent Recoveries” Under RMBS PSAs

1. Introduction

Matter of Wells Fargo Bank v. HBK Master Fund L.P. (2026 NY Slip Op 05368) is an Appellate Division, First Department decision arising from a CPLR article 77 “instruction” proceeding brought by Wells Fargo Bank, National Association in its capacity as securities administrator and/or trustee for 34 residential mortgage-backed securities (RMBS) trusts.

The case concerns a high-stakes allocation question triggered by Home Affordable Modification Program (HAMP) loan modifications: when mortgage principal was deferred (not forgiven) under HAMP and that deferred principal was initially reported by servicers (and treated by the trustee) as a Realized Loss, how should later payments of that deferred principal be allocated among certificateholders?

The dispute split investors along structural lines. The trustee and subordinate certificateholders contended that payments of previously deferred principal are “Subsequent Recoveries” under the pooling and servicing agreements (PSAs), producing “write ups” that economically benefit only subordinate classes (as the PSAs’ Subsequent Recoveries provisions are drafted to do). Senior certificateholders and respondent-appellant HBK Master Fund L.P. contested that characterization, proposing alternative allocation paths that would funnel some or all value through the senior/subordinate waterfall.

2. Summary of the Opinion

The First Department unanimously affirmed a post-bench-trial order holding that payments of previously deferred principal (which had been treated as Realized Losses upon HAMP modification) should be treated as Subsequent Recoveries within the meaning of the PSAs—or, even where they do not fit the definitions neatly, should nonetheless be treated as Subsequent Recoveries.

The court’s core moves were:

  • It agreed that under most PSAs the deferred-principal repayments do not fit “squarely” within the technical definition of Subsequent Recoveries, largely because the PSAs tie recoveries to “Liquidated Mortgage Loans” and the trial record lacked evidence that HAMP-modified loans were “liquidated” as the agreements define that concept.
  • It held that these repayments should still be treated as Subsequent Recoveries given (i) the structure of the PSAs and, most importantly, (ii) the parties’ course of performance, including consistent trustee reporting and investor non-objection.
  • It rejected appellants’ claimed interpretive inferences from the fact that only two PSAs expressly referenced modified loans producing Realized Losses.
  • It found no reversible evidentiary error, emphasizing that various materials were admitted/considered for notice and “effect on the listener,” and that any error was harmless given cumulative proof.

3. Analysis

A. Precedents Cited

1) Wells Fargo Bank, N.A. v All Respondents for This Special Proceeding (227 AD3d 597, 597 [1st Dept 2024])

This prior appeal framed the case’s posture: the First Department had already held that the PSAs were ambiguous on whether deferred-principal payments constitute Subsequent Recoveries and that Treasury guidance did not “definitively” resolve it. That holding drove the procedural pivot to a 17-day bench trial focused on extrinsic evidence, particularly performance and market understanding.

2) Matter of Wells Fargo Bank, N.A. (198 AD3d 156 [1st Dept 2021], lv dismissed 38 NY3d 998 [2022], lv denied 41 NY3d 910 [2024], lv dismissed 41 NY3d 1013 [2024])

The decision treats the so-called “JPM action” as important context on what Subsequent Recoveries provisions do: the cited language underscores that where governing agreements “conspicuously” exclude senior classes from write-up instructions, the “plain and unambiguous intent” is that only subordinate certificates receive write-ups.

That precedent mattered in two ways. First, it explained why the dispute became economically acute only after 2021, when the trustee revised methodology to align write-ups with the contractual exclusion of seniors. Second, it supported the court’s acceptance that “Subsequent Recoveries” in these PSAs are structurally designed to benefit subordinate holders—not as an accident, but as a deliberate allocation mechanism.

3) Quadrant Structured Prods. Co., Ltd. v Vertin (23 NY3d 549, 560 [2014])

Appellants invoked the interpretive idea that omissions can be meaningful—especially where a term appears in other similar contracts. The First Department acknowledged that principle but found it unhelpful here. Only two of 34 PSAs contained an explicit definition including modified loans that resulted in Realized Loss; the court refused to treat that limited drafting variation as a decisive signal of an intentional exclusion across the remaining PSAs.

The court’s use of Quadrant is restrained: it treats the “omission implies intent” canon as contingent on context, and rejects it where the relevant event (HAMP plus Treasury’s loss-allocation directive) was not reasonably within the parties’ foresight.

4) Herbert Rosenthal Jewelry Corp. v St. Paul Fire & Mar. Ins. Co. (21 AD2d 160, 165 [1st Dept 1964], affd 17 NY2d 857 [1966])

The court borrowed this equitable-contractual construction idea for “unanticipated future situations”: when parties failed to anticipate a later-developed scenario, a court may construe language to align with what the parties would have intended had their attention been drawn to the events as they actually occurred—so long as the result remains “within the language” of the agreement.

That citation supports the court’s “spirit over letter” conclusion: deferred-principal repayments did not perfectly match the PSAs’ liquidation-linked definition, but they were close enough in function (a reversal of a loss booking) that the agreement’s recovery mechanism could be applied without rewriting the contract from scratch.

5) Matter of Bank of N.Y. Mellon (202 AD3d 465, 466 [1st Dept 2022])

This case is cited for the proposition that course of performance is powerful evidence in interpreting ambiguous RMBS trust agreements. The court used it to bolster its central factual/legal finding: the trustee’s long-running practice, visible in remittance reports and not objected to, strongly indicates the parties’ shared understanding.

6) Federal Ins. Co. v Americas Ins. Co. (258 AD2d 39, 44 [1st Dept 1999]) and Continental Cas. Co. v Rapid-American Corp. (80 NY2d 640, 651 [1993])

These decisions supply the doctrinal backbone: course of performance is often “the most persuasive evidence” of the parties’ intent. Here, those principles justified leaning heavily on (i) trustee reporting practice, (ii) investor ability to discern treatment, and (iii) the lack of contemporaneous investor objection.

7) Matter of Reuters Ltd. v Dow Jones Telerate (231 AD2d 337, 343-344 [1st Dept 1997])

The opinion cites this case in a footnote to explain why “industry custom” did not resolve the dispute. Because a major actor (U.S. Bank National Association) took a different approach to deferred-principal payments, uniform trade usage could not be shown. This reinforced the turn toward agreement-specific evidence (performance under these PSAs) rather than market-wide custom.

B. Legal Reasoning

1) The contractual “fit” problem: HAMP deferrals were not literal “liquidations”

The PSAs generally define Subsequent Recoveries as amounts received “specifically related to a Liquidated Mortgage Loan” that resulted in a Realized Loss, “after liquidation or disposition.” They also define “Liquidated Mortgage Loan” as a defaulted loan where the servicer has determined that “all amounts” expected to be recovered have been recovered.

After trial, the court concluded there was no evidence that servicers made the “all amounts recovered” determination with respect to HAMP modifications. It found such a determination would be illogical because HAMP-modified loans remained active: the nondeferred principal continued to amortize and the deferred portion remained due later; there was no actual loan bifurcation.

The opinion also distinguished the loss of future interest accrual on the deferred portion: there is “no entitlement to interest until the time of accrual,” so the absence of future accrual did not convert the transaction into a liquidation of principal.

2) The functional-equivalence pivot: deferrals were treated as “akin to” partial liquidations

Even though HAMP modifications did not extinguish principal, Treasury guidance and servicer reporting treated the forborne principal as a realized loss at modification, with later payoff collections characterized as “principal recovery.” The court accepted evidence (fact and expert) that this regime was understood as a functional partial liquidation for RMBS accounting and allocation purposes.

This “functional” lens let the court connect two PSA mechanisms that, in ordinary conditions, pair neatly: Realized Loss write-downs and Subsequent Recoveries write-ups. Once principal had been written down as a Realized Loss (as SD 10-05 directed unless the PSA “explicitly and affirmatively” said otherwise), the court viewed later collection of that same principal as properly handled through the recovery/write-up channel rather than re-waterfalling it as ordinary principal.

3) Structure: Subsequent Recoveries as the PSA’s intended write-up mechanism

The court credited trial evidence that Subsequent Recoveries operate as the primary mechanism to “write back up” certificates after Realized Loss write-downs—i.e., “two sides of the same coin.” It also accepted that alternative “loss reversal” techniques might not mirror the write-up effect, could fail to fully reverse losses, and could create structural anomalies (including overcollateralization and unanticipated residual cash flows).

This structural reasoning matters because the dispute was not simply semantic (“is it called a recovery?”) but distributive: calling it a Subsequent Recovery triggers the PSA’s subordinate-only write-up logic, while calling it principal or a seniority-ordered loss reversal re-routes value across the capital stack.

4) Course of performance: the decisive interpretive evidence

The court’s most consequential holding is interpretive and evidentiary: where the agreement’s text is ill-fitting and ambiguous as applied to an unforeseen program like HAMP, course of performance can supply the best evidence of intended treatment.

The court found that Wells Fargo consistently treated deferred-principal payments as Subsequent Recoveries, that this treatment was visible to investors through monthly remittance reports, and that investors did not object. The JPM filings and Deer Park letters were treated as corroborating that the reports were intelligible to sophisticated investors on this point.

Importantly, the court separated (i) the classification decision (treat as Subsequent Recovery) from (ii) the question of which classes receive the write-up. Even though Wells Fargo had previously written up senior holders until it changed methodology after the JPM action, the court treated that history as confirming a stable practice of classifying the payments as Subsequent Recoveries in the first place.

5) Canons and drafting variation: why “expressio unius” and selective language did not control

Two PSAs (BSMF 2007-AR5 and BSABS 2007-AC6) explicitly include a modified loan that resulted in a Realized Loss within Subsequent Recoveries. Appellants urged the inference that the absence of similar language in the other 32 PSAs signaled exclusion. The court rejected that inference, reasoning that (a) the parties did not foresee HAMP and Treasury’s mandated loss treatment, and (b) the language was not “readily found in other, similar contracts” when it appeared in only 2 of 34.

C. Impact

  • RMBS trustee administration in New York: The decision strengthens trustees’ ability to rely on long-running reporting and allocation practice (remittance reports, investor acquiescence) to resolve PSA ambiguities in Article 77 proceedings, especially where exogenous federal programs forced accounting treatments not contemplated by 2005–2007-era RMBS drafting.
  • Subordinate-only recovery economics: By affirming treatment of deferred-principal repayments as Subsequent Recoveries despite definitional mismatch, the court effectively preserves the bargain that Subsequent Recoveries are a subordinate-focused “write-up” feature, rather than a value source to be re-allocated through seniority waterfalls when it reappears later as cash.
  • Limits of “industry custom” arguments: The footnote regarding U.S. Bank’s different approach cautions litigants that “custom and usage” must be uniform to matter; divergent trustee practice will push courts back to agreement-specific extrinsic evidence.
  • Drafting and due diligence consequences: Future PSA drafting (and investor diligence) may respond by explicitly addressing principal forbearance/deferral and defining whether later collections are “principal,” “recoveries,” or some bespoke category—precisely to avoid the interpretive weight that course-of-performance evidence can carry.

4. Complex Concepts Simplified

  • RMBS trust / PSA: A trust holds mortgage loans; the PSA is the governing contract setting payment rules to investors (certificateholders).
  • Senior vs. subordinate vs. residual certificates: “Senior” classes are paid first and absorb losses last; “subordinate” classes are paid later and absorb losses first; “residual” is typically the most junior, often receiving value only after others are satisfied.
  • Waterfall: The contractual payment priority rules distributing collections (interest/principal) across certificate classes.
  • Write-down / write-up: A “write-down” reduces a certificate’s principal balance when losses are realized; a “write-up” increases it when recoveries are recognized.
  • Realized Loss: A contract-defined event that triggers loss allocation (and write-downs). Here, Treasury guidance pushed trustees to treat HAMP forbearance as realized loss when servicers reported it that way.
  • Subsequent Recoveries: A PSA mechanism to reverse some prior realized losses (often through write-ups). In these PSAs, the recovery mechanism is drafted to benefit subordinate holders only.
  • Course of performance: How parties actually performed under the contract over time (e.g., consistent remittance reporting and lack of objection). New York courts treat it as highly persuasive evidence of intended meaning when text is ambiguous.
  • CPLR article 77: A New York procedural device allowing trustees to seek court instructions on trust administration disputes, commonly used in RMBS controversies.

5. Conclusion

Matter of Wells Fargo Bank v. HBK Master Fund L.P. establishes a practical and contract-centered rule for legacy RMBS disputes: where HAMP-driven principal deferrals were treated as Realized Losses and later repaid, those repayments should be treated as Subsequent Recoveries—even if the PSAs’ technical definition (tied to “Liquidated Mortgage Loans”) does not perfectly fit—when the PSA structure and, especially, the parties’ course of performance show that is how the bargain functioned in practice.

The decision is significant not because it rewrites PSAs to accommodate federal programs, but because it clarifies how New York courts will resolve RMBS-era contractual ambiguity: by pairing loss and recovery mechanisms coherently, discounting overconfident drafting-canons in unforeseeable contexts, and giving determinative weight to consistent trustee practice that sophisticated investors could observe and did not timely contest.