Friday, October 12, 2012

Did Bank of America Asset-Strip Countrywide? Were CEO Moynihan's Statements Vague and Informal?

Did Bank of America (BAC) engage in asset stripping of Countrywide after its 2008 acquisition? Did BAC pay fair value for those assets by making a contemporaneous payment to Countrywide of fair value, or is BAC crediting capital contributions it made to Countrywide to fund Countrywide settlements of MBS litigation? Does it even matter whether BAC paid fair value for the transfer of Countrywide's assets? And even if BAC paid fair and contemporaneous value to Countrywide for the transfer to BAC of Countrywide's entire mortgage platform, was Countrywide left with insufficient assets in view of its massive contingent liabilities and, with no operating business remaining, no means to generate funds to pay them?

Did BAC executives engage in "vague and informal" statements regarding BAC's assumption of Countrywide's liabilities, as alleged by BAC, or do the statements by BAC's CEO and CFO regarding payment by BAC of Countrywide's liabilities "when they are due" constitute  BAC's formal and considered assumption of Countrywide's liabilities because of such practical business realities as avoiding severe reputational harm to BAC's franchise itself? And do the various instances when BAC funded Countrywide's litigation settlements provide the best evidence of this practical business reality?

The answers to these simple questions will go a long way in deciding whether BAC will be found to have successor liability for Countrywide's liabilities.

The summary judgment motions (SJ) by BAC and MBIA (MBI) with respect to parent BAC's successor liability for the liabilities of acquired Countrywide, originally filed under seal September 28, 2012, were unsealed (but for limited redactions) on October 11, 2012.  Successor liability is a crucial issue for both BAC and MBI to win, since any judgment on primary liability by MBI would go unsatisfied if MBI had recourse only to the assets of Countrywide.

MBI and BAC disagreed in their SJs with respect to which law should apply, with MBI arguing for New York law and BAC arguing for Delaware law.  Judge Bransten applied New York law to an earlier motion with respect to successor liability, and there was nothing contained in the BAC SJ that would lead me to believe that she would change her mind.

On the merits, MBI argues that after BAC acquired Countrywide, it engaged in numerous asset-stripping transactions, leaving Countrywide only with toxic assets and massive contingent liabilities.  If true, this would go a long way to winning its case for successor liability under the de facto merger doctrine.

The MBI SJ states that the de facto merger doctrine requires (1) continuity of ownership, (2) cessation of ordinary business and dissolution of the acquired corporation as soon as possible, (3) assumption by the successor of the liabilities ordinarily necessary for the uninterrupted continuation of the business of the acquired corporation, and (4) continuity of management, personnel, physical location, assets, and general business operations. MBI argues that all these factors apply here.

BAC argues that under New York law, the asset seller must acquire an equity interest in the asset purchaser in order to satisfy the condition of continuity of ownership, which MBI can't satisfy under the facts.  Judge Bransten will have to sort this out, but my view is that BAC will lose on this heroic reading of the cases it cites for its argument.

MBI goes on to point out that BAC has had to fund Countrywide with massive capital contributions to fund settlement of Countrywide's liabilities. The exact amounts following the $ signs for completed and prospective settlements are redacted, but the word after each redaction is "billions", and it appears to my eye that each redaction covers three typed spaces (double digits and a comma).  Moreover, notwithstanding even these massive capital contributions by BAC, Countrywide's most recent financial statement shows negative equity.

BAC in its motion denies that BAC engaged in asset-stripping but paid approximately fair value for the assets transferred by Countrywide to BAC.  However, the questions arise whether BAC,  in connection with a non-arms' length transaction with Countrywide in which Countrywide transferred basically its entire mortgage platform, made payment of full and fair value to Countrywide that realistically and fully compensated Countrywide, or whether BAC is either putting forth an accounting for the transfer that belies economic reality, or is counting later capital contributions to fund Countrywide settlements as consideration paid for the earlier asset transfers.

I can't tell from the motions whether BAC stripped Countrywide of its assets to acquire Countrywide's mortgage platform, and then only dropped money into Countrywide to provide Countrywide the wherewithal to settle litigation matters with Assured Guaranty, Syncora and others, and then used these settlement fundings as "credit" for the assets acquired much earlier, or whether BAC's claimed exchange of contemporaneous fair value for Countrywide's mortgage platform is more lawyer argumentation than economic reality.  But in view of the four elements of de facto merger doctrine under New York law, this question of contemporaneous and fair value may not be relevant.

With respect to successor liability, MBI argues that BAC executives carefully thought through the expected amount of Countrywide's contingent liabilities and based its acquisition price for Countrywide in view of this estimate (showing that they acknowledged responsibility for these liabilities), and that they were acutely aware of BAC's practical need to assume those liabilities in order to protect BAC's reputation and goodwill. BAC dismisses these statements as non-binding and informal.  BAC argues that in order to prove implied assumption of liabilities, MBI must have relied on these statements, which it can't prove since they occurred well after the MBI insurance transactions. MBI counters that no reliance is necessary for the implied assumption of tort liabilities, and MBI is suing for, among other things, fraud which constitutes a tort.

Perhaps the reply motions will shed more light, but as I analyze the arguments, if BAC seeks to argue that its funding of Countrywide settlements was gratuitous and not considered by BAC to be a business necessity, and that BAC fairly capitalized Countrywide in exchange for Countrywide's transfer of its entire mortgage business to BAC, and that BAC didn't continue the business of Countrywide after asset-stripping and left Countrywide only to manage its contingent liabilities, these arguments will find an uphill climb in persuading with Justice Bransten.

NB:  this blog is not intended to be investment advice, and should not be relied upon by anyone to constitute investment advice.  Investing is a tough game, and everyone must do and own their own work, because you will certainly own your investments.

Disclosure: long MBI.  Follow me on twitter.

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