Thursday, November 8, 2012

Is Bank of America's Article 77 $8.5 Billion Settlement Hostage to its Case with MBIA?

On June 28, 2011, Bank of America (together with its afilliates, BAC) entered into a settlement agreement (Settlement Agreement) with Bank of New York Mellon, the trustee (Trustee) of 530 mortgage-backed securitization trusts, under which the Trustee, on behalf of trust investors holding over $200 billion of mortgage-backed securities (mbs), agreed to release all fraud, breach of representation and warranty (R/W), and other claims (Released Claims) those mbs investors could assert against BAC for payment by BAC of $8.5 billion.

At the time this Settlement Agreement was entered into, these BAC mbs trusts had (i) already experienced losses in excess of $25 billion, (ii) losses on loans over 60 days delinquent that was projected to be an additional $50 billion, and (iii) further losses on loans in addition to these delinquent loans that was projected to be over $32 billion, aggregating a total amount of experienced and projected losses for these BAC mbs trusts equal to over $107 billion.

Interestingly, the Trustee and BAC could have simply closed the Settlement Agreement at the time of its execution during the summer 2011 by BAC's payment of money to the Trustee, and the Trustee's issuance of a release of the Released Claims to BAC.  While it was forseeable that the Settlement Agreement would have been challenged by some mbs investors who thought the $8.5 billion settlement amount was too low for the release of the Released Claims in connection with over $107 billion in expected losses, any such challenge would have been ajudicated on the merits based upon the reasonableness of the Trustee's consummation of these transactions under the Settlement Agreement in the summer of 2011.  Developments subsequent to a closing of the Settlement Agreement would not have affected the Trustee's reasonableness in releasing the Released Claims in exchange for receipt of $8.5 billion if those actions were closed and completed at that time.

Instead, the Trustee and BAC did something quite different.  They elected to postpone consummation of the transactions contemplated by the Settlement Agreement (the $8.5 billion payment and release of Release Claims) until a further condition was satisfied: obtaining judicial approval of the reasonableness of the Trustee's actions pursuant to an Article 77 action filed in the Commercial Division of the Supreme Court of New York.

Because the Settlement Agreement, by its terms, cannot be closed until Article 77 approval is obtained (or it is determined that it cannot be obtained, or the condition is waived), the transactions contemplated by the Settlement Agreement remain prospective with no legal effect unless and until such Article 77 approval is obtained.

There is a crucial distinction that must be kept in mind in connection with any analysis of the Trustee's reasonableness in an Article 77 proceeding: is the court in an Article 77 hearing determining the reasonableness of the Trustee in entering into the Settlement Agreement in the summer of 2011 (understanding that no payment was made and no claims released then), or is it determining the reasonableness of the Trustee's release of the Released Claims for payment of $8.5 billion when these actions are permitted to occur, under the Settlement Agreement?

The Settlement Agreement states:  "the terms of this Settlement Agreement are subject to and conditioned upon 'Final Court Approval' [judicial approval in an Article 77 proceeding that the Settlement Agreement expressly authorizes the Trustee to commence]...If at any time Final Court Approval of the Settlement shall become legally impossible (including by reason of the denial of Final Court Approval by a court with no possibility of further appeal or proceedings that could result in Final Court Approval), the Settlement Agreement shall be null and void and have no further effect as to the Parties...[except for provisions not relevant]" [emphasis added].

So, given that the Settlement Agreement is contingent and the transactions contemplated by the Settlement Agreement are prospective, the focus of the reasonableness of the Trustee in an Article 77 proceeding should be not whether it was reasonable for the Trustee to enter into the Settlement Agreement in the summer of 2011, but rather whether it is reasonable for the Trustee to perform the transactions...release the Released Claims for payment of $8.5 billion...only at such time those transactions are permitted to close and have legal effect.

Therefore, any inquiry into the reasonableness of the Trustee should remain an open question subject to legal developments post-summer 2011 until such time as the Settlement Agreement is enforceable against BAC and the Trustee...and that will only occur when Article 77 proceeding has been completed and a favorable decision rendered, such that the transactions contemplated by the Settlement Agreement can have legal effect and be consummated. 

The Article 77 schedule contemplates a hearing schedule that will last well into the spring of 2013 with a decsion by Justice Kapnick expected much later in 2013 (considering that Justice Kapnick has not yet issued her opinion in the BAC Article 78 hearing against MBIA and the NYDFS that concluded in June 2012).

So, this raises a fascinating question: what happens if the legal analysis that the Trustee obtained in the summer of 2011 that, in its view, supported the reasonableness of the transactions contemplated by the Settlement Agreement, is rendered stale or wrong by judicial holdings subsequent to the summer of 2011, such that at the time the Trustee seeks to obtain judicial approval to consummate the Settlement Agreement transactions (the only time the Trustee can enforce the Settlement Agreement against BAC), the Trustee's actions can no longer be fairly regarded as reasonable?

It so happens that this fascinating, and financially momentous to BAC, question is presented with full force in the MBIA v. BAC fraud and R/W litigation currently approaching trial before Justice Bransten in the same court as the Article 77 proceeding. Incredibly, it is BAC, itself, that is pursuing a strategy in the MBIA litigation that, given Justice Bransten's judicial decisions to date and motions that are expected to be argued just next month in this litigation, is creating judicial doubt as to the reasonableness of the Trustee's consummation of the Settlement Agreement with BAC.

I have stated in this blog before, here, that BAC's litigation strategy in the context of its legacy Countrywide mbs claims appears idiotic and self-defeating, by creating adverse judicial precedents in the MBIA proceeding that can be applied against BAC by the use of offensive collateral estoppel in much larger proceedings against it.  BAC's strategy to continue litigation with MBIA risks creating additional judicial precedents that effectively makes the Article 77 proceeding a hostage to BAC's MBIA litigation.  It must be kept in mind that through the assertion of offensive collateral estoppel, it is generally the case that any judicial finding of law and fact in the MBIA litigation adverse to BAC that is at issue in the Article 77 proceeding can be enforced against BAC by objecting mbs investors.

This appears to me to be just another example of breathtakingly stupid legal risk assessment by BAC's executives and board of directors.

BAC's and the Trustee's argument that the Trustee's actions in respect of the Settlement Agreement should be deemed reasonable can be found in the Trustee's Memorandum of Law in support of its Motion for Approval of the Settlement Agreement.

In this motion, the Trustee argues that it was guided by counsel on the legal issues – including the viability of Countrywide’s defenses and Bank of America’s corporate separateness arguments – and that it has received separate opinions from experts in corporate and contract law on these issues.

An examination of these "opinions from experts in corporate and contract law" is very revealing in terms of the extent to which they may be superseded by legal developments in BAC's litigation with MBIA; but first, it is instructive to consider whether they are in fact legal "opinions".

Professor of Law and Business Barry Adler provided to Trustee's counsel what is purported to be a legal opinion regarding the "causation" requirement with respect to liability for breaches of R/Ws in the securitization documents that "materially and adversely affects the interest of the owner” of the securitized loan. In his "opinion", Professor Adler states "I have not been retained as a lawyer in connection with this matter, nor do I owe any duty to Mayer Brown [Trustee's counsel] or BNY Mellon in connection with this matter. In this opinion, I make no recommendation to Mayer Brown or BNY Mellon." Professor Adler concludes "it is not possible to conclude with any confidence how a court would interpret a provision such as [the materiality and adversely affects the interests] provision... And I make no such prediction".

Having practiced corporate law for over 20 years, I have a hard time understanding how Professor Adler's writing can be considered an opinion of law upon which the Trustee is entitled to rely.  The essential attribute of a legal opinion is that the lawyer is retained by a client and delivers an opinion upon which the client can rely, and which is subject to a duty of care and standard of diligence.  Nothing like that happened in the case of Professor Adler's writing, which resembles more a general interest article about the law than an opinion of law.

However, semantics aside, it is clear that judicial causation rulings have overtaken BAC and Professor Adler.  New York State Supreme Justice Bransten in the MBIA v BAC case and Federal District Court Judges Crotty and Rakoff in other mbs monoline insurance cases have each construed that this causation language does not require a showing that the breach of a R/W caused the loss incurred by the monoline insurer, and Judge Rakoff explicitly held that this same reasoning applies to a mbs investor situation, such as would apply in the Article 77 proceeding. Justice Bransten will have the opportunity to apply this causation holding directly to the mbs investor putback situation in a MBIA summary judgement motion heard next month.

Likewise, an important legal opinion relied upon by the Trustee relates to successor liability by BAC for the liabilities of Countrywide. Professor of Law Daines purports to provide the Trustee an opinion regarding successor liability in the BAC/Countrywide context, but states that his "memo...does not constitute legal advice, but gives my general opinions as an academic interested in corporate law and is limited by the available factual record and certain assumptions I make."  Again, not really a legal opinion, more so an article by someone with an academic interest.

In any event, Professor Daines concludes "BAC has a reasonable argument that any successor liability claim would be defeated...[and while]... a simple reading of some New York cases may lead to a conclusion that BAC would be liable under a de facto merger I conclude below, I do not believe that New York law will apply."  Again, a judicial ruling is about to overtake BAC and Professor Daines, as Justice Bransten is set to hear summary judgment motions regarding BAC's successor liability in MBIA v BAC next month.  While it is uncertain how Justice Bransten will rule, I have gotten the distinct impression through my reading of a prior preliminary motion regarding BAC's successor liability, the successor liability briefs filed in connection with the successor liability summary judgment motions to be heard next month, and some transcripts of colloquy with counsel before Justice Bransten that it is more likely than not that Justice Bransten will apply New York de facto merger law which, even Professor Daines would concede, is adverse to BAC.

So, much of the legal underpinning to any claim in the Article 77 hearing that the Trustee's actions to release the Released Claims under the Settlement Agreement are reasonable are indeed held hostage to developments in the MBIA v BAC litigation.  One important legal construct, loss causation, has already been vitiated and the other important legal construct, lack of BAC successor liability, appears to be in jeopardy.

Given the importance to BAC of obtaining judicial approval of the $8.5 billion settlement, and understanding that the Settlement Agreement is not enforceable by the parties unless and until that judicial approval is obtained, so that the question of the Trustee's reasonableness in performing the transactions should be considered an open question until the Settlement Agreement is enforceable, why would BAC continue with the MBIA litigation and risk undercutting judicial approval of the much more important Article 77 settlement?

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.


  1. Very interesting. Why on earth did BAC/BNYM not simply go the other way and conclude the transaction at the time, there and then?

  2. I have to believe that BNYM insisted on obtaining judicial approval of its action, to protect itself from suit.