Monday, March 4, 2013

Double, Double,Toil and Trouble: Articles 77 and 78

Justice Kapnick issued her long-awaited opinion on the Article 78 hearing regarding MBIA's transformation transaction (Transformation) (ICYMI, MBIA wins), and it was air-tight and even subtly in-your-face. To read the opinion, see here.  I am on record before the decision as saying the likelihood of MBIA's success on the Article 78 case was 90%.  Bank of America (BAC) has stated that it will appeal Justice Kapnick's ruling.  Having read her decision, I will up MBIA's likelihood of success on appeal to 99.98%.  We are talking Ivory soap quality here.

I say air-tight because the opinion addressed each of BAC's arguments and dismissed them with faultless appeals to statutory language, case law and logic.  BAC's strategy was to argue that an "arbitrary and capricious" standard of judicial review should not be applied to the decision by the New York Department of Financial Services (NYDFS) to approve the Transformation, but rather the court was obliged to apply a less onerous standard that looked to whether there were any factual errors or errors of law underpinning the NYDFS decision.

BAC understood that it could not win under the appropriate "arbitrary and capricious" standard of review, and so it tried inundate Justice Kapnick with as many alternative arguments and claims as could withstand the red-faced standard of legal argumentation.  In many instances,  BAC's arguments for a different standard of review were not grounded by any citations to statute and case law, or were cited to cases that were inapposite to the facts in the Article 78 hearing.  Justice Kapnick simply pointed this out each and every time, and dismissed each of BAC's claims.

An example is BAC's claim that the stock redemption element of the Transformation should have been analyzed under New York insurance statutory law applicable to stock dividends, insofar as stock redemptions have a similar financial effect upon the issuer as a stock dividend.  Except, as Justice Kapnick curtly pointed out, NY statutory insurance law applies a particular standard to stock dividends that it doesn't apply to stock redemptions.  So, perhaps BAC might want to amend the statute given its particular insight, but the Court would decline the invitation. End of argument.

I say subtly in-your-face because of two portions of Justice Kapnick's opinion, in particular.  Everyone knows that BAC's Article 78 case serves a dual purpose:  i) try to invalidate the Transformation, and ii) generate leverage to negotiate a favorable settlement of MBIA's fraud and mbs putback action against BAC.  Hence, here comes an interesting footnote to Justice Kapnick's opinion:

"The court notes at the outset, that after reviewing a voluminous number of Article 78 cases spanning many years, including, but not limited to those brought against the NYID, the Court is not aware of any Article 78 proceeding where the petitioners, who are seeking to overturn an agency's decision, were not the original applicants or otherwise parties to the proceeding at the agnecy level"

In other words, while clothed in a mild form of understatement, the Court is saying "we know why you, BAC, are here.  We are not naive."  Bob Ehrlichman, may he rest in peace, would have called this footnote a "modified, limited zinger".

The other modified, limited zinger that I would highlight is the following:

"During oral argument on May 18, 2012, Petitioners [BAC] handed up a case appendix entitled "Courts Have Long Held That Article 78 Petitions Should be Granted When an Agency Acts on Inaccurate or Incomplete Information."  After reviewing the Appendix, the Court finds that none of the 14 cases cited provide a basis for this Court to annul the Approval Letter [approving the Transformation]".

In other words, the Court is essentially saying "here comes BAC with its best hope to argue that an "arbitrary and capricious" standard should not apply to approval of an agency decision when that decision is based upon inaccurate information, and it turns out that none of the cases BAC cites are worth the Court's consideration.  Excuse me?"

And Sullivan & Cromwell (BAC counsel) charges how much an hour?

What may be lost in this long-awaited analysis of Justice Kapnick's Article 78 decision are the simultaneous goings-on in her other BAC proceeding of note, the Article 77 hearing to consider the approval of Bank of New York Mellon's decision as Trustee to approve BAC's settlement of over $100 billion in actual and potential mbs investor losses for $8.5 billion.

Filings in the Article 77 action are going to heat up, but I recommend that you read two important expert opinion filings already made by AIG as an objecting investor:  Professor Tamar Frankel's opinion here and Professor Coates's opinion here. [Full disclosure:  I took Professor's Frankel's Corporation Law class in law school in 1978.  May she be a lesson to all of us in longevity and engagement!]

I have argued that BAC's Article 77 case is held hostage to MBIA's summary judgment motion regarding BAC successor liability here, and that BAC will likely lose on this motion here.  Hence, BAC should be strongly motivated to settle its litigation with MBIA.  Interestingly, the objecting mbs investors are off to a strong start with these expert opinion submissions, and BAC may not be out of harms' way even if it settles with MBIA before Justice Bransten issues her successor liability opinion.

[UPDATE:  It is unusual to find a well-written article about a court opinion.  Here is an excellent piece written about the decision.]

Double, Double, Toil and Trouble,
Fire burn, and caldron bubble.
Macbeth, Act IV, Scene 1

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. I have been trying to catch up on the MBIA thesis quickly (given yesterday's news)and your site has been extremely valuable, so thanks.

    My question is simple.... if they can now firewall the the structured finance arm what is the downside case with the stock?

    It seems like you can essentially buy the National Public Finance arm at a steep discount and you get a free call option on the MBIA vs Countrywide litigation. Where can MBIA still get in big trouble?

    1. i would agree alot of risk has been taken off mbia with the art 78 decision. however, mbia corp is still having a liquidity problem and there is risk of nydfs putting it in rehabilitation. while one may think such an event would be inconsequential for mbia given consent solicitation and indenture amendment as well as art 78 decision, mbia ceo brown said in last earnings CC that this would be disruptive and mbia would loses value. i suppose he meant that if mbia can settle with bac, there will be residual value at mbia. NB: not investment advice.

    2. should say at end: "residual value at mbia corp."

  2. I can honestly say that Mr Herzeca research is the best thing on the internet and better than the so called equity analysts

  3. Hi Christian

    Thanks for all your work on MBIA. It has been invaluable. I was wondering if you could step us through the appeal process. What needs to occur and how much time it could take (if you can ballpark that). as you mentioned above, liquidity remains an issue for MBIA and so time is still an important factor and I am wondering how much longer BofA can drag this out.

  4. hey sigurd. i would first note that bac is a little equivocal about appeal. their outside lawyer (guiffra at sullivan & cromwell) said he would file appeal, but their pr spokesman (grayson) said bac would proceed with fraudulent conveyance (plenary) action. in a sense, the plenary action is "stronger" for bac in the sense that they haven't already lost it at the trial court, and the ratings agencies will look at the plenary action and see more risk potential there than any appeal of the art 78. so i really look at the art 78 appeal more as an opportunity for the outside lawyer to pad his bill than as a part of bac's arsenal.