Tuesday, March 19, 2013

The Core Question Presented to Justice Kapnick in the Bank of America Article 77 Proceeding

I have posted on the Bank of America (BAC) Article 77 proceeding regarding both substantive merits (Linsanity and the Bank of America Article 77 Settlement Valuation Experts ) and procedural stance (Handicapping Bank of America's Article 77 (Spoiler Alert: Who the Hell Knows? and Is Bank of America's Article 77 $8.5 Billion Settlement Hostage to its Case with MBIA?)

In a complicated situation, the core question presented to Justice Kapnick in the Article 77 is the following: 

"Is it reasonable for the settlement agreement to be approved by the Article 77 court, notwithstanding that the settlement agreement is made contingent and unenforceable by its terms until approved by the court, and such court approval is at a time when an important legal underpinning (mbs damage causation) to the settlement is no longer valid, if the committing to the settlement occurred prior to the demise of the legal underpinning?" 

This is essentially a $20-$40 billion question.

If Justice Bransten issues an adverse BAC successor liability decision before the Article 77 begins, that would only add a second legal underpinning to the settlement that would no longer be valid.

I can hear BAC's response to this question already: "One freezes in time for purposes of Article 77 court approval the relevant caselaw relating to mbs damage casuation that existed at the time the settlement was entered into.  The court is just determining the reasonableness of the trustee at the time the settlement agreement was entered into."  

Under this view, Justice Kapnick is obliged to disregard Judge Rakoff's opinion in Assured Gauranty v Flagstar that made clear that New York law relating to mbs damages requires only a showing that a representation and warranty breach had a material and adverse effect upon an mbs holder's risk of loss, instead of a showing that the breach caused the actual loan loss incurred by the mbs holder.

I would agree with this view if the settlement agreement resulted in the consummation of the settlement transactions at the time (or even if the settlement agreement was made enforceable by the parties, but enforcement was enjoined at the request of a third party pending judicial approval) .  If the transactions contemplated by the settlement agreement had closed, and repurchase and other claims against BAC were released and BAC paid $8.5 billion, then a subsequent court review of the settlement transactions would have measured the trustee's reasonableness at the time the transactions occurred.

But the settlement transactions have not occurred, and it was the parties themselves, the trustee and BAC, who expressly provided that the settlement transactions shall not occur, and that the settlement agreement shall remain contingent and unenforceable by the parties.  The settlement agreement requires and awaits court approval in order to for the settlement agreement provisions to become enforceable and for the settlement transactions to occur.  So what law is the Article 77 court to apply to these prospective settlement transactions which, at the time they are considered by the court, remain open and expressly unenforceable under the terms of the settlement agreement?  The law relating to causation at the time the settlement agreement was entered into, or the law relating to causation at the time the settlement transactions first become enforceable under the terms of the settlement agreement?

To my mind, the relevant analogy relates to a court decision made under old law, where new law arising after the court decision would reverse the decision.  If the court decision is still "open" and subject to appeal, of course an appeals court would apply new law in connection with the appeal.  If the court decision is "closed" once all right of appeal has lapsed, then the court decision under old law cannot be reopened and would be binding upon the parties.

In the case of the settlement agreement in the Article 77, the settlement agreement is still "open" and the transactions contemplated by the settlement agreement are unenforceable and expressly not permitted to occur by the very terms of the settlement agreement, until Justice Kapnick hears the case.

So, given these provisions of the settlement agreement, does Justice Kapnick apply old law or new law relating to mbs damage causation in connection with her determination whether or not the settlement transactions are to become enforceable? 

Seems to me, the essence of what makes an agreement an agreement, and not just a piece of paper (or these days, a digital file), is that the agreement is enforceable by the parties to the agreement.  So if Justice Kapnick is to apply good law at the time the trustee actually becomes a party to an enforceable agreement, Justice Kapnick should apply current law with respect to mbs damage causation.

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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