Tuesday, April 30, 2013

MBIA Wins on the Law But Must Go To Trial. Has the Settlement Bid/Ask Spread Just Narrowed?

The Summary Judgment Decisions

On April 29, Justice Bransten rendered decisions with respect to Countrywide's primary liability and Bank of America's successor liability to MBIA.

The executive summary is that on every material question of law that Justice Bransten considered in these motions, Justice Bransten ruled in favor of MBIA.  However, Justice Bransten also found that with respect to most of the claims covered by these decided questions of law, there was a sufficient factual dispute raised by Bank of America (BAC) to warrant going to trial to resolve these issues of fact.

The burden of proof for MBIA on a summary judgment motion is to show that there is no genuine dispute as to fact with respect to a claim.  While the standard is the same, different judges interpret this summary judgment standard in the context of disputed facts differently, with some judges looking harder to see if the dispute is real, or is in reality simply conjured up by a defendant in order to get to trial.

Justice Bransten is not that judge, and she gave BAC the benefit of the doubt with respect to questions of fact that BAC was able to raise.

It should be remembered, however, that the burden of proof to establish a fact at trial is much easier for MBIA to surmount than on motion for summary judgment.  If the burden of proof at summary judgment is that MBIA had to establish a fact with a 95% degree of certainty, that burden goes down to 51% at trial.

With respect to the motion for summary judgment on BAC's successor liability, I have posted earlier, Why Bank of America Will Lose on Successor Liability, that Justice Bransten would apply New York law with respect to the issue, and would apply New York's law on de facto merger without grafting any requirement that the asset transfer be made for less than adequate consideration, which was argued by BAC.

On these questions of law, I was right and Justice Bransten ruled completely in favor of MBIA.  Because of this, I also thought that there was a 75% likelihood that Justice Bransten would grant summary judgment on successor liability, as I did not discern any genuine questions of fact raised by BAC in the briefing papers, as most of the facts alleged by MBIA came directly from BAC documents or BAC deponent testimony.  On this I was wrong.

In walking through the four part de facto merger test under New York law (" The four "hallmarks" of de facto merger under New York law include: ( 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 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 operation.), Justice Bransten found that BAC raised questions of fact that precluded a determination at the summary judgment stage.

I would not quibble with any of these determinations, except to the extent Justice Bransten gave credence to a BAC argument that it was significant that Countrywide transferred assets to BANA, a subsidiary of BAC, rather than BAC itself.  Justice Bransten seems to believe this calls into question whether BAC directly controlled this transfer, which was a factual question she felt she couldn't determine on summary judgment.

I believe the important factual analysis is whether Countrywide transferred assets out of Countrywide itself, and those assets were continued as a mortgage platform business operated by BAC, whether directly or through a subsidiary.  Even using the very thin reed standard of factual dispute that Justice Bransten employed at the summary judgment stage, it does not seem to me to be relevant where the assets went as long as BAC was the ultimate parent entity of the transferee. 

At trial, if there is a trial as I discuss below, I would have to conclude that MBIA's chances of prevailing on BAC's successor liability are at least 75%.  What Justice Bransten did in her opinions, both for BAC successor liability as well as Countrywide primary liability discussed below, was provide MBIA a trial roadmap, showing MBIA what questions of fact MBIA needs to concentrate on and bolster, understanding that MBIA need only show a preponderance of the evidence to prevail. 

Importantly, there are no legal issue hurdles contained in this roadmap, and no factual proof showing would appear to be problematic to MBIA.

As for Countrywide's primary liability, again it was a clear victory on the law for MBIA and a victory for BAC to get to a trial.

The most important legal issue argued by BAC was that MBIA's recovery for both of its fraud and breach of contract claims under insurance law as well as contract law was limited to the contractual remedy of pursuing the repurchase protocol, as a "sole remedy."  

Justice Bransten flatly rejected this BAC argument, and held that MBIA was entitled under the insurance law to pursue compensatory damages, even as the 1st Department recently held that recissory damages was unavailable.  Apparently, BAC counsel's letters to Justice Bransten after the 1st Department decision were not persuasive.  See Did the New York Appellate Court Just Eliminate Bank of America's "Sole Remedy" Defense?

This availability of compensatory damages under insurance law was a huge win for MBIA as it does not require that MBIA reasonably relied upon the representations and warranties (R&W) made by Countrywide, but only that MBIA would not have issued its insurance policies had it been aware that the R&Ws were breached by Countrywide.  Justice Bransten specifically found that, under the insurance law claim that she found was not barred by BAC's sole remedy argument, no reasonable reliance showing need be made by MBIA.

Moreover, Justice Bransten found that performing loans that breached R&Ws were subject to repurchase in all of the securitizations at issue, and not just the one securitization addressed by the 1st Department when it ruled in MBIA's favor on the question.

Again, as with the successor liability holding, Justice Bransten stopped short of concluding that BAC was in material breach of its R&Ws, and that material breach had a material and adverse effect upon MBIA, holding that these were fact-intensive inquiries that she would reserve for trial.  Let's remember, however, from Judge Rakoff what is the material and adverse effect standard that MBIA must show at trial...namely, that MBIA incurred an increased risk at loss at day one of the securitizations, understanding that risk of loss may or may not result in actual loan defaults.

In this regard, I would take Justice Bransten to task for finding that there was a genuine issue of fact with respect to the definition of "qualified appraiser" for purposes of that BAC R&W.  This breach affects 1,423 out of 6,000 loans sampled, and so it is highly relevant to the breach analysis.  I simply would not have found that BAC presented enough of a question of fact with respect to the term, especially when MBIA presented testimony by BAC itself that concluded that BAC's loans in question were not subject to a qualified appraiser.  Again, though, what might have been too hard for MBIA to show at summary judgment stage will be far easier at trial.

Settlement Bid/Ask 

The only fair reading of the summary judgment opinions is that while MBIA lost on timing, it won on the law, and the factual disputes found by Justice Bransten that justified a denial of summary judgment do not appear to be difficult for MBIA to prove at trial.  Indeed, MBIA now has a roadmap for the trial, and there are no impediments, in terms of questions of law, to keep MBIA from obtaining a full damage recovery at trial.

Indeed, MBIA's counsel should be banging on the doors of Justice Bransten's chambers in an effort to schedule a trial as soon as possible.  

But, given that MBIA Insurance's liquidity is evaporating and MBIA has disclosed that it doesn't expect MBIA Insurance to avoid being placed in rehabilitation absent a prior settlement of the litigation, one wonders whether either MBIA management or the New York Department of Financial Services (NYFS) would view it in their best interest to continue the litigation after MBIA Insurance places itself, or the NYDFS places MBIA Insurance, into rehabilitation.  If not, pre-rehabilitation settlement is their best option.

MBIA CEO Brown had this to say on MBIA's 2012 4th quarter earnings conference call:

"We will continue to be motivated to reach a negotiated settlement because of the potential disruption and loss of value that would be triggered by a regulatory proceeding against MBIA [Insurance]. In addition I believe that Bank of America will also be motivated to achieve a settlement in order to avoid having their CMBS claims substantially diluted and delayed. Settlements occur when the perceived economic values converge and there's substantial drivers we think should suggest such a convergence. However if that is wrong, both companies will be damaged as a consequence. Moreover as I've said in the past, we will not accept a non-economic settlement."

(MBIA investors will have the opportunity to listen in on MBIA's 2013 1st quarter earnings conference call on May 9 to compare notes.)

One may think that the convergence of the settlement bid/ask is in process, given that the summary judgment decisions show to BAC that the most likely outcome of the trial will be substantially adverse to BAC, while MBIA gets closer to a rehabilitation event involving MBIA Insurance that MBIA recognizes will be adverse to it.

In terms of what this narrowing of the bid/ask spread might look like, let me think aloud with you, dear reader. 

Hasn't the prospect of a MBIA Insurance rehabilitation put a practical lid on MBIA's expected net recovery?  Isn't the practical net recovery ceiling for MBIA in settlement sufficient funds from BAC, after commutation of BAC's cds policies, to repay the $1.65 billion secured loan from its municipal guaranty affiliate, National?  Even if MBIA wins at trial $5 billion in damages from BAC, after repaying the National secured loan, won't the rest of the damage award likely get soaked up by MBIA Insurance rehabilitation claimants who assert damages or accelerate claims that are insured by MBIA Insurance, such that there will be nothing substantial to trickle down to the residual interest of MBIA?

If this is right, doesn't it make sense for MBIA to agree to a $1.65 billion net of commutation payment from BAC, or perhaps something more than that to make sure that MBIA Insurance is financially stable until it obtains mbs recoveries from Credit Suisse and ResCapUnless MBIA is able to raise financing to tide MBIA Insurance over for a couple of years, which it doesn't seem willing to do at its current share price, does MBIA have a practical alternative?

On the other hand, given the fair reading of Justice Bransten's summary judgment opinions, doesn't it seem likely that BAC would see that it is in its best interest to hit that bid?

Wouldn't NYDFS superintendent Lawsky become a hero mediator by achieving this outcome, a stable MBIA Insurance, a litigation-free National able to get rated by rating agencies again and begin to write new municipal finance business, with no regulated companies in rehabilitation?

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. Wouldn't compensatory damages also include the claims by parties affected by the rehabilitation? MBIA could argue that the $4-5B in losses caused the liquidity crisis which in turn caused those claims, so why wouldn't BAC be on the hook for those as well?

  2. Well done Christian. I can't believe there aren't more comments of congrats here. You called this right all the way thru. Bravo! As for me I am onto Tivo vs Motorolla Mobility (GOOG).. fireworks start June 10th (that is if they get there).

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