There was a lot of chest thumping Wednesday by noteholders
who don't like the proposed $8.5 billion settlement between
Bank of America and investors in securities backed by
Countrywide mortgages. Bill Frey of Greenwich Financial, a firm
that structures asset-backed securities, told Tom Hals of
Reuters that he had been "bombarded" with e-mails from angry
Countrywide noteholders. He's urging them to rise up in
opposition to the settlement proposal. "If investors were to
open their mouths," Frey told Hals, "they can push for a better
and fairer settlement, or they can get two cents on the dollar
like they are getting."
Good luck with that.
The lawyers who structured the BofA settlement saw such
protests coming from a mile away and armored the deal against
them. Their most powerful defense? The New York state law they
chose as a vehicle for judicial approval of the settlement:
Article 77, which provides for a "special proceeding related to
express trust."
It's a creative use of the law, to say the least. Article
77, which allows a trustee to seek a judicial endorsement of
trust-related decisions, is usually invoked in garden-variety
trust disputes, not $8.5 billion deals affecting hundreds of
trust beneficiaries. But the Countrywide securitizations that
the BofA settlement addresses were offered via 530 different
trusts, making trust law a legitimate prism through which to
assess the proposal. Moreover, there is precedent for using
Article 77 to win court approval of decisions by trustees in
commercial cases, according to a brief filed in conjunction
with the BofA agreement, which cites a 1998 case called In re
Application of IBJ Schroder Bank & Trust Co.
The lawyers who put together the BofA deal-- principally
Kathy Patrick and Robert Madden of Gibbs & Bruns (for a large
investor group); Ted Mirvis of Wachtell, Lipton, Rosen & Katz
(for Bank of America); and Jason Kravitt and Matthew Ingber of
Mayer Brown (for Bank of New York Mellon, the trustee in the
securitizations)-weighed all kinds of options for obtaining
judicial approval of the settlement. They considered state and
federal courts in various jurisdictions, but ultimately came to
a consensus that an Article 77 proceeding made the most sense,
even though the law had never been applied to any trust matter
of this scope and size "You could think of this as 530 trusts
all being heard," said Madden of Gibbs & Bruns. "It's very
pragmatic."
It's also weighted in favor of deal supporters. Here's the
beauty of the Article 77 vehicle for BofA and BoNY: Under trust
law, the bar for blocking a decision by the trustee is
incredibly high. Anyone with an interest in the trust has a
right to challenge the trustee's decision. But unless
objectors can show that the trustee, in this case BoNY, abused
its discretion, acted unreasonably, or otherwise breached its
fiduciary duty to the trusts' beneficiaries, the court is not
supposed to interfere with the trustee's power.
That's a tough standard to meet for anyone who doesn't like
the proposed BofA deal. The trust contracts signed by investors
in the Countrywide securitizations clearly state that the
trustee, BoNY, has the power to enforce the terms of the trust.
The contracts don't expressly give BoNY the power to settle
claims-which may be an avenue of attack on the deal for
challengers-but New York case law provides considerable
precedent. So assuming the court agrees that the trustee has
the power to settle on behalf of noteholders, the judge's only
inquiry is whether the trustee acted unreasonably.
In their petition requesting approval of the deal, BoNY's
lawyers from Mayer Brown lay out all of the precautionary
measures the trustee took to assure a reasonable settlement.
Among other steps, BoNY brought in five expert consultants to
opine on the legal and practical considerations any
trust-by-trust litigation against Bank of America would entail.
The expert opinions led the trustee to a determination that the
most noteholders could get by litigating against the bank was
$8.8 to $11 billion--and that's without discounting for any of
the defenses BofA could raise. "A settlement payout of $8.5
billion is viewed by the trustee as falling within a small
variance of that pre-discounted settlement range," the petition
says. Weighed against the uncertainty of years-long litigation,
it's going to be very difficult to show that an $8.5 billion
settlement-in which investors retain their notes, as well as
potential securities law claims-is an unreasonable abuse of the
trustee's discretion.
The high bar for challengers is only one of the benefits
BofA and BoNY get from the Article 77 proceeding. The
settlement agreement has some of the trappings of a class
action resolution. It establishes a notice system to get out
word of the settlement. It allows time for noteholders who
don't like the deal to file objections. It offers a plan for
distributing the $8.5 billion to investors, and provides
important non-monetary relief in the form of changes to the way
the underlying mortgages are serviced.
But unlike a class action, an Article 77 proceeding has no
opt-out provisions, so if New York state supreme court judge
Barbara Kapnick approves the settlement, the deal will bind all
noteholders to its terms-a crucial consideration for BofA.
BoNY, meanwhile, gets to have its cake and eat it too under
Article 77. The trustee gets the benefit of broad discretion
for its decision to settle, as well as the protection of
judicial approval of the deal. "We felt the device made sense
because it brings closure on a lot of issues for all of the
parties," BoNY counsel Jason Kravitt of Mayer Brown.
OTC left messages for investor lawyers David Grais of Grais
& Ellsworth and Talcott Franklin of Talcott Franklin, P.C.,
whose pending Countrywide securitization cases will be swept
into the settlement if it's approved. Neither called back.
(Reporting by Alison Frankel)