With a week to go before an Aug. 30 deadline to intervene in the proposed $8.5 billion Countrywide mortgage-backed securities settlement, New York State Supreme Court Judge Barbara Kapnick on Monday granted intervention motions from noteholders who want to conduct discovery on the deal. The New York and Delaware Attorneys General, meanwhile, filed stipulations giving them more time to respond to arguments -- from Bank of New York Mellon (the Countrywide MBS trustee) and the 22 big institutional investors who support the deal -- that they don't have standing to intervene. (The briefs opposing Delaware's intervention were filed last Friday; the NYAG opposition briefs came in earlier last week.)

The New York Times report that the Justice Department is pressuring NY AG Eric Schneiderman to agree to a 50-state mortgage servicing deal with Bank of America and other major mortgage lenders may complicate the AGs' involvement in the Countrywide noteholders' deal. The best arguments the AGs can make for standing in the proceeding are that New York and Delaware mortgage holders will be affected by the servicing provisions in the proposed agreement. A more sweeping settlement would take those arguments away and help keep regulators out of the MBS deal.

If that occurs, only dissenting noteholders could stop the settlement from winning Kapnick's approval. Under Article 77 of New York's rules of civil procedure, they'll have to show that BNY Mellon, as trustee, acted unreasonably. To date, objectors and their lawyers (principally from Grais & Ellsworth and Scott + Scott) have asserted that BNY Mellon didn't provide all noteholders with sufficient information about the mortgages underlying the Countrywide securities, and engaged in secret talks with BofA and the 22 institutional investors represented by Gibbs & Bruns. AIG has also questioned Gibbs & Bruns' motive for supporting the settlement; the firm is set to reap $85 million in fees if the deal goes through. (Gibbs & Bruns, of course, doesn't have an obligation to all noteholders, just to its clients.)

The sexiest, most accessible objectors' argument is that Bank of New York Mellon had a financial motive to support Bank of America's settlement proposal. BofA and BNY Mellon executed a side agreement, attached as Exhibit C to the June 29 settlement proposal, granting the trustee indemnification for negotiating and supporting the deal. Objectors have pounced upon the three-page side letter as evidence that BNY Mellon is more concerned with its own exposure than with protecting the interests of noteholders.

BNY Mellon and its lawyers at Dechert and Mayer Brown have countered that the indemnification side letter grants the bank no protection it didn't already have via the Pooling and Servicing Agreements under which the Countrywide mortgage-backed securities were offered. Kathy Patrick of Gibbs & Bruns has made the same argument in filings and in her first appearance before Judge Kapnick on Aug. 5.

But on Friday, Bank of America's lawyers chimed in -- with as forceful a brief as I've ever seen from the bank. BofA, remember, isn't a party to the Article 77 proceeding, so it couldn't address the indemnity issue head on. Instead, the bank's lawyers -- from Wachtell, Lipton, Rosen & Katz and Goodwin Procter -- used the excuse of a memorandum of law in the Walnut Place investors' put-back suit against the bank, also underway before Judge Kapnick, to address the allegation that BNY Mellon received valuable indemnity in exchange for the supporting the proposed $8.5 billion MBS settlement.

The indemnity side letter, the BofA brief said, "provides no expansion of the pre-existing indemnity at all. The trustee got nothing to which it was not previously entitled." The pre-existing pooling and servicing agreements already indemnified BNY Mellon as the Countrywide MBS trustee, the brief said. According to BofA, the side letter, which specifically refers back to the PSA and includes the phrase "we confirm" at least three times, merely reiterates what is already evident from the trusts' documentation.

"That is and was always perfectly clear, because the pre-existing indemnification provisions expressly covered any loss, liability or expense 'incurred in connection with any claim or legal action' relating to the PSA, the certificates issued under the PSA, or 'in connection with the performance of any of the trustee's duties' under the PSA," BofA asserted. "Accordingly, that recital in Exhibit C added absolutely nothing to the pre-existing indemnification of the trustee."

The settlement's objectors have also argued that the side letter transferred BNY Mellon's indemnity from Countrywide to Bank of America. Beth Kaswan of Scott + Scott told me that's the crucial benefit of the side letter for BNY Mellon. "The right of indemnity against a solvent company versus a company with limited assets is a completely different animal," she said.

Bank of America's brief, however, said BofA has been on the hook for Countrywide's liability under the MBS securitization agreements since Bank of America took over Countrywide's mortgage servicing operations. "The indemnity has thus long been on the Bank of America side of the line, not on the Countrywide side," the brief said. "So there was no practical benefit to the trustee in the Bank of America guaranty of the indemnity obligation under the PSAs. That indemnity was not, as Walnut Place falsely asserts, provided by Countrywide. It had long been an obligation on the Bank of America side."

Finally, BofA's brief asserted, the objectors' indemnity argument "makes no sense." The side letter, BofA's lawyers noted, only gave BNY Mellon additional indemnity for the proposed MBS settlement. If the settlement is approved, BNY Mellon has no liability because it acted in good faith, the brief said. If Kapnick rejects the deal, the trustee has no liability for the settlement because there is no settlement. Regardless, the indemnity side letter doesn't amount to a conflict of interest, according to BofA.

"Either way, the trustee is no better off than if it never proposed the settlement," the brief said. "The trustee could have just sat there, done nothing, and let the institutional investors litigate their claims against Bank of America and Countrywide. The trustee would have had the indemnity that it already had, and there would have been no settlement for anyone to complain about, let alone threaten suit over. So the trustee is not better off having proposed the settlement to the court than if it had not."

The only question the BofA brief doesn't address is why the very smart lawyers who represent BofA and BNY Mellon felt the need to execute a side letter if the letter confers no benefits on the trustee. A lawyer involved in negotiating the deal told me, "It was just ice in winter -- typical lawyers' belts and suspenders and crazy glue."

I'm guessing objectors aren't going to be satisfied with that explanation, though David Grais, who's counsel to Walnut Place, didn't respond to my email requesting comment. If I had to bet, I'd put money on the indemnification side letter rearing its head again in any additional intervention petitions filed in the next seven days. More grist for Judge Kapnick.

(Reporting by Alison Frankel)

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