Way back in June, a day or so after Bank of America announced its proposed $8.5 billion settlement with Countrywide mortgage-backed securities investors, I wrote about the very peculiar vehicle through which the bank was seeking judicial approval of the arrangement. The settlement was filed by the Countrywide MBS trustee, Bank of New York Mellon, under Article 77 of the New York state code. Article 77, which allows a trustee to seek a judicial endorsement of trust-related decisions, is usually invoked in garden-variety trust disputes, not in an $8.5 billion deal affecting thousands of beneficiaries in 530 trusts. But the law offered distinct advantages for BofA, BNY Mellon, and the group of 22 institutional investors that negotiated the Countrywide MBS settlement. Under New York trust law, trustees have broad discretion to make decisions on behalf of the trusts they oversee. As long as the judge presiding over an Article 77 proceeding determines that the trustee has acted reasonably and hasn't abused its discretion, the trustee's decision gets a stamp of judicial approval. Anyone who disagrees with the trustee -- and the banks and institutional investors that negotiated the BofA proposed settlement knew that there would be many investors who didn't like it -- bears the heavy burden of proving that the trustee acted outside the bounds of reason.
At the very first substantive hearing on the settlement, Manhattan State Supreme Court Justice Barbara Kapnick made a comment that underscored settlement supporters' strategic wisdom in picking Article 77 as their vehicle. In response to discovery demands by some of the disgruntled Countrywide MBS holders that moved to intervene in the proceeding, Kapnick said that BNY Mellon and the investors who supported the deal had set the rules when they filed the case under Article 77. "That's the proceeding they brought," Kapnick said, after noting that she had to look up the obscure provision in the New York code. "It's not, it's not a class action. There aren't provisions in there to opt out that you are talking about. That's not what this is. If you started it, maybe that's what you would have done, but they started it and that's what they did. I have to work, at least now, within the confines of the proceeding that is before me."
On Monday, after the proposed settlement spent months on a detour in the federal courts, the 2nd Circuit Court of Appeals essentially said the same thing as Kapnick: The settlement should be evaluated through an Article 77 proceeding because that's what BNY Mellon filed.
In a 32-page ruling by Chief Judge Dennis Jacobs (for a panel that also included Judges Peter Hall and Raymond Lohier), the 2nd Circuit concluded that U.S. District Judge William Pauley erred in finding that the proposed settlement belongs in federal court as a mass action under the Class Action Fairness Act. Citing its own previous rulings in Greenwich Financial v. Countrywide and Estate of Barbara Pew v. Cardarelli -- and hewing closely to what Bank of America counsel Theodore Mirvis of Wachtell, Lipton, Rosen & Katz said at oral arguments earlier this month -- the appeals court said that the case falls under the securities exception to CAFA since it involves the trustee's duties under the Countrywide MBS pooling and servicing agreements. Notwithstanding Pauley's complex reasoning about the trustee's obligations deriving from New York common law, the 2nd Circuit said, the securities exception keeps the case in state court. (In a bit of vindication for those of us who have struggled to grasp the slippery provisions of the securities exception, Jacobs conceded that "the wording of the exception (like much of CAFA) does not easily give up its meaning.")
The securities exception holding depended on the 2nd Circuit's clarification of exactly what BNY Mellon sought in the Article 77 proceeding -- a question that got muddled when Grais & Ellsworth, as counsel to the hedge fund Baupost (acting under the nom de litigation Walnut Place) removed the proposed settlement to federal court. Grais & Ellsworth had argued that the case was a disguised class action, in which BofA and BNY Mellon were asking for judicial approval of the $8.5 million deal. The appeals court said what mattered wasn't Grais & Ellsworth's interpretation of the proceeding, but the case that was actually filed by BNY Mellon. "[Walnut's] wish list does not alter the nature of the relief sought by the trustee," the opinion said. "As a structural matter, relief would be limited by the purposes and procedural features of Article 77," which considers only the reasonableness of the trustee's decision to settle, not necessarily the merits of the settlement. "Whether a New York court is able and willing to grant the relief sought in this case is an issue for the New York courts," the opinion said.
The 2nd Circuit didn't express any of its own reservations about the use of Article 77, simply noting that BNY Mellon "asks for a construction of the PSA and an instruction that its planned course of action complies with its obligations under that document and the law of trusts -- consistent with other proceedings brought under Article 77."
In the broad scope of MBS representations and warranties litigation, in which investors and bond insurers have demanded that banks buy back billions of dollars of allegedly deficient underlying mortgage loans, the 2nd Circuit's implicit endorsement of the Article 77 vehicle may be the most important component of Monday's ruling. Gibbs & Bruns, the law firm that represents the institutional investors that negotiated the $8.5 billion deal with BofA, has demanded investigations of underlying loans in mortgage-backed securities issued by Morgan Stanley, Wells Fargo, and JPMorgan Chase -- the start of the process that produced the proposed BofA deal. Monday's ruling revives the probability that Gibbs & Bruns will press the other banks for global settlements that similarly take advantage of Article 77.
Of course, BofA and its fellow deal supporters haven't won approval from Kapnick in New York state court. They've only won the right to consideration of the trustee's decision under Article 77. Walnut Place's vigorous opposition to the settlement flushed more than 20 other Countrywide MBS investors into the open with objections to the deal, including allegations that BNY Mellon is conflicted because of an indemnity agreement with Bank of America and claims that only senior investors, such as the Gibbs & Bruns group, will benefit from the cash part of the proposed settlement. Kapnick will have to consider those arguments in evaluating the trustee's actions. She will also have to decide what to do about objections from the New York and Delaware Attorneys General, whose motions to intervene were pending before her when the case was removed to federal court. Pauley permitted their intervention, but it's not clear whether Kapnick is bound by that ruling. The New York AG, you'll recall, has filed proposed counterclaims against BNY Mellon for alleged failures as an MBS trustee.
Walnut counsel Owen Cyrulnik of Grais & Ellworth declined my request for comment. A BNY Mellon spokesman declined Reuters' request. (The bank is represented in the BofA case by Dechert and Mayer Brown.) BofA's spokesman offered a statement: "Bank of America's chief interest has been that the proposed settlement be considered and eventually approved by a court of unquestionable jurisdiction," he said. "We are gratified that the matter has been resolved on appeal. We believe the trustee acted reasonably in entering into the settlement agreement and we look forward to completing judicial proceedings to approve the decision." BofA counsel Mirvis of Wachtell sent an email statement: "Yippee."
(An earlier version of this blog post incorrectly identified DLA Piper as counsel for BNY Mellon. The bank is represented in this case by Dechert and Mayer Brown.)
(Reporting by Alison Frankel)
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