On Friday, the Wall Street Journal called Bank of America's 2008
acquisition of the tottering mortgage giant Countrywide a $40 billion mistake. Sure, the bank only paid a total of $4.5
billion to pick up Countrywide, paying $2 billion for a minority
stake in 2007 and another $2.5 billion for the rest of the
company in 2008. BofA had its eye on Countrywide's then
profitable mortgage servicing business, but since the
acquisition Countrywide and its deficient mortgages have been
pretty much nothing but trouble for Bank of America, which has
seen its share price drop 68 percent and is still digesting what
the Journal estimated to be at least $40 billion in "total real
estate losses, settlements with government agencies and amounts
pledged to investors who purchased poor-performing Countrywide
mortgage-backed securities." The Journal's Dan Fitzpatrick
quoted a North Carolina banking professor who called BofA's
Countrywide acquisition "the worst deal in the history of
Ouch. But thanks to a New York appeals court, BofA may have
just put a fence around one big swath of Countrywide liability.
On Thursday the Appellate Division, First Department, upheld
Manhattan State Supreme Court Justice Barbara's Kapnick's ruling
that the mortgage-backed securities investor Walnut Place may not proceed with a breach of contract case against Countrywide.
That ruling will severely limit the options for Walnut and the
other investors who have objected to Bank of America's proposed
$8.5 billion global settlement with Countrywide MBS noteholders.
It also puts the focus in the litigation over the global
settlement on Bank of New York Mellon and its conduct as
Countrywide's MBS trustee, which Kapnick is also overseeing. My
prediction: Unless Kapnick finds that BNY Mellon didn't fulfill
its duties as trustee in reaching that settlement, Countrywide
MBS investors can't sue outside of the deal.
And here's why. MBS pooling and servicing contracts, you'll
recall, make it exceedingly difficult for noteholders to bring
claims that underlying loans breached representations and
warranties by mortgage issuers like Countrywide. Under standard
PSA terms, investors can't take any action unless they've
amassed support from noteholders with 25 percent of the voting
rights in a particular MBS trust. If they manage to get over
that procedural hurdle, they must then demand an investigation
of reps and warranties breaches from the MBS trustee and then
wait months for the trustee to respond. Only if the MBS trustee
fails to take action on their behalf can investors bring their
own breach of contract, or put-back suit.
Few private-label MBS investors have managed to run that
obstacle course and file their own put-back claims. Walnut
Place, a nom de litigation for the hedge fund Baupost, is in
that small group. In April 2011, Walnut's lawyers at Grais &
Ellsworthsued Countrywide and MBS trustee Bank of New York Mellon in Manhattan State Supreme Court, claiming that they'd
breached the PSAs governing two Countrywide MBS trusts.
Last July, after Bank of America announced that it had
reached a global $8.5 billion put-back settlement with a group
of 22 institutional investors in Countrywide mortgage-backed
notes, BofA and Countrywide moved to dismiss the Walnut suit.
They argued that Walnut didn't have a cause of action under the
pooling and servicing agreements because BNY Mellon had already taken action on its behalf: The trustee had entered into the
negotiations that produced the $8.5 billion proposed settlement.
It was a supremely self-serving argument by BofA's lawyers
at Wachtell, Lipton, Rosen & Katz and Countrywide counsel at
Goodwin Procter. Walnut had already surfaced as one of the
leading objectors to the proposed global settlement, arguing
that it cut the legs out from under its suit against the banks.
BofA and Countrywide essentially said Walnut was right -- the
global settlement did, in fact, pre-empt its put-back suit --
but that was tough luck for Walnut and every other Countrywide
MBS investor. According to BofA, the global deal offered it
broad protection because noteholders simply couldn't satisfy the
contract requirement of showing the MBS trustee hadn't taken
In March, Kapnick agreed with the banks. "The trustee did,
in fact, act upon [Walnut's] complaints, as demonstrated by the
settlement agreement reached with the defendants and submitted
to this court," she wrote. "That settlement includes the claims
at issue here." I noted at the time that Kapnick's reasoning
could just as well apply to every other Countrywide MBS
investor, since the $8.5 billion deal purports to resolve all of
their put-back claims. If Walnut -- which had, after all, filed
its suit before the global settlement was announced -- couldn't
get over the procedural wall of showing the trustee failed to
act, I said, it was hard to see how any other investor could do
The one-page appeals court ruling makes it all the more
unlikely that any Countrywide MBS investor has a viable claim
outside of the global settlement, with a caveat I'll get to in a
minute. The no-action clause in the pooling and servicing
contract is not ambiguous, the First Department said, and
clearly bars Walnut's suit. The court considered Walnut's
arguments that the "event of default" provision doesn't apply
and concluded that Walnut's interpretation of the pooling and
servicing agreements "would improperly excise the ... provision
and distort the plain meaning of the clause."
That curt rejection of Walnut's reasoning doesn't leave much
hope for Countrywide MBS investors with put-back claims --
unless Kapnick finds that BNY Mellon wasn't acting in their best
interests when it entered into the proposed global settlement.
That's the caveat I mentioned. There's a dispute in the special
Article 77 proceeding over which side bears the burden of proof.
BNY Mellon, which filed the case, believes objectors to the
settlement have to show that it acted outside the bounds of
reason when it agreed to the settlement. Objectors have argued
that the trustee has to prove that the deal was reasonable.
Either way, if the judge finds BNY Mellon was conflicted because
of indemnity agreements with Countrywide or Bank of America,
it's conceivable that investors could bring their own breach of
In the meantime, you can bet that the First Department
ruling will entrench the banks as litigation with objectors
continues. After all, compared to the $40 billion the
Countrywide deal is costing BofA, legal fees are peanuts.
(Reporting by Alison Frankel)
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