May We Cut In? – State AGs Object to Proposed Securitization Settlement
Blayne V. Scofield | Bloomberg Law
On June 29, 2011, The Bank of New York Mellon (BNY Mellon) filed a petition under Section 7701 of the New York Civil Practice Laws and Rules (CPLR) in the New York State Supreme Court seeking approval of a proposed settlement. If accepted by the court, the proposed settlement would resolve disputes between BNY Mellon, Bank of America Corporation (BAC), and 22 large, high-profile investors regarding residential mortgage securitizations. However, the Attorneys General of Delaware (DAG) and New York (NYAG) each objected to the proposal.
Investors Alleged that Bank of America Breached Securitization Documents
The securitizations at issue were created between 2004 and 2008 and include 530 separate securitization trusts. BNY Mellon acts as trustee for the trusts, and BAC’s subsidiaries (BAC Entities), including Countrywide Financial Corp., sold residential mortgages into the trusts and serviced the loans backing the securitizations. The selling and servicing activities conducted by the BAC Entities were generally governed by contracts known as “Pooling and Servicing Agreements” (Agreements).
In letters to BNY Mellon, the investors claimed that the BAC Entities sold low quality loans to the trusts in violation of representations and warranties in the Agreements, and that they failed to service the loans in accordance with the Agreements. Under the proposed settlement, the BAC Entities agreed to pay $8.5 billion to the trusts in compensation for the low-quality loans and BAC agreed to guarantee the settlement payment. The BAC Entities also agreed to reform their servicing procedures. In exchange, BAC and the BAC entities would receive a broad release from the investors’ claims.
In its petition, BNY Mellon claimed that the settlement was reasonable and would yield greater benefits than a resolution achieved via litigation. To support its view, it argued that the BAC Entities appeared to possess valid defenses and that liability may need to be determined on a loan-by-loan basis. These factors, BNY Mellon asserted, could lead to expensive and protracted litigation. It also cited an analysis showing that any amounts received from a judgment would be less than the settlement amount because the BAC Entities’ resources would be drained by defense expenses and the payment of claims related to other securitizations. Finally, BNY Mellon asserted that legal doctrines of corporate separateness would likely protect BAC from liability in the event the BAC Entities were unable to pay a judgment whereas BAC expressly agreed to guarantee payment of the settlement.
AGs Objected to Settlement Proposal
The DAG and NYAG each objected to the settlement and sought to intervene under CPLR §§ 1012(a)(2) and 1013. A party may intervene by right under CPLR § 1012(a)(2) if its interests are inadequately represented in the proceeding and it may be bound by the court’s decision. A party may intervene with the court’s permission under CPLR § 1013 if its claim or defense involves a common question of law or fact with the pending proceeding and consideration of its claim will not cause undue delay or prejudice.
In seeking to intervene, the DAG explained that a small number of the securitization trusts were creatures of Delaware law and it was conducting an investigation into possible violations of Delaware law. He sought to intervene to protect the interests of Delaware investors who were excluded from the settlement negotiations, preserve Delaware’s potential claims against the BAC Entities for violations of Delaware law, and ensure that claims against trusts created under Delaware law are resolved in accordance with Delaware law.
The NYAG took a more aggressive stance. Like the DAG, the NYAG sought to intervene to protect the interests of investors who did not participate in the settlement negotiations. In addition, however, the NYAG accused BNY Mellon of breaching its fiduciary duties and fraud (both under N.Y. Exec. Law § 63(12) and under the Martin Act, N.Y. Gen. Bus. Law § 352) and indicated similar claims may be brought against the BAC Entities. Critically, the NYAG asserted that BNY Mellon breached its fiduciary duties in negotiating the settlement and that the BAC Entities, by participating in the negotiations, may have aided and abetted the alleged breach of BNY Mellon’s fiduciary duties.
The intervention of state Attorneys General in what is essentially a contract dispute among several private parties could hinder the settlement process for this case as well as several other securitization disputes involving billions of dollars that are currently pending in courts. In particular, the NYAG’s fiduciary duty charges may deter issuers and trustees from entertaining settlement proposals, which could draw out the resolution of these disputes for many years to come.
Under orders issued by the court, preliminary objections to the petition must be filed by August 31, 2011, and a discovery hearing is scheduled for September 16, 2011. Reponses to objections and other submissions supporting the settlement must be filed by October 31, 2011. The court is tentatively slated to rule on the proposed settlement at a hearing on November 17, 2011.
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