BofA MBS settlement shocker: Grais removes case to federal court

By Alison Frankel
August 26, 2011

There is never a dull moment in Bank of America’s attempt to resolve its Countrywide mortgage-backed securities liability. In a stunning move Friday, the law firm leading the fight against BofA’s proposed $8.5 billion settlement with Countrywide MBS noteholders removed the case from New York state supreme court to federal court. “The purpose of removal is to make sure that this proceeding is adjudicated in the proper forum,” Grais & Ellsworth wrote in a letter to lawyers for Bank of New York Mellon (the Countrywide MBS trustee) and for the big institutional investors who crafted the proposed settlement. “We believe in good faith that this proceeding is subject to federal jurisdiction as a mass action under the Class Action Fairness Act.” (Here’s the Grais & Ellsworth letter with the removal petition attached.)

The removal to federal court plunges the proposed settlement, at least temporarily, into more uncertainty than ever. Judge Barbara Kapnick, who is presiding over the unusual state court proceeding to evaluate the proposed deal, had imposed an August 30 deadline for Countrywide MBS investors to intervene in the case. She had also established a preliminary schedule for the discovery Grais & Ellsworth and other objectors’ counsel have demanded from BNY Mellon, BofA, and the institutional investors and their Gibbs & Bruns counsel. The removal to federal court means that Judge Kapnick isn’t in charge of the case, so it’s not clear whether lawyers are required to abide by her schedule.

The Grais & Ellsworth filing was a surprise tactic. The firm has been in the state court litigation since early July, filing its initial petition to intervene only days after Bank of New York Mellon, as Countrywide trustee, filed a suit asking for court approval of the settlement of investors’ claims. David Grais even appeared before Judge Kapnick at an August 5 hearing on objectors’ requests for expedited discovery. Grais & Ellsworth apparently waited to remove the case to federal court until Judge Kapnick granted the firm’s motion to intervene in the state court case on Monday. (Grais, who was not in the office Friday, didn’t respond to my e-mail; his partner Owen Cyrulnik, who signed the letter to opposing counsel, didn’t respond to an e-mail and phone message.)

You can bet that BNY Mellon and the institutional investors will move quickly to try to get the case back to Judge Kapnick, whose first substantive ruling, albeit on a minor procedural matter, went their way. Lawyers from Mayer Brown and Dechert (for BNY Mellon) and Gibbs & Bruns (for the investors backing the settlement) will be filing remand motions next week, possibly as soon as Monday or Tuesday. Whoever hears the remand fight — Grais & Ellsworth’s petition said the case is related to a Countrywide MBS investor suit before Manhattan federal judge William Pauley -- will have to deal with all kinds of novel questions. Among them: Grais & Ellsworth’s own previous precedent on put-back claims in federal court.

Grais’s argument for sending the $8.5 billion proposed settlement to federal court comes under the Class Action Fairness Act, the 2005 law that requires big-money class actions to be litigated under the oversight of a federal judge. CAFA also mandates that mass actions, in which at least 100 plaintiffs have filed parallel suits seeking money damages against the same defendant, be transferred to federal court. Grais & Ellsworth is asserting that because the proposed Countrywide MBS settlement will resolve the claims of investors in 530 trusts, it’s a mass action under CAFA.

But here’s the thing: there’s actually only one plaintiff in the proceeding before Judge Kapnick. As I’ve explained, the banks and the Gibbs & Bruns investor group that negotiated the proposed settlement are seeking court approval for the $8.5 billion deal under Article 77, a provision of the New York rules of civil procedure that’s typically invoked in small-time family trust matters. The lawyers behind the settlement opted for an Article 77 proceeding — instead of a class action — specifically because New York trust laws give broad leeway to trustees, who are presumed to be acting in the interests of trust beneficiaries unless someone can show they acted unreasonably. It may turn out that the banks’ Article 77 strategy also undermines Grais & Ellsworth’s attempt to move the case to federal court because technically the case is not a mass action.

There’s also the little matter of a previous ruling by the U.S. Court of Appeals for the Second Circuit, upholding a Manhattan federal court’s remand of a Countrywide MBS put-back case to state court. It’s worth taking a moment to consider that case, in which a plaintiff called Greenwich Financial Services asserted in New York state supreme court that Countrywide had breached representations and warranties about the mortgage loans underlying notes Greenwich bought. Those are the exact sort of investor claims, remember, that are at issue in the proposed $8.5 billion settlement.

Countrywide removed the case to federal court under the Class Action Fairness Act. (Sound familiar?) Greenwich successfully remanded the case to state court, arguing that CAFA didn’t apply to its put-back suit because of an exception in the class action law for cases related to rights and duties, including fiduciary duties, over securities. It was a smart argument by Greenwich’s lawyers, who badly wanted to keep the case in state court. Put-back suits argue that the MBS sponsor is required to buy back underlying mortgages that breach the representations the sponsor made about them. They’re based on the issuer’s contractual duty, not on fraud allegations.

Countrywide appealed, but the Second Circuit found that “as long as a plaintiff’s claim seeks enforcement of a right that arises from an appropriate instrument, its falls within the [CAFA] exception.” (Technically, the appellate court found that it didn’t have jurisdiction to hear Countrywide’s appeal.)

The Article 77 proceeding that Grais & Ellsworth has now removed to federal court is distinct from the Greenwich case because it was filed by the Countrywide MBS trustee, not by an investor. Nevertheless, the Second Circuit seemed pretty clear that put-back claims, which the Article 77 proceeding addresses, are an exception to the Class Action Fairness Act.

Grais & Ellsworth, as it happens, knows the Greenwich precedent very well: Grais represented the plaintiff who fought so hard — and effectively — to remand the put-back case to state court. And guess who oversaw the Greenwich case when it returned to state court? Judge Kapnick! Last October, she dismissed Grais’s case on procedural grounds, finding that Greenwich didn’t own the requisite 25 percent voting rights that would have permitted it to demand put-backs.

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