Why Countrywide bankruptcy likely won’t solve BofA MBS problems

October 11, 2011

The drumbeat of calls for Bank of America to put what remains of Countrywide into Chapter 11 has grown so loud and relentless that according to a report last month by Bloomberg, BofA is actually considering what’s been called the “nuclear option.” Resorting to a Countrywide Chapter 11 would be fraught with unknown but surely devastating consequences for a commercial bank, as bankruptcy guru Harvey Miller of Weil, Gotshal & Manges explained in a fascinating Bloomberg video. But more significantly, there’s a good chance it wouldn’t accomplish the intended goal of roping off BofA’s liability for Countrywide’s mortgage-backed securities mess.

If Bank of America can succeed in limiting its MBS litigation losses to Countrywide’s remaining assets, it will have to show that it didn’t assume liability for Countrywide’s conduct when it acquired the mortgage company in 2008. That’s known as successor liability, and it was one of the key questions Bank of New York Mellon considered as it weighed the fairness of BofA’s proposed $8.5 billion settlement with Countrywide MBS investors. BNY Mellon’s expert, Professor Robert Daines of Stanford Law School, produced a 58-page treatise that concluded it would be very difficult for MBS investors to establish BofA’s successor liability.

Professor Daines looked at a variety of theories plaintiffs could pursue to stick BofA with the hot potato of Countrywide MBS liability. Most, he said, are non-starters, but if there’s any route to successor liability it would probably be through an argument, under New York law, that BofA’s acquisition of Countrywide was a de facto merger. There’s a four-prong test for such a determination, according to the professor, but its interpretation depends to a very large extent on the judge hearing the case. “The doctrine is thus unpredictable and there is even a disagreement about how the four-factor test should be applied: several decisions suggest that the courts apply a ‘flexible’ standard: i.e., they consider all of the factors and that any of these factors could trigger a de facto merger,” Professor Daines wrote in the analysis for BNY Mellon.

In other words, if a New York judge decides an acquiring company should be tagged with the liabilities of its target, the judge has a lot of discretion to make it happen. BofA didn’t have to look very far for proof of that. In April 2010, New York supreme court judge Eileen Bransten refused to dismiss allegations that BofA has successor liability for MBIA’s MBS claims against Countrywide. She found that MBIA offered sufficient evidence — the judge noted in particular that BofA had stripped Countrywide of its assets and shut down the Countrywide brand — to assert the deal was a de facto merger. Judge Bransten ruled that BofA must remain a defendant in MBIA’s case under MBIA’s successor liability theory.

It’s significant that when Countrywide and BofA appealed parts of Judge Bransten’s April 2010 ruling to the state’s appellate division, the defendants didn’t ask for review of her finding on successor liability. Typically, when defendants don’t appeal a ruling like that, it’s because they’re worried about setting appellate precedent that will guide future determinations on the same issue. BofA didn’t show a whole lot of confidence in its arguments against MBIA’s de facto merger theory when it let stand Judge Bransten’s preliminary ruling on its successor liability.

And that brings us to the hearing last Wednesday before the same judge in several bond insurers’ cases against Countrywide and BofA. Yesterday I wrote about the morning session, in which the judge heard arguments about whether Countrywide can argue that the economic downturn — and not its underwriting deficiencies — led to MBS failures. In the afternoon arguments, BofA and the bond insurers addressed BofA’s motion to consolidate all four insurers’ successor liability cases.

The bank’s lawyer, Jonathan Rosenberg of O’Melveny & Myers, told Judge Bransten that the consolidation is a matter of efficiency. All of the insurers will be deposing the same BofA witnesses and looking at the same BofA evidence to assert virtually identical theories, so why not litigate the cases at the same time?

MBIA’s lawyer, Peter Calamari at Quinn Emanuel Urquhart & Sullivan, had an answer to that question: Because MBIA is close to a summary judgment motion on BofA’s successor liability and the other bond insurers aren’t. BofA is stalling, Calamari argued, because it’s afraid Judge Bransten will rule the same way she did on the bank’s motion to dismiss, concluding BofA’s acquisition of Countrywide was a de facto merger so the bank is on the hook for successor liability. “The evidence that has been produced so far and has been obtained so far is extremely strong evidence of a de facto merger,” Calamari argued. “You would think that if this were a weak case or an insignificant claim they would say, ‘Hey, let’s get summary judgment done, let’s get it out of the way, we’ll win the case and it will be over.’ [Instead] they are trying to stop it dead in its tracks.”

BofA may even have given Judge Bransten — who, remember, has broad discretion in analyzing the de facto merger question — additional reasons to confirm her preliminary ruling, according to the transcript. “To the extent [the insurers] want to argue there has been integration activity, yes, there has been integration activities in furtherance of the asset sales,” O’Melveny’s Rosenberg said near the end of the hearing. “To the extent they want to argue that certain Countrywide employees now work for Bank of America and that Bank of America employees have provided services to Countrywide, that’s all undisputed. We’ve acknowledged that in our interrogatories.” The bank also acknowledged earlier in the session that two Countrywide entities, one named as a defendant by MBIA and one by Financial Guaranty, “have de jur [merged] into Bank of America.”

MBIA’s Calamari urged Judge Bransten to push its successor liability case forward because “the underlying defendant could well declare bankruptcy and we would be in a position of sitting around waiting.” But if he wins the successor liability fight, it won’t matter if Countrywide’s in bankruptcy anyway.

I left a phone message with BofA counsel Rosenberg of O’Melveny and sent a detailed e-mail requesting comment to a BofA spokesman, but didn’t hear back from either of them.

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