Opinion

Alison Frankel

BofA catches big break: Walnut drops challenge to $8.5 bln MBS deal

By Alison Frankel
July 24, 2012

Late last month, without any fanfare, a New York appeals court issued a terse, one-page ruling that upheld the dismissal of Walnut Place’s breach-of-contract suit against Countrywide, Bank of America and Countrywide’s mortgage-backed securitization trustee, Bank of New York Mellon. It was an abrupt end for what was once a promising attempt at vindication for an MBS investor. It was also a huge setback for Walnut, its lawyers at Grais & Ellsworth and all the other Countrywide MBS investors who were counting on litigation against BofA as an alternative to the bank’s proposed $8.5 billion global settlement of breach-of-contract, or put-back, claims.

That one-page appellate ruling reverberated powerfully on Monday, when Walnut – otherwise known as the Boston hedge fund Baupost – filed a request to withdraw from the special New York proceeding to evaluate BofA’s MBS settlement. Framed as a letter to New York State Supreme Court Justice Barbara Kapnick from Grais partner Owen Cyrulnik, the request offered no explanation for Walnut’s withdrawal; Cyrulnik and Baupost spokeswoman Elaine Mann declined to comment.

But Baupost was facing an imminent decision about whether to request leave to appeal the dismissal of its case against BofA to New York’s highest court. Given the unlikely prospect that the Court of Appeals would agree to take the case, the hedge fund appears to have decided not to continue to spend money on litigation with little chance of a return. And given that the dismissal of Walnut’s suit makes it very difficult for the hedge fund – or any other MBS investor – to recover on put-back claims outside of the global settlement, Walnut apparently determined that it wasn’t economically rational to continue its challenge to the $8.5 billion deal. (From what I’ve heard, Bank of America did not pay Walnut anything in exchange for the hedge fund’s withdrawal; a Bank of America spokesman declined to comment to my Reuters colleague Karen Freifeld.)

In fact, according to the International Financing Review, which checked a trading database of securitized debt run by Empirasign Strategies, Walnut Place has teed up several of its Countrywide notes to be sold into the secondary MBS market Tuesday. The fund seems to have decided to cut its losses and move on.

That’s very good news for Bank of America, BNY Mellon and the major institutional investors pushing for approval of the $8.5 billion settlement. Walnut wasn’t the only intervenor challenging the deal, and AIG counsel Daniel Reilly of Reilly Pozner said Monday that the other members of the intervenors’ steering committee – Keller Rohrback on behalf of three Federal Home Loan Banks and Miller & Wrubel for the Triaxx collateralized debt vehicle – intend to continue to pursue discovery on how the deal was put together and whether it’s adequate. Both the New York and Delaware attorneys general have also intervened in the case.

But Walnut was the first Countrywide MBS investor to challenge the settlement, and its lawyers deployed some of the tactics that have caused BofA and BNY the most trouble. It was Walnut, for instance, that removed the special proceeding to federal court, where the banks spent months litigating in front of an unfriendly judge before the U.S. Court of Appeals for the 2nd Circuit sent the proposed settlement back to state court. Walnut was also one of the first investors to assert that BNY Mellon was too conflicted to represent the interests of Countrywide MBS noteholders because of a side letter specifying its indemnification agreement with Bank of America. Baupost chief Seth Klarman, moreover, is known as one of the savviest investors in the business. With Walnut out of the case, BofA loses a sophisticated, well-funded and well-advised opponent.

AIG counsel Reilly has been leading the charge since the case returned to Kapnick in state court. That creates an interesting opportunity for supporters of the settlement. Unlike Walnut Place, which was counting on its individual put-back case against BofA and BNY Mellon, AIG has sued BofA for securities law violations. The insurer is claiming $10 billion in damages for alleged deficiencies in mortgage-backed securities issued by Countrywide, BofA, Merrill Lynch and other related entities. Kathy Patrick of Gibbs & Bruns, who represents the investors supporting the settlement, has already questioned whether AIG is using its intervention in the global deal as leverage in its own securities suits. Expect Patrick and lawyers for BNY Mellon, Mayer Brown and Dechert to argue that AIG is holding up payment to thousands of Countrywide investors in order to improve its litigation posture in AIG cases against BofA.

The next development in the litigation over the settlement is an Aug. 2 hearing before Kapnick, at which the banks have said they will request a formal discovery settlement. That should provide some clues about whether the judge regards Walnut’s departure as a turning point.

Not long after Walnut filed its request to withdraw from the litigation, the 2nd Circuit issued an order that’s a fitting coda on Walnut’s experience in this case. The appeals court ordered the hedge fund to pay BNY Mellon’s filing fee in its appeal of the removal of the litigation to federal court. The total? $761.60. It’s not nearly enough to hurt, but just enough to rankle.

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