It’s (finally) time for objectors to BofA’s MBS deal to make their case

June 4, 2013

To say that the hearing to evaluate Bank of America’s proposed $8.5 billion breach of contract settlement with investors in Countrywide mortgage-backed securities got off to a slow start would be something of an understatement. In a courtroom so crowded that New York State Supreme Court Justice Barbara Kapnick repeatedly admonished observers to clear a path to the door, the judge heard hours of pretrial motions, many on issues she regarded as already settled. In particular, objectors to the settlement – led by AIG, several Federal Home Loan Banks and other assorted pension and investment funds – told Kapnick that they should not be forced to proceed with opening statements until they’ve had a chance to take depositions based on privileged communications between Bank of New York Mellon, the Countrywide MBS trustee, and its lawyers at Mayer Brown. Kapnick ordered the documents produced late last month, and AIG counsel Daniel Reilly of Reilly Pozner said it wouldn’t be fair to begin a hearing to determine whether BNY Mellon made a reasonable decision to agree to the $8.5 billion settlement – which resolves potential claims by 530 trusts that Countrywide breached representations and warranties about underlying mortgage loans – until objectors have quizzed witnesses on the confidential material.

Kathy Patrick of Gibbs & Bruns, who represents BlackRock, Pimco, MetLife and other major institutional investors that negotiated the deal with BofA and BNY Mellon, said the objectors just wanted to delay Kapnick’s final reckoning of the settlement, which is being evaluated in a special proceeding under New York trust law. Reilly, who argued unsuccessfully last week for a stay of the case while the state appeals court considers whether it should be heard by a jury, insisted that he just wants the proceeding to be fair. Judge Kapnick, meanwhile, seemed preoccupied with getting the actual hearing under way. “I am trying to make this go ahead,” she told the objectors at one stage. “I am not going to reopen a point we spent an inordinate amount of time arguing about,” she said at another. “At some point, you have to get going with this.”

The delay issue came to a head in the afternoon session, when yet more motions to limit testimony and evidence had to be resolved. Reilly asked the judge to restrict Patrick from asserting that 93 percent of Countrywide MBS investors support the settlement when, in fact, the majority of certificate holders haven’t opined one way or the other. Patrick stood up and promised that she’d henceforth say that 93 percent do not object to the deal.

“You say whatever you want,” Kapnick told Patrick. “I get it.” She then turned to Reilly. “I don’t know who you think you’re talking to,” she said, reminding him, yet again, that there’s no jury hearing the case, just a judge who has been listening to arguments from settlement supporters and detractors for almost two years.

Patrick ventured that perhaps it was finally time for BNYM counsel Matthew Ingber of Mayer Brown to deliver the trial’s first opening statement. “No, he has some more problems,” Kapnick said, referring to Reilly. “I know you want to start,” she said to Patrick. “I want to start too.”

“I do too, your honor,” Reilly said, prompting laughter in the courtroom that, unfortunately, drowned out a joking response by Kapnick, who referred back to the phantom 93 percent battle. “At this point, we have to have a little levity,” the judge said.

Kapnick could joke because she’d just about reached the end of pretrial motions (except for a final ruling that lawyers from Wachtell, Lipton, Rosen & Katz may remain in the courtroom as counsel for BofA even though they are slated to appear as witnesses).

But her irritation throughout Monday’s session points up a real mystery in this case: Why do the objectors seem intent on delaying the proceeding to determine whether BNY Mellon made a reasonable, good faith decision to accept the $8.5 billion settlement on behalf of all Countrywide MBS investors?

The objectors, 65 entities including 22 associated with AIG (according to AIG counsel Reilly), would say that they’re only trying to make the proceeding as fair as possible. They can’t put forth their best case, they’d say, without making full use of the privileged communications they received last week, and, for that matter, without an appellate ruling on their (surely hopeless) motion to have the case tried before a jury rather than before Kapnick. I’m sure that’s true. It’s also true that the objectors’ end game, as they themselves conceded in briefs last month, is not to kill the settlement and drive every Countrywide MBS investor into litigation with Bank of America and Bank of New York Mellon. It’s to reopen negotiations with them at the table alongside the major investors in the Gibbs & Bruns group. In short, they want more money.

AIG, in particular, wants blood from Bank of America. As you know, AIG brought $10.5 billion in securities claims against BofA, Merrill Lynch and Countrywide in 2011. Kathy Patrick has long insisted (most recently in an article in Sunday’s Wall Street Journal) that AIG is using its objection to the global put-back deal as leverage in its own litigation against BofA. You won’t hear Reilly or AIG lawyer Michael Carlinsky of Quinn Emanuel Urquhart & Sullivan say that, but if AIG were to withdraw from the put-back hearing, the opposition would lose its most vocal, influential member.

I’ve compared the objectors to a guerilla troop, better suited for sniper fire from chosen vantage points than for the full-blown battle of a hearing. Nevertheless, on Tuesday they’ll be flushed into the open.

In the last hour of Monday’s hearing, BNY Mellon counsel Ingber tried to anticipate the arguments objectors will make when their turn comes. They’ll say that the trustee should have looked at underlying loan files before entering the settlement, but, according to Ingber, the trustee decided that the time and expense of sorting through even a sample of the 1.6 million underlying mortgages wasn’t justified, especially because any decision on the proper sample size or extent of re-underwriting would be questioned. Ingber predicted that objectors will argue that the trustee should have provided notice of settlement talks to all Countrywide MBS investors; Ingber asked rhetorically what that notice should have been and what action the investors who now object would have taken once they received it. “What do they think would have happened if notice were given?” he said. “It wouldn’t have changed the trustee’s analysis.”

In one of the only mild surprises in Ingber’s presentation, he mentioned that BofA actually invited “some of the objectors” to participate in settlement talks. That caught the attention of Judge Kapnick, who asked for details. Ingber promised they’d be supplied in testimony by deal proponents. (Ingber didn’t specify which objectors had received the invitation. I’ve previously reported that AIG claims to have reached out to Gibbs & Bruns early in the settlement process and that BNY Mellon has said that lawyers for a hedge fund that has since sold off its Countrywide MBS were invited into the talks.)

The last part of Ingber’s presentation addressed what seems to me to be the strongest arguments of the objectors, that BNY Mellon made a deal with the institutional investors to forestall the declaration of an event of default 60 days after the Gibbs & Bruns group served a demand notice. The objectors have contended that the trustee signed the so-called forbearance agreement because it wanted to avoid the heightened duties and exposure that would come with the declaration of an event of default. That interest, detractors argue, put BNY Mellon in conflict with MBS investors outside of the Gibbs group.

Ingber said that the privileged documents just turned over to objectors would show that even Mayer Brown wasn’t sure, as BNY Mellon strategized about the Gibbs group’s demands, precisely what would trigger an event of default. Once it began talks with the institutional investor group, it became clear that litigation over whether a default had occurred would be a distraction. Ingber said that the trustee entered the forbearance agreement to permit productive settlement talks to move forward, acting in the interests of certificate holders, not against them. “Without the forbearance agreement we could have made zero progress with Countrywide and Bank of America,” he said. “The forbearance agreement solved the issue.” (It also didn’t prevent any other investor from sending a notice of default to the trustee, Ingber said, and, moreover, tolled the statute of limitations on put-back claims by all MBS investors.)

For the trustee, Ingber said in conclusion, deciding to accept a settlement that brought billions more to certificate holders than they would likely receive through risky and protracted litigation “was an easy call and it was done for the right reason,” he said. “The decision was supported by law, supported by facts, and supported by common sense.”

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