Opinion

Alison Frankel

Can JPM’s $4.5 bln deal with MBS investors avoid BofA’s pitfalls?

By Alison Frankel
November 19, 2013

Is this timing merely a coincidence? On Friday, JPMorgan Chase and the Houston law firm Gibbs & Bruns announced that they had reached a $4.5 billion settlement to resolve allegations that the bank breached representations and warranties to private investors in 330 JPMorgan and Bear Stearns mortgage-backed securities trusts. Gibbs & Bruns negotiated the JPMorgan settlement on behalf of 21 major institutional investors, including BlackRock, Pimco, Goldman Sachs and MetLife. Two days after the JPMorgan announcement, Kathy Patrick of Gibbs appeared in New York State Supreme Court to make her closing argument in support of her clients’ previous deal, an $8.5 billion settlement with Bank of America that has been held up for 2-1/2 years by a small group of Countrywide MBS investors who object to the deal. Will Patrick be back in court in 2016 to defend the JPMorgan settlement?

She could well be, but there are important differences between the JPMorgan and BofA put-back settlements, some structural and some a matter of circumstance, that should reduce the friction for JPMorgan. Gibbs & Bruns, which is slated to receive $85 million , or 1 percent, in fees if the BofA settlement is approved, is in line for $66 million, or 1.47 percent, in fees from the JPMorgan deal, according to the JPMorgan settlement agreement. That extra share will be worth it to JPMorgan if Gibbs & Bruns used its bruising experience with Countrywide MBS objectors to improve the new deal.

Let’s look first at tweaks to the settlement structure. Bank of America’s settlement was actually filed by Bank of New York Mellon, the lone MBS trustee for all of the 430 Countrywide trusts whose breach-of-contract claims would be resolved in the proposed $8.5 billion deal. BNY Mellon asked for a judicial determination, through a special New York state-court trust proceeding known as Article 77, that it was acting within its discretion when it accepted BofA’s global settlement offer. BofA, BNY Mellon and the Gibbs & Bruns group believed that to obtain approval of the settlement under the broad latitude trustees enjoy under New York law, BNY Mellon would simply have to show that it did not abuse its power or act in conflict with the trusts’ interests. Objectors, led by AIG, have since howled that (among other things) BNY Mellon made no distinction between Countrywide MBS trusts when it agreed to a global settlement. As the lone trustee, it accepted BofA’s offer on behalf of all of the 430 Countrywide trusts in the deal. BofA, BNY Mellon and the investor group, meanwhile, have stood by the one-for-all nature of the global settlement. If the court finds that BNY Mellon did not properly execute its trustee duties, they contend, the entire $8.5 billion settlement collapses.

The JPMorgan settlement, by contrast, involves seven different MBS trustees and seems to anticipate that not all of the trustees will participate in the settlement on behalf of all the JPMorgan and Bear trusts they oversee. The agreement between the bank and the Gibbs & Bruns group, remember, is meaningless unless the MBS trustees enter the deal, since only the trustees have the power to settle the trusts’ claim. The investors in the Gibbs group have a large enough stake to direct the decisions of the trustees in many of the trusts (though the settlement agreement does not specify how many). Trustees overseeing trusts that aren’t controlled by Gibbs investors will have to make their own determination about whether to enter the settlement. Trustees will also have to decide whether to ask courts to approve their settlement decisions. The agreement between Gibbs & Bruns and JPMorgan does not refer explicitly to trustees obtaining court approval through New York’s Article 77 or any other trust proceeding, and trustees could theoretically enter the settlement without approval from certificate holders or a court. Chances are, though, that if the trustees agree to settle, they will ask a judge to bless that decision in order to insulate themselves from potential liability to MBS certificate holders in the trusts they oversee.

But unlike BofA, JPMorgan seems to be willing to proceed with the settlement even if some of the 330 trusts reject the deal. The agreement with Gibbs & Bruns includes a provision on “non-settling trusts” that envisions a few such scenarios: A trustee may decline to enter the settlement for any or all of the trusts it’s in charge of, or a court may refuse to approve a trustee’s decision to settle. In any of those events, the non-settling trust’s share of the $4.5 billion would revert to JPMorgan.

That provision, which seems akin to an opt-out in a class action settlement, could save JPMorgan a lot of grief. In some JPMorgan or Bear trusts, investors outside of the Gibbs & Bruns group hold enough voting rights to direct the actions of the trustee; some of the trusts in this deal – unlike the BofA deal – are backed by bond insurers, who typically call the shots for offerings they’ve insured. If controlling investors or bond insurers don’t like the proposed JPMorgan settlement, they can presumably instruct the trustee to reject it. JPMorgan has a walk-away provision in the agreement with Gibbs & Bruns, in the event that a lot of trusts refuse to enter the settlement. But if it’s only a few, the bank will still be able to resolve most of its put-back liability to private investors through the Gibbs settlement and can settle separately with the opt-outs.

The JPMorgan agreement also gives trustees 60 days to evaluate the settlement, and more time if they request it and the bank agrees. In the BofA deal, objectors have hammered BNY Mellon for agreeing to BofA’s $8.5 billion offer without examining underlying mortgage loan files for breaches of representations and warranties. The JPMorgan settlement seems to anticipate that trustees will want to see such documentation; the bank pledges in the agreement to expedite document production.

Nor can the trustees be accused of colluding with JPMorgan to reach the settlement – as BNY Mellon has been in the BofA case – because they weren’t part of the negotiations of the deal. They’re tasked with deciding simply whether the settlement is fair to the trusts.

All of these changes seem designed to blunt the power of potential objectors, who can’t leverage their influence to try and tank the entire deal and (depending on how trustees opt to evaluate the settlement proposal) can’t make some of the most persuasive points AIG and its fellow objectors have made about BNY Mellon and BofA in the Countrywide deal.

That’s not to say there won’t be objectors. Unlike Bank of America, which was facing put-back claims by only one private Countrywide MBS investor at the time it reached its proposed global settlement, JPMorgan and Bear are already defending several breach-of-contract suits by trustees acting at the direction of certificate holders in various trusts. The furthest-along case involves claims by the Boston hedge fund Baupost in Chancery Court in Delaware, where Ropes & Gray‘s summary judgment motion for Baupost is pending. There are also put-back cases under way in New York state court by Quinn Emanuel Urquhart & Sullivan and Labaton Sucharow. And, of course, there are well-developed breach-of-contract cases against JPMorgan and Bear by bond insurers, in both state and federal court. Lead lawyers in those cases either declined to comment or didn’t return my calls, but clearly, the monolines and certificate holders who have already instructed trustees to file put-back claims may not be thrilled with a settlement they didn’t negotiate, especially since their lawyers have already sunk time and money into the litigation. It will be particularly interesting to see if the Gibbs & Bruns group also has a big stake in any of the trusts with pending suits against JPMorgan and Bear, and how that impacts the litigation. Trustees may be stuck, for instance, between Gibbs investors that support the settlement and bond insurers that don’t.

If existing put-back suits increase the likelihood that the JPMorgan settlement will face opposition, the statute of limitations may have an opposite effect. When Bank of America proposed its global settlement in June 2011, investors were still within the six-year time limit for breach-of-contract claims under New York law for most MBS. Since then, two state-court trial judges overseeing MBS put-back litigation have reached different conclusions about when the clock starts ticking. The intermediate state appeals court will hear the issue next month. If it sides with the trial judges who said time runs out six years after the MBS offering date, then investors who haven’t already sued JPMorgan will have little hope of recovery outside of the global settlement (assuming, of course, that they haven’t signed tolling agreements with the bank). That could be a very important consideration for trustees evaluating whether to enter the settlement.

JPMorgan lawyers have had their hands full in finalizing the Justice Department settlement, but if I were them, I’d get serious now about settling with the private investors and bond insurers that have filed put-back claims. Settling in the next 60 days will minimize the odds that trustees will reject the Gibbs & Bruns deal. I should point out, of course, that litigation over the BofA global put-back deal went in directions I sure didn’t foresee (and I wasn’t the only one!). Strange things happen when this much money is at stake.

(Reporting by Alison Frankel)

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