Alison Frankel

The megabillion-dollar game of chicken between Bank of America and the bond insurer MBIA just got even more perilous. On Monday MBIA filed a notice that it is cross-appealing the ruling by Manhattan State Supreme Court Justice Eileen Bransten. MBIA wants reconsideration of Bransten’s finding that the bond insurer is not entitled to summary judgment on its claims that Countrywide breached representations and warranties on the mortgage-backed securities MBIA agreed to insure. You might think MBIA’s decision to appeal is a surprise, given the many routes to recovery Bransten gave MBIA on its insurance fraud claims against Countrywide. But as always in the incredibly complex litigation between Bank of America and MBIA, there are many layers to every move by either side.

Bransten’s rulings were undoubtedly a boon for the monolines Syncora and MBIA. The judge said the bond insurers don’t have to establish a direct causal link between the alleged deficiencies in the mortgage loans underlying the securities they agreed to insure and the subsequent payouts the insurers had to make on those MBS policies. Under Bransten’s opinion, MBIA and Syncora can prove insurance fraud merely by establishing that they relied on Countrywide’s alleged misrepresentations when they agreed to write the policies at issue in the litigation. And to prove a breach of the insurance agreements, they need only prove that Countrywide materially misrepresented the risk profile of the underlying mortgage pools.

Nevertheless, two days after Bransten issued her opinion, Syncora’s lawyers at Debevoise & Plimpton filed a notice of appeal. That’s because the decision wasn’t all good news for the monolines: Bransten denied Syncora and MBIA summary judgment on their interpretation of the MBS contracts they signed with Countrywide. The monolines argued that Countrywide was required to buy back every underlying mortgage that didn’t live up to the representations and warranties the issuer made about the mortgage pool. Bransten, however, said the contract language was too ambiguous for the issue to be decided on summary judgment. Syncora said it was seeking a reversal of that part of the ruling.

For Countrywide and Bank of America, Syncora’s appeal notice set off alarm bells. Bransten’s ruling on the reps and warranties question was actually more important to Bank of America — in the broad scope of MBS litigation — than the judge’s insurance-law conclusions. If Bransten had agreed with the monolines’ argument on Countrywide’s obligation to buy back deficient mortgages, the bank’s total MBS exposure could have increased drastically, because the ruling would have extended to MBS investors as well as bond insurers. The bank avoided a calamity in Bransten’s decision; Syncora’s appeal revived the prospect of reps and warranties disaster.

So on Jan. 25, Countrywide’s lawyers at Goodwin Procter filed their own notices of appeal of Bransten’s ruling in both the Syncora and MBIA cases. Countrywide’s biggest fear is that the state appeals court will disagree with Bransten on the reps and warranties issue, so its notice in the MBIA case pointed out to the appellate court that Bransten had sided with the bank on that issue. The notice asked only for a reconsideration of Bransten’s ruling that the bond insurers are entitled to damages on the insurance-law claims.

MBIA obviously wasn’t going to permit Syncora and Countrywide to argue at the appeals court without having a say of its own. The bond insurer’s notice raises the stakes for the Appellate Division, First Department, by explicitly citing Bransten’s ruling that Countrywide may assert an affirmative defense that the monolines’ losses were due to economic circumstances, not to alleged deficiencies in MBS underwriting. MBIA wants the appeals court to reverse Bransten not only on the reps and warranties ruling, but also on Countrywide’s affirmative defenses.

For all three of these litigants, sending the case to the appellate division means more uncertainty and a much longer wait for an ultimate resolution. MBIA and Bank of America each seem to be waiting for the other side to run out of time; cash-strapped MBIA is already booking almost $3 billion in expected reps and warranties revenue from BofA; and BofA’s stockholders would doubtless appreciate resolution of the MBIA mess. But to return to the chicken-game metaphor, neither the bank nor the bond insurer appears willing to be the first to get out of the way.

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None of the firms battling Countrywide and Bank of America on behalf of mortgage-backed securities investors has dedicated more resources to the fight than Quinn Emanuel Urquhart & Sullivan. Quinn represents some of the biggest MBS claimants in suits against Countrywide, including AIG and the Federal Housing Finance Agency. The firm also represents MBIA in the bond insurer’s long-running New York State case against Countrywide. If anyone on the plaintiffs’ side has the goods on Countrywide and Bank of America, in other words, it’s Quinn Emanuel.

That’s why a ruling Thursday by U.S. District Judge Mariana Pfaelzer of Los Angeles federal court is such a blow to Countrywide MBS investors. Pfaelzer, who’s overseeing the consolidated federal-court MBS litigation against Countrywide, dismissed Allstate’s successor-liability and fraudulent-conveyance claims against Bank of America, with prejudice. Quinn represents Allstate, and offered detailed allegations that Bank of America’s 2008 acquisition of Countrywide was structured to deliver Countrywide’s revenue-producing businesses to BofA while simultaneously walling off the mortgage company’s looming liability for subprime mortgages and mortgage-backed securities.

Pfaelzer said, however, that Quinn Emanuel hadn’t come up with sufficient facts to back its assertions. She rejected two different theories: first, that Bank of America and Countrywide engaged in a fraudulent conveyance or transfer; and second, that BofA’s acquisition of Countrywide was a de facto merger. The judge has previously found for Bank of America in two other rulings on the de facto merger question (here’s Pfaelzer’s April 2011 opinion in an MBS class action against Countrywide), but this is the first time she’s delivered a definitive ruling on fraudulent-conveyance allegations.

“Once (Allstate’s) legal conclusions are stripped away, the court is left with the rather bare description of (acquisition) transactions contained in the (amended complaint),” Pfaelzer wrote. “Those paragraphs describe the asserts that Countrywide sold and their prices. They do not contain any indication that any other market for these assets existed, or what the assets’ ‘true’ market value was, or what the accounting value of the assets was, or why the court should disregard the very concrete intangible benefit that proceeds from the asset sales were used to pay off debt, increase capital, and otherwise allow Countrywide to remain in business.”

The judge also said Quinn Emanuel hadn’t shown enough evidence that BofA and Countrywide were aware of the mortgage-backed securities claims that awaited Countrywide at the time of the 2008 acquisition. Interestingly, Quinn pointed to a 2007 MBS class action against Countrywide to show that BofA knew about Countrywide’s MBS exposure and structured its acquisition to protect the bank. Pfaelzer relied on the same 2007 class-action filing this summer when she set a time limit on MBS claims against Countrywide. But in Thursday’s ruling, she reasoned that even though the 2007 class action suit put plaintiffs on notice, it didn’t portend insolvency for Countrywide.

Bank of America’s liability for Countrywide MBS failings is a huge issue for investors who want to recover their losses. In the bank’s proposed $8.5 billion breach-of-contract settlement with Countrywide investors, MBS trustee Bank of New York Mellon obtained an expert opinion that Countrywide has less than $5 billion in assets. That’s obviously a lot less money than MBS investors want to wring from BofA (and, for that matter, a lot less than the $15 billion the bank has taken in reserves for MBS liability). But Pfaelzer’s continued resistance to successor liability for BofA, especially given the considerable effort Quinn Emanuel put into the Allstate amended complaint, doesn’t bode well for investors. You can bet that lawyers for Countrywide and Bank of America will use the successor-liability issue as leverage in settlement talks.

I should note that Manhattan State Supreme Court Justice Eileen Bransten, who’s overseeing monoline litigation against Countrywide and BofA, has come down differently than Pfaelzer in a preliminary ruling on successor liability. MBIA and its lawyers at Quinn Emanuel are right now engaged in discovery on BofA’s Countrywide deal, including depositions of the executives who structured the acquisition. Evidence they obtain in that case could eventually impact successor liability rulings in other courts.

Bank of America is represented by O’Melveny & Myers in the Allstate case. Countrywide is represented by Goodwin Procter. A BofA spokesman said the bank is “pleased with Judge Pfaelzer’s ruling.”

Allstate counsel Daniel Brockett of Quinn Emanuel told me his client is considering its options for appeal. “We’re disappointed in the ruling,” he said. “We think Judge Pfaelzer imposed a pleading standard that is impossible to meet without discovery.” He also emphasized that the judge’s successor-liability ruling doesn’t go to the merits of Allstate’s MBS claim against Countrywide. Pfaelzer has already refused to dismiss Allstate’s fraud claim, which is proceeding to discovery, Brockett said.

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Tuesday’s parallel rulings by Manhattan State Supreme Justice Eileen Bransten in MBIA and Syncora suits against Countrywide were a big win for the bond insurers. The judge concluded that MBIA and Syncora need only show that Countrywide materially misled them at the time they agreed to write insurance on Countrywide mortgage-backed notes, not that the alleged misrepresentations led directly to MBS defaults and subsequent insurance payouts. Bransten is considered a leading judge on MBS issues, so her grant of summary judgment on the insurance fraud and contract issues should be a boon to all of the monolines engaged in do-or-die litigation with MBS issuers.

But for MBS investors hoping Bransten would set a low bar for claims that Countrywide breached mortgage-backed securitization agreements, the rulings have to be considered a disappointment. Both Syncora’s lawyers at Debevoise & Plimpton and MBIA’s counsel at Quinn Emanuel Urquhart & Sullivan had moved for summary judgment on a baseline question: could they demand that Countrywide repurchase any underlying mortgage loan that materially breached the MBS issuer’s representations and warranties in securitization agreements?

If Bransten had agreed with the Syncora and MBIA interpretations of the agreements’ put-back clauses, the bond insurers would have had to show only that an underlying loan was deficient, not that the alleged deficiency contributed to the mortgage’s default — or, for that matter, that the underlying loan even was in default. The insurers wanted the judge to rule that as a matter of contract, Countrywide was required to repurchase every flawed mortgage in underlying pools.

Had Bransten adopted that reading of the contracts, she could have swung untold billions in MBS liability from investors to issuers. As you surely recall, the embattled BofA $8.5 billion settlement with Countrywide MBS investors was the result of put-back claims of an institutional investor group led by Black Rock and Pimco and represented by Gibbs & Bruns. The same investors have since asserted put-back claims against Morgan Stanley (based on notes with a face value of $6 billion) and JPMorgan Chase (based on $95 billion in MBS). Other investors, publicly and anonymously, have called upon MBS trustees to act on their put-back claims; most recently, U.S. Bank, as trustee in some Bear Stearns MBS trusts, filed a $95 million summons against JPMorgan Chase in New York state court. A ruling from a leading judge that set a low bar for put-backs would have given the investors asserting reps and warranties claims huge leverage over MBS issuers.

But Bransten denied the MBIA and Syncora summary judgment motions on Countrywide’s put-back liability. Specifically, she found that the securitization contracts were ambiguous on several points so the bond insurers’ contract-related claims couldn’t be decided on summary judgment. That doesn’t necessarily mean that after considering the two sides’ interpretations of the contract, as well as industry practice, an ultimate fact-finder won’t agree with Syncora and MBIA on put-backs; Bransten said, in fact, that MBIA had “posited a strong argument” for its view of one securitization contract. Moreover, MBIA and Syncora have alternate routes to the same recovery they’re claiming from alleged reps and warranties breaches.

Nevertheless, the implication of Bransten’s rulings is that put-backs will remain a loan-by-loan slugfest, at least until another judge considers the issue. That’s good news for BofA — which has signaled in regulatory filings that an adverse ruling on put-back loss causation would significantly change its reported liability — and for other MBS issuers as well. Bank disclosure of put-back liability has become a heated topic, and several banks beefed up disclosures in third-quarter 2011 filings. But MBS issuers escaped calamity thanks to Bransten’s refusal to endorse the bond insurers’ liberal reading of securitization agreements.

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There’s a cautionary note to MBIA deep in Manhattan State Supreme Court Justice Eileen Bransten‘s long-awaited, 27-page loss-causation decision in MBIA’s mortgage-backed securities case against Countrywide. The bond insurer, Bransten warned, must prove that it was damaged as a “direct result” of Countrywide’s allegedly material misrepresentations about the MBS certificates MBIA agreed to insure. “As has been aptly pointed out by Countrywide, this will not be an easy task,” the judge wrote.

But unless I am seriously misreading Bransten’s ruling (and her companion decision in Syncora’s case) it’s going to be a lot easier for the bond insurers to recover against Countrywide as a result of the judge’s reasoning. Yes, MBIA and Syncora have to prove they were duped into writing insurance policies on Countrywide mortage-backed securities. The monolines have never asserted that they don’t have to show Countrywide made material misrepresentations at the time they agreed to issue insurance. They believe they’ve got plenty of evidence — from the MBS pooling and servicing agreements, from the loan tapes they were permitted to see, and from the shadow credit ratings conferred on the MBS notes — that Countrywide misled insurers about the quality of the mortgages in the underlying loan pools.

Instead, the key question before Bransten was whether the insurers would also have to show that Countrywide’s alleged misrepresentations were the direct cause of the MBS failures for which insurers had to pay out policy claims. And on this issue, the judge sided squarely with the monolines. “No basis in law exists to mandate that MBIA establish a direct causal link,” she concluded.

Her rulings will permit the bond insurers to argue both that Countrywide committed fraud in inducing them to write policies and that Countrywide breached its insurance agreements with Syncora and MBIA. To establish fraud, MBIA and Syncora will have to show that they relied on Countrywide’s alleged misrepresentations when they agreed to write the specific policies at issue in the litigation. To prove a breach of the insurance agreements, they need only prove that Countrywide materially misrepresented the risk profile of the underlying mortgage pools. There are, in other words, a lot of routes to recovery for Syncora and MBIA — and given that Bransten is the leading jurist in the monoline MBS litigation, for other bond insurers as well, assuming other New York state-court judges adopt her thinking.

MBIA and Syncora even still have a possibility of recovery on their alternate put-back theory, although Bransten denied them summary judgment on put-backs in Tuesday’s rulings. The bond insurers had argued that Countrywide breached MBS pooling and servicing agreements when it allegedly misrepresented the quality of the underlying loan pools so it’s liable, under those contracts, to put back any deficient mortgages — the same put-back claims some MBS investors have made against issuers. The judge denied summary judgment because she found that the Countrywide pooling and servicing contract language is ambiguous. That’s a boon to Countrywide’s parent, Bank of America, and to other MBS issuers facing put-back claims. (More on that tomorrow.) But for the bond insurers, the put-back contract claims — which are still alive, even though Bransten denied summary judgment — were always an alternative route to the damages they also sought under their insurance-law claims.

And under Bransten’s rulings, even if the bond insurers end up with nothing on their put-back claims, they can still recover everything they’ve paid out on Countrywide MBS claims. That’s because the judge adopted the monolines’ theory of “rescissory damages,” finding that if MBIA and Syncora prove their cases, they’re entitled to be made whole by Countrywide, as if they’d never written insurance on Countrywide MBS. Again, if Bransten’s reasoning on rescissory damages guides other New York State judges, Ambac and Assured Guaranty also have reason to cheer her rulings.

For the record (as if you didn’t know), MBIA is represented by Quinn Emanuel Urquhart & Sullivan; Syncora by Debevoise & Plimpton; and Countrywide by Goodwin Procter.

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The folks who follow every development in the mega-billions poker match between Bank of America and the bond insurer MBIA have last week been buzzing even more loudly than usual about the prospect of a global deal. Tuesday’s settlement between MBIA and Morgan Stanley leaves BofA as the most important remaining member of the dwindling bank group challenging MBIA’s 2009 restructuring. There’s a de facto deadline of Dec. 30 for settlements in that case, since that’s the day New York’s top financial regulator, Benjamin Lawsky of the Department of Financial Services, has to file a key response to the banks’ allegations. Both Lawsky and MBIA execs have been very clear: they want resolution. So the pressure is on BofA to make a deal.

Moreover, MBIA really needs a global settlement with BofA, in which the bank not only drops out of the restructuring case but also ponies up to resolve the bond insurer’s mortgage-backed securities claims. MBIA filed an 8K with the Securities and Exchange Commission Thursday, disclosing the good news that its commutation deals have wiped out $20 billion in exposure, including more than $10 billion its has eliminated just in the fourth quarter of 2011. The bad news in the filing, however, is that MBIA’s payments to banks have exceeded its statutory loss reserves by $500 million, and the insurer may not have enough liquidity to reach more settlements. Remember, MBIA has already booked a $2.8 billion anticipated recovery on MBS put-back claims. Clearly, the bond insurer is counting on getting some big money from BofA on the MBS side.

The wild card in this poker game is loss causation and MBS liability for BofA (and other issuers). You’ll recall that in early October, New York State Supreme Court Justice Eileen Bransten heard arguments on a summary judgment motion by MBIA in its case against Countrywide. MBIA asked the judge to rule on the issue that will determine the magnitude of bank exposure to MBS claims by bond insurers: are the banks liable for misrepresenting the underwriting on loans in underlying mortgage pools starting from the day they signed deals with monoline insurers? Or can the banks cite the economic crisis — and not their own deficient underwriting — as the reason so many mortgage loans have gone bad? Bransten’s reasoning on loss causation could swing billions, or even tens of billions, of dollars of liability between the banks and the monolines.

Banks, bond insurers, and MBS investors have been waiting anxiously for the judge’s loss causation ruling since that October hearing. But Friday is Bransten’s last day in chambers before she leaves for a vacation that will keep her out of court until after New Year’s. So with BofA and MBIA looking at a December 30 deadline for settlement in the restructuring case, is there a chance that a global deal will moot Bransten’s loss causation ruling in the MBS case?

Never fear, MBS players. Even if MBIA and BofA settle, Bransten still has to rule, thanks to Syncora. MBIA’s case against Countrywide gets all the ink, but the much-smaller bond insurer Syncora also has an MBS case against Countrywide — and has also moved for summary judgment on the loss causation issue. Syncora counsel Donald Hawthorne of Debevoise & Plimpton argued for an expansive interpretation of bank liability at the October hearing before Bransten, alongside MBIA counsel Philippe Selendy of Quinn Emanuel Urquhart & Sullivan.

Unless BofA also reaches a deal with Syncora, come January it and other MBS issuers are going to have to face the consequences of a crucial ruling from a judge who has so far sided against the bank at just about every turn.

A BofA spokesman declined comment.

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My colleague Karen Freifeld was in Manhattan State Supreme Court Thursday when Bank of America counsel Theodore Mirvis of Wachtell, Lipton, Rosen & Katz stood up to argue for the dismissal of Walnut Place’s suit demanding millions of dollars in put-backs in two Countrywide mortgage-backed securities trusts. Everyone who follows MBS litigation knows that Walnut, represented by Grais & Ellsworth, is the leading objector to BofA’s embattled $8.5 billion settlement with Countrywide MBS investors. But Freifeld was the first journalist to pick up Mirvis’s big disclosure: Walnut Place, he told Justice Barbara Kapnick, is actually the distressed debt hedge fund Baupost.

Late Friday, Baupost informed its partners (as the fund calls clients) that it is indeed Walnut Place. But according to a source who disclosed the memo’s content to Reuters, the hedge fund said it is litigating to protect its clients’ investment — and not, as a blog suggested Thursday night, because it has shorted Bank of America stock.

“From time to time and for a variety of reasons [Baupost] forms legal entities to consolidate investments. Walnut Place is such an example,” the Baupost memo said. “It holds certain of our residential mortgage-backed securities investments. Walnut Place has initiated legal actions against the originator of the loans underlying those securities because we believe there have been egregious deficiencies in the underwriting of mortgages. That litigation is intended to protect the interests of our investors and is ongoing.”

The hedge-fund blog Zero Hedge speculated Thursday night that Baupost, as Walnut Place, may be fighting the proposed BofA MBS settlement because it has shorted Bank of America stock and taken a long position on MBIA, which is also engaged in do-or-die MBS litigation with BofA. The Baupost client memo — without naming the Zero Hedge blog — firmly rejected that assertion as “unfounded and completely false.”

“We have on occasion owned a small amount of default protection on Bank of America debt as part of our overall portfolio hedging strategy through which we hold credit default swaps on a diverse group of financial institutions and other corporate issuers,” the memo said. “We currently have no long or short position in equity, corporate debt, or credit default swaps of Bank of America or MBIA.”

The back story on Baupost and Walnut Place certainly supports Baupost’s position that it wasn’t using Walnut as a vehicle to hide its investment in Countrywide mortgage-backed notes. BofA counsel Mirvis called Baupost a vulture fund in court Thursday, but the fund and its president, Seth Klarman, are renowned investors. In a profile of Klarman last June, Absolute Return + Alpha reported that Baupost has profited mightily in the economic downturn, expanding from about $7 billion under management in 2007 to more than $21 billion in 2010. (It’s now $23 billion.) Last month, Klarman got the Charlie Rose treatment in a 40-minute interview about his charitable foundation, Facing History and Ourselves, and investing strategy. (The distressed-debt blogosphere scrutinized the interview for pearls of investment wisdom, as Business Insider noted.)

Baupost contacted Bank of New York Mellon (the Countrywide MBS trustee) under its own name back in August 2010, as BofA revealed in a May 2011 motion to dismiss the Walnut Place put-back suit. In a pair of letters from the hedge fund’s lawyers at Grais & Ellsworth and Hanify & King, Baupost demanded that BNY Mellon assert put-back claims against Countrywide for deficient mortgages in two MBS trusts in which the fund was a noteholder.

Interestingly, the Baupost letters landed at BNY Mellon at about the same time that major institutional investors represented by Gibbs & Bruns distanced themselves from a plan by Countrywide MBS noteholders working through Talcott Franklin’s Investors Clearinghouse to send a demand letter to the Countrywide MBS trustee. I haven’t seen any evidence that Baupost was active in the Clearinghouse, but the hedge fund’s counsel, David Grais, certainly was.

According to the BofA motion to dismiss the Walnut case, BNY Mellon next heard from Baupost in December 2010 — but in the December letter, Grais & Ellsworth wrote on behalf of Walnut Place, which said it had been assigned the hedge fund’s interests in one of the Countrywide MBS trusts. In January, BNY Mellon received a second Walnut Place letter asserting Baupost’s interest in another trust. BofA later confirmed that various Walnut Place entities were incorporated in Delaware in December, just before Grais & Ellsworth sent the first Walnut letter to BNY Mellon. The bank’s lawyers subsequently called Walnut a “made-for-litigation” fiction; Baupost’s memo to client Friday, however, made it seem as though the hedge fund frequently aggregates investments for administrative reasons, which was its stated reason for creating Walnut.

As BofA and BNY Mellon engaged in negotiations with the Gibbs & Bruns investor group last fall and winter, Walnut Place counsel Grais rejected BNY Mellon’s overtures to talk. (The two sides vehemently disagree on the terms of the trustee’s invitation.) Walnut filed its put-back suit in February and has since fought to preserve its rights to litigate its own case, rather than see its claims subsumed in the $8.5 billion settlement BofA proposed in June.

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