As most know by now, the ridiculously low $8.5 billion putback settlement, which was supposed to have been closed by now, and which was the key driver in preventing Bank of America from trading far, far lower (and requiring much more capital), is the wildcard that would allow the bank to package tens if not hundreds of billions of claims against the bank in a "tidy (and very small) little package." The key factor allowing this settlement to be structured in its existing form, was that the lawsuit was filed in New York State Court, which allows for a little something known as Article 77, or a provision permitting "special proceeding related to express trust." The details are provided below, but in essence boil down to the following: the settlement in its current form can only be enacted if the lawsuit is conducted under New York State law. Well, minutes ago, David Grais, attorney for Walnut Place, which as we have repeatedly observed represents those interests who claim the $8.5 billion settlement is massively insufficient and are engaged in litigation seeking far greater recoveries, filed a request to transfer the lawsuit from State Court to Federal Court where everything basically begins a new. More than anything, this latest development may explain why Bank of America has been scrambling to raise tens of billions in the open market as an adverse court decision, one granting Grais' request, means the bank is suddenly open to unlimited downside capital risk. In the meantime, add major litigation headline risk to everything else that BAC has going for it...
Manal Mehta explains why this could be a gamechanger:
If this happens, basically renders the Article 77 irrelevant. Article 77 is a New York Statute. Bank of America wanted to use Article 77 to make the settlement binding upon all 530 trusts including those who objected to the settlement. Class action in Federal Court allows parties to opt out of the settlement.
And here is Reuters' Allison Frenkel explaining the nuances of Article 77:
There was a lot of chest thumping Wednesday by noteholders who don't like the proposed $8.5 billion settlement between Bank of America and investors in securities backed by Countrywide mortgages. Bill Frey of Greenwich Financial, a firm that structures asset-backed securities, told Tom Hals of Reuters that he had been "bombarded" with e-mails from angry Countrywide noteholders. He's urging them to rise up in opposition to the settlement proposal. "If investors were to open their mouths," Frey told Hals, "they can push for a better and fairer settlement, or they can get two cents on the dollar like they are getting."
Good luck with that.
The lawyers who structured the BofA settlement saw such protests coming from a mile away and armored the deal against them. Their most powerful defense? The New York state law they chose as a vehicle for judicial approval of the settlement: Article 77, which provides for a "special proceeding related to express trust."
It's a creative use of the law, to say the least. Article 77, which allows a trustee to seek a judicial endorsement of trust-related decisions, is usually invoked in garden-variety trust disputes, not $8.5 billion deals affecting hundreds of trust beneficiaries. But the Countrywide securitizations that the BofA settlement addresses were offered via 530 different trusts, making trust law a legitimate prism through which to assess the proposal. Moreover, there is precedent for using Article 77 to win court approval of decisions by trustees in commercial cases, according to a brief filed in conjunction with the BofA agreement, which cites a 1998 case called In re Application of IBJ Schroder Bank & Trust Co.
The lawyers who put together the BofA deal-- principally Kathy Patrick and Robert Madden of Gibbs & Bruns (for a large investor group); Ted Mirvis of Wachtell, Lipton, Rosen & Katz (for Bank of America); and Jason Kravitt and Matthew Ingber of Mayer Brown (for Bank of New York Mellon, the trustee in the securitizations)-weighed all kinds of options for obtaining judicial approval of the settlement. They considered state and federal courts in various jurisdictions, but ultimately came to a consensus that an Article 77 proceeding made the most sense, even though the law had never been applied to any trust matter of this scope and size "You could think of this as 530 trusts all being heard," said Madden of Gibbs & Bruns. "It's very pragmatic."
It's also weighted in favor of deal supporters. Here's the beauty of the Article 77 vehicle for BofA and BoNY: Under trust law, the bar for blocking a decision by the trustee is incredibly high. Anyone with an interest in the trust has a right to challenge the trustee's decision. But unless objectors can show that the trustee, in this case BoNY, abused its discretion, acted unreasonably, or otherwise breached its fiduciary duty to the trusts' beneficiaries, the court is not supposed to interfere with the trustee's power.
That's a tough standard to meet for anyone who doesn't like the proposed BofA deal. The trust contracts signed by investors in the Countrywide securitizations clearly state that the trustee, BoNY, has the power to enforce the terms of the trust. The contracts don't expressly give BoNY the power to settle claims-which may be an avenue of attack on the deal for challengers-but New York case law provides considerable precedent. So assuming the court agrees that the trustee has the power to settle on behalf of noteholders, the judge's only inquiry is whether the trustee acted unreasonably.
In their petition requesting approval of the deal, BoNY's lawyers from Mayer Brown lay out all of the precautionary measures the trustee took to assure a reasonable settlement. Among other steps, BoNY brought in five expert consultants to opine on the legal and practical considerations any trust-by-trust litigation against Bank of America would entail. The expert opinions led the trustee to a determination that the most noteholders could get by litigating against the bank was $8.8 to $11 billion--and that's without discounting for any of the defenses BofA could raise. "A settlement payout of $8.5 billion is viewed by the trustee as falling within a small variance of that pre-discounted settlement range," the petition says. Weighed against the uncertainty of years-long litigation, it's going to be very difficult to show that an $8.5 billion settlement-in which investors retain their notes, as well as potential securities law claims-is an unreasonable abuse of the trustee's discretion.
And the just released court filing.