Bank of America BofA in the United States

Bank of America, which bought Countrywide Financial Corp. in 2008, settled with large hedge funds, but some investors objected and succeeded in having it removed to federal court.

Countrywide Financial – Bank of America Merger and Home Loans

By Pamela A. MacLean. She is a freelance writer based in the Bay Area (California) and has reported on state and federal courts for more than 25 years.

Bank of America’s future hangs on two conflicting judicial determinations of successor liability for Countrywide’s bad mortgages.

Bank of America is still trying to shake off a financial hangover from its 2008 acquisition of Countrywide Financial for $4 billion in stock.

Soon after the takeover, BofA’s effort to strip the meat off Countrywide and toss the carcass of toxic securities onto investors sparked multiple lawsuits alleging fraud, breach of contract, and bad faith. The bank’s commitment eleven months later to assume nearly $17 billion in Countrywide debt and guarantees seems like chump change today.

At the time of the purchase, Countrywide – the nation’s largest residential lender – had originated $408 billion in mortgages and held a loan-servicing portfolio of $1.5 trillion. To date, Bank of America has reported spending about $40 billion on Countrywide since 2007, and costs continue to mount.

As the risks ratchet up, so have the bank’s efforts to shield itself from potential successor liability. Now BofA’s fate appears to rest in the hands of two judges – one a federal judge in California’s Central District, the other a state court justice in New York. So far, they have expressed opposing views of Bank of America’s responsibility for the mounting Countrywide tab.

In early 2009 U.S. District Judge Mariana R. Pfaelzer of Los Angeles rejected an investment fund’s claim that BofA is obligated to pay for any and all of Countrywide’s indiscretions. Relying on little legal analysis, Pfaelzer wrote, “Nothing properly before the court suggests that BofA has done more than expressly assume some liabilities in consideration of the acquisition. … Nor does anything properly before the court suggest that BofA has de facto merged with Countrywide.”

Judge Pfaelzer then dismissed the bank as defendant without determining whether the laws of California, Delaware, North Carolina, or New York should apply (Argent Classic Convertible Arbitrage Fund L.P. v. Countrywide Fin. Corp., 07-CV-7097 (C.D. Cal. order issued Mar. 19, 2009)).

Countrywide and Argent settled the California litigation in 2010. But by then BofA was facing a similar suit in New York brought by MBIA, the nation’s largest bond insurer and an investor in 15 Countrywide mortgage-backed securities pools. The bank’s lawyers brandished Pfaelzer’s ruling, hoping for a similar outcome. But State Supreme Court Justice Eileen Bransten rejected Pfaelzer’s approach and applied more plaintiff-friendly New York law instead. Bransten found support for MBIA’s allegations that BofA’s buyout of Countrywide amounted to a de facto merger, raising the prospect that the bank would be liable for repurchasing billions in bad mortgages (MBIA Ins. Corp. v. Countrywide Home Loans, 2009 WL 2135167 (N.Y. Sup. Ct. order issued Apr. 27, 2010)).

Back in California, Pfaelzer had a second chance to rule on the question of BofA’s liability when another institutional investor sued Countrywide in 2010. This time the judge applied Delaware law (based on Countrywide’s incorporation), again rejecting successor liability claims and dismissing Bank of America from the case (Maine State Ret. Sys. v. Countrywide Fin. Corp., No. 10-CV-302 (C.D. Cal. order issued Apr. 20, 2011).

BofA got even more good news in August 2011 when eight additional federal shareholder actions against Countrywide – lawsuits originally filed in Illinois, New York, Ohio, and Oklahoma – were consolidated in Pfaelzer’s court. In November she certified those cases as a class action, leaving Countrywide and a half-dozen of its former underwriters as defendants (In re Countrywide Fin. Corp. Mortgage-Backed Sec. Litig., 11-MDL-2265).

With summary judgment motions now looming – both before Pfaelzer in Los Angeles and before Bransten in New York – the financial stakes are immense. William Frey, CEO of Greenwich Financial Services and a plaintiff in another suit against Countrywide in New York, estimates that BofA could be liable for “north of $100 billion.”

At that magnitude, the liability would exceed Countrywide’s assets – and could drag BofA into a liquidity crisis that threatens its solvency. According to Isaac Gradman, a mortgage litigation expert who blogs at The Subprime Shakeout, the key question for the presiding judges is which state’s laws to apply. Delaware requires a showing of fraud to establish successor liability; both New York and California offer plaintiffs easier standards in cases that may involve a de facto merger.

Exaggerating only slightly, Gradman says that if the bank eventually is kept on the hook for Countrywide’s debts, “You can’t help but look at BofA’s takeover as the most egregiously horrible decision of all time.”

But establishing successor liability won’t be easy for the plaintiffs. Robert Daines, a Stanford Law School professor, says the two legal theories involved – corporate veil piercing and successor liability – are fact-intensive and “may turn on documents or testimony that would be produced at trial.” To succeed on either theory, according to Daines, the plaintiffs would probably need to show that BofA materially underpaid for the Countrywide assets.

In a memo he wrote for lawyers representing Bank of New York Mellon in separate BofA-related litigation, Daines listed four exceptions to the general rule that a buyer is not liable for the seller’s debts: if it agrees to assume liability, if it is a mere continuation of the selling company, if it engages in fraud, or if the asset sale is a de facto merger between the buyer and seller.

Delaware courts, Daines wrote, are loath to recognize de facto mergers “because it would create a great deal of uncertainty.” In New York, however, he cited language from a venerable federal case describing de facto mergers as a “judge-made device for avoiding patent injustice that might befall a party simply because a merger has been called something else.” (See In re Penn Central Securities Litigation, 367 F. Supp. 1158, 1170 (E.D. Pa. 1973).)

Daines concluded carefully: “Though I think the economic arguments and bulk of the case law favor [BofA], I cannot ignore the stream of case law in New York and elsewhere that is something of a wild card – the relatively wooden application of which could theoretically hold [BofA] liable.”

Surely BofA’s lawyers at New York’s Wachtell, Lipton, Rosen & Katz anticipated such claims when they structured the all-stock Countrywide acquisition in January 2008. But according to Thomas J. Hall, a specialist in financial institution lawsuits at New York’s Chadbourne & Parke, it can be difficult for buyers to prevent claims of successor liability and still acquire the assets they want. “[BofA] took many managers, personnel, and business operations [from Countrywide],” Hall says. “If they hadn’t done that, they would have gotten assets, but not all they wanted. That’s where merger starts to creep in.”

The class action before Judge Pfaelzer may turn on choice of law. “Our position has been that California law should apply,” says Julie Goldsmith Reiser, a partner at Cohen Milstein Sellers & Toll in Washington, D.C., and co-lead counsel for the Maine State plaintiffs. “Delaware law applies to each company’s shareholders when you’re talking about rights and responsibilities. [But] in our situation, we believe Countrywide committed a tort. It misrepresented its loans to investors – third parties who don’t control the transaction, vote on the transaction, or get compensated for the transaction. Our suggestion is the court should apply tort law.”

BofA’s spokeswoman Shirley Norton declined to comment on the successor liability issues, and company lawyers were not permitted to discuss the Maine State case. But in court filings Matthew Close, a partner in the Los Angeles office of O’Melveny & Myers, argued for BofA that Countrywide’s reincarnation as the bank’s subsidiary in 2008 “was not an asset transfer that could qualify as a de facto merger.”

Nor would Countrywide’s sale of assets to the bank satisfy the continuity-of-ownership requirement for successor liability, Close argued: Consideration for the asset transfer was not BofA stock but rather the bank’s assumption of Countrywide’s debts and guarantees, among other things. Close dismissed New York Justice Bransten’s decision in MBIA because the plaintiffs failed to allege that BofA’s acquisition of Countrywide was “engineered to harm [its] shareholders and creditors.”

Judge Pfaelzer’s earlier rulings notwithstanding, Reiser has another theory to support the plaintiffs’ de facto merger claim. BofA’s intent in acquiring Countrywide should be determined, she says, by looking at how the IRS treated the transaction. Reiser argues that merger documents indicate it was considered a tax-free “reorganization” under the Internal Revenue Code (28 U.S.C. § 368). That is exactly what the plaintiffs allege: Countrywide shareholders became BofA shareholders, Countrywide’s business continued, and BofA assumed its obligations. “If you’re going to take [over] a company … you can’t just shed its liabilities,” Reiser contends. “Otherwise, whenever a company gets into trouble it would sell to somebody else, who would continue to run it just to avoid tort liability.

“Countrywide could have gone into bankruptcy, but instead it sold itself to Bank of America,” she says. “Bank of America should stand behind the liabilities.”

Bank of America Settlement of mortgage-backed securities claims

by Thomas Brom (2011)

In October 2011, Iridian Asset Management devoted its Q3 client letter to the confluence of legal pressures on BofA to “put back,” or buy, bad securitized mortgages underwritten by its ill-starred acquisition, Countrywide Financial.

Put-backs, according to standard mortgage pooling and servicing agreements, are required if the underwriter breaches representations and warranties made to investors in residential mortgage-backed securities (RMBS). Iridian did the math on put-back requests pending with BofA: $47 billion in requests from a major investor group represented by Houston’s Gibbs & Brun, plus $165 billion from Fannie Mae, Freddie Mac, and private insurers.

Assuming that the bank would earn off-setting profits during several years of buy-backs, Iridian came up with an estimated total pretax loss of $113 billion.

“[I]t is very difficult for us to imagine an outcome where Bank of America does not suffer at least $50 billion in unanticipated pre-tax losses,” the analysts wrote. “We are playing for credit defaults and bankruptcies, for – if not a systemic risk – then at least a mortal threat to important actors within the system,” they concluded.
That 2010 letter – and others like it written by competing analysts – must have lit a fire under BofA’s lawyers.

According to pleadings in a New York proceeding to approve a proposed settlement, negotiations began in earnest last November between BofA, the trustee for Countrywide’s RMBS, and 22 institutional investors. Announced in June, the deal required BofA to pay beneficiaries in 530 trusts with estimated losses of $108 billion a total of $8.5 billion – or about 8 cents on the dollar.

The trustee – Bank of New York Mellon (BoNY) – sought court approval under Article 77 of the New York Civil Practice Law and Rules (N.Y. C.P.L.R. § 7701), a unilateral proceeding usually invoked in family trust matters (In re Bank of New York Mellon, No. 651786/2011 (N.Y. Sup. Ct. (N.Y. Cnty.) petition for instructions filed June 29, 2011). Under the New York law, interested parties could move to intervene or object, but they could not opt out of the settlement. Most important, under the procedural rules the trustee is required only to show that it acted reasonably and within its powers.

There was much more in the agreement’s fine print. The deal includes a permanent bar to further litigation by any trust investors against BofA or Countrywide Financial, and binds the bank, the trustee, and the 22 institutional investors in a three-way confidentiality agreement. In a side letter, BofA indemnified the trustee for any costs and liability it might incur for claims from other certificate holders. And the bank – ostensibly the liable party in this deal – agreed to pay $85 million in attorneys fees to the investors’ counsel, Gibbs & Brun.

Though the 22 named parties lack the requisite percentage of voting rights in more than half of the covered trusts – and have no voting rights at all in 28 of them – they are a formidable group that includes the New York Fed, Goldman Sachs, PIMCO, Blackrock Financial, the Federal Home Loan Bank of Atlanta, and a long list of major insurers. In a petition to intervene in support of the deal, they argued it was “fair, reasonable and in the clear interest of the Covered Trusts.” In July, BofA’s stock inched upward.

But the proposed deal may be too clever by half, sparking immediate petitions to intervene or object. “Investors must – and, in my opinion, will – challenge this settlement as not in the interests of the bondholders,” attorney Isaac Gradman posted on his blog, Subprime Shakeout. “A more reasonable settlement would be in the range of $25 to $50 billion.”

The Article 77 strategy to get the deal approved drew as much flak as the settlement terms. Georgetown Law Professor Adam J. Levitan wrote on Credit Slips that “BoNY has not established its authority to settle claims on behalf of the trust.” And in an academic paper, Levitan pointed out glaring conflicts of interest: two-thirds of BoNY’s mortgage-backed securities trusteeships are for Countrywide/Bank of America. “Because such a large portion of [BoNY] Mellon’s RMBS trustee business comes from one single depositor,” he wrote, [BoNY] Mellon will inevitably have to be deferential to that depositor.”

By the late August filing deadline, petitions to intervene or object had been filed by several groups of hedge funds, six regional Federal Home Loan Banks, union pension funds, AIG (which also sued BoNY alleging fraud), the Federal Deposit Insurance Corp., and the state attorneys general of New York and Delaware.

New York Attorney General Eric T. Schneiderman’s petition pulled no punches, invoking parens patriae on behalf of the state’s investors and adding counter-claims of his own against BoNY for breach of fiduciary duty, fraud, and aiding-and-abetting violations. According to the petition, “Countrywide and BofA face liability for persistent illegality in: (1) repeatedly breaching representations and warranties concerning loan quality; (2) repeatedly failing to provide complete mortgage files as it was required to do under the Governing Agreements, and (3) repeatedly acting pursuant to self-interest, rather than investors’ interest in servicing.”

“This is big,” posted Gradman, who is also principal at the RMBS consulting firm IMG Enterprises in Petaluma. “[T]he AG has blown the cover off of the issue of improper transfer of mortgage loans into RMBS trusts. This has truly been the third rail of RMBS problems, which few plaintiffs have dared touch, and yet the AG has now seized it with a vice grip.”

Attorneys representing BoNY bitterly opposed Schneiderman’s petition, asserting that he lacked standing and dismissing his fraud allegations as having “no bearing on the question of whether the Trustee acted reasonably and in good faith in entering into the Settlement.” The institutional investors also objected, saying Schneiderman’s petition “would deprive certificate holders of their right to an expedited resolution of this matter.”

Days later at a funeral for former New York governor Hugh Carey, the deputy director of the New York Fed – one of the 22 institutional investors supporting the settlement – personally urged Schneiderman to back off. “Schneiderman is finding out the rabbit hole is far deeper than he had realized,” Gradman says.

New York Supreme Court Judge Barbara R. Kapnick made a series of rulings on the various petitions and scheduled a hearing for November 17. But in late August David J. Grais of New York’s Grais & Ellsworth, representing intervenor Walnut Place LLC, removed the case to federal court under the Class Action Fairness Act, claiming it was a mass action. Attorneys for the trustee quickly sought remand, asserting that “Walnut timed the removal to give itself two bites at the apple on contested procedural matters.” Regardless of venue, however, arguments on standing and the scope of discovery will inevitably delay a ruling on the settlement for many months.

In an interview, Gradman says the proposed deal represents a bold move to quickly clean up BofA’s immense Countrywide RMBS liabilities. But he adds, “If BofA’s strategy was to settle all claims at once, it’s not going so well. Schneiderman has shown he’s willing to touch mortgage transfers – which is a nightmare that could undermine the entire system.”

In 2010 Iridian’s Q3 letter concluded, “The big banks have reserved billions of dollars for litigation expenses concerning put backs. … [W]e expect this all-out war between the biggest financial institutions in the world to be played out in the courts over a period of two to three years.”

Note: In March 2012, the Bank of America settlement with investors over losses in mortgage-backed bonds was sent back to state (New York) court. The U.S. Court of Appeals for the Second Circuit ruled that the Class Action Fairness Act of 2005 requires the remand to the New York state Supreme Court.

Countrywide Financial – Bank of America Acquisition which lead to the Countrywide Lending Settlement

Pamela A. MacLean

In March thousands of foreclosed mortgage holders began receiving relief checks for subprime loans originated by Calabasas-based Countrywide Financial Corp., acquired by Bank of America in July 2008. The money flows from an $8.68 billion settlement of the predatory lending class action brought against Countrywide by the attorneys general of seven states.

The settlement, brokered in October 2008 by California AG Jerry Brown and the office of the Illinois Attorney General, called for BofA to modify the loans of nearly 400,000 homeowners nationwide, suspend foreclosures for eligible borrowers, and eliminate certain fees. Borrowers who had been displaced due to foreclosure prior to the settlement were to receive direct payments for relocation. If all eligible California borrowers participate, their savings from loan modifications could total $3.5 billion (People v. Countrywide Fin. Corp., No. LC083076 (Los Angeles Super. Ct. judgment entered Oct. 20, 2008)).

When the settlement was signed it looked like a perfect deal – so good that 45 states and the District of Columbia eventually joined the agreement. “Tragically, California and the other states have had to step in because federal authorities shamelessly failed to even minimally regulate mortgage lending,” Brown said as he announced the deal.
The settlement wasn’t bad for BofA, either. Countrywide admitted no wrongdoing, and the AGs either dismissed pending lawsuits or dropped ongoing investigations.

But there was a problem: Nobody bothered to guarantee that investors in Countrywide’s mortgage-backed securities – sold to investors in a variety of trusts – would go along with the deal. Those investors owned 88 percent of Countrywide’s subprime mortgages.

Isaac M. Gradman, a securities litigator at Howard Rice Nemerovski Canady Falk & Rabkin in San Francisco, calls the failure to include investor cooperation in the pact “unsophisticated.” Says Gradman, “It’s easy to agree on a settlement when it involves other people’s money.” In an article he wrote, Gradman called the deal “one of the largest and potentially most ill-conceived legal settlements in history.”

Michael Aguirre, a principal in San Diego’s Aguirre, Morris & Severson, says, “Brown recognized the settlement would give him big, big press and he would not have to fight to the death in court.” In 2008 Aguirre – then city attorney of San Diego – sued Countrywide separately and included fraud allegations. But Aguirre lost a reelection bid later that year, and the new city attorney – working with Brown – dropped the suit.

Brown rejects criticism of the settlement. “By requiring lenders to evaluate consumers for modifications, our office has effectively required Countrywide to consult with investors and bondholders,” says Evan Westrup, a spokesman for Brown’s office.

But David J. Grais, name partner in New York’s Grais & Ellsworth who represents trust investors in a class action against Countrywide, contends that BofA neglected to seek approval from the buyers of its securitized mortgages. “I’ve never met an investor who was asked,” Grais says.

The loan modifications specified in the settlement had the effect of reducing cash flow to investors through lower principal and interest payments. According to Grais’s suit, this could depress the value of the plaintiffs’ certificates by billions (Greenwich Fin. Serv. Distressed Mortgage Fund 3, LLC v. Countrywide Fin. Corp., No. 650474/2008 (N.Y. Sup. Ct. (N.Y. County) complaint filed Dec. 1, 2008)).

The class action seeks a declaratory judgment that, under agreements governing Countrywide’s mortgage-backed trusts, BofA must repurchase every mortgage loan for which it cut the payments by at least the amount of the unpaid principal and accrued interest.

Grais stipulates in his pleadings that the plaintiffs have no beef with the settlement between the AGs and Countrywide, “nor do plaintiffs take any position about whether the cost of reducing payments on loans [other than those Countrywide sold to plaintiffs] may be passed to the trusts that purchased those loans.” He simply wants the court to declare that “Countrywide must fulfill this contractual obligation” and buy back certain modified loans from the trust.

Rick Simon, spokesman for Bank of America Home Loans, declined to comment on the litigation. “The settlement came just months after Bank of America acquired Countrywide,” he says. “The bank moved very quickly to come to a settlement, which has been a model for the federal government in announcing its affordable home program.”
At the end of 2008 Countrywide removed the class action to federal court, but the case was remanded to the Supreme Court of New York (Greenwich Fin. Serv. Distressed Mortgage Fund 3, LLC v. Countrywide Fin. Corp., 654 F. Supp. 2d 192 (S.D.N.Y. 2009)). The thrift appealed the remand and also moved to dismiss the suit in state court – and that’s when the case got really interesting.

Rather than wait for the courts to determine whether it had to buy back what may be $80 billion in toxic mortgages, BofA lobbied Congress to provide a safe harbor for lenders that agree to modify home loans or enter workouts with borrowers. In May 2009 President Obama signed the Helping Families Save Their Homes Act (P.L. 111-22).

In October 2009, Countrywide’s lawyers argued that the act rendered ineffective contract provisions that Countrywide must get investor approval to modify loans. Howard Rice’s Gradman says that if the defense argument succeeds, trust investors could challenge the safe harbor provision under the Fifth Amendment’s takings clause.
“Now the government doesn’t just have a dog in the fight,” he says. “For constitutional reasons and also because of the government’s interest in enforcing the sanctity of contracts, it’s got a very big dog in it.”

Meanwhile, the bank has other Countrywide-related litigation to worry about. At least three insurers that guaranteed Countrywide’s mortgage-backed securities have asked New York’s supreme court to hold BofA vicariously liable for its subsidiary’s shoddy loan practices. “There are a lot of investors lying awake at night wondering whether Bank of America is liable,” Grais says.

Even in states where claimants have begun to receive payments, the shine is now off the Countrywide settlement. “Modifying loans is taking longer than we expected, and we’re getting complaints from homeowners,” says Kristin Alexander, a spokeswoman for Washington’s attorney general. “But we’re still working with Bank of America.”

The bank has an uphill battle. A record number of U.S. homeowners – more than 900,000 of them – dropped into foreclosure between January and March 2010. Nearly a quarter of those were in California. In June, BofA announced that it would extend its three-year loan modification program through 2012.

Countrywide Financial Scandal Developments

In February 2012, the alleged fraud claims against Bank of America was dismissed. In details, the U.S. District Court Judge threw out an investor’s lawsuit that claimed Bank of America’s 2008 acquisition of home loan giant Countrywide Financial amounted to a fraud on creditors.

The federal judge dismissed with prejudice plaintiffs’ claim of successor liability and fraudulent conveyance, ruling that Bank of America is not liable for judgments made against Countrywide.

The Judge described plaintiff’s argument that the deal was structured to defraud “maddeningly circular.”

The dismissal could have an impact beyond the plaintiff Allstate Insurance Co. More than a dozen similar cases-a significant percentage of the Countrywide buyout litigation–are in Pfaelzer’s court, and other courts could cite her ruling.