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In a ruling dated October 7, 2010, New York County Supreme Court Judge Barbara R. Kapnick tossed out Greenwich Financial’s lawsuit against Countrywide. The suit sought a declaratory judgment that Countrywide had to repurchase any loans that it modified pursuant to its settlement with state Attorneys General. The Order, available here, grants Countrywide’s Motion to Dismiss the Complaint–thereby disposing of the case entirely–because Greenwich failed to comply with the procedural preconditions to bringing suit.
In an article from the Wall St. Journal today, Greenwich attorney David Grais, of the law firm Grais & Ellsworth is quoted as saying that, “We are reviewing the opinion and considering whether to file an appeal.” However, given the facts as recounted in Judge Kapnick’s Order, it would seem that Greenwich has a steep hill to climb to succeed on any appeal.
In its Motion to Dismiss, Countrywide, the servicer in the challenged RMBS deals, relied on Section 10.08 of the Pooling and Servicing Agreement (“PSA”), a provision that sets forth the procedural preconditions for bondholders wishing to initiate suit. Included in these preconditions, which are standard in most PSAs, are the requirements that the bondholders to first approach the Trustee with proof of ownership of 25% of the voting rights in the Trust and proof of some Event of Default, make a written demand on the Trustee to institute an action in its own name to remedy such Default within 60 days, and provide the Trustee reasonable indemnity against costs and liabilities arising from any such suit. There is no argument from Greenwich that it failed to comply with these preconditions before bringing its action.
Instead, Greenwich argued in Opposition to the Motion to Dismiss that it was not required to comply with these preconditions for three reasons: 1) these preconditions apply only to actions that may unfairly benefit one class of bondholders over another, and Greenwich’s suit would benefit all bondholders equally; 2) the preconditions only apply where there is an Event of Default, defined as the failure of the servicer to perform certain identified acts, and not including the failure to repurchase a modified mortgage; and 3) that compliance with the preconditions is excused because such a demand would have been futile. In support of the third point, Plaintiff argued that, soon after instituting suit, it served on the Trustee a request that it join in the suit, which the Trustee refused. Countrywide countered that this request did not comply with the procedural preconditions of Section 10.08. Judge Kapnick rejected all of these arguments, essentially finding that the language of Section 10.08 applied broadly to all actions, and that Greenwich had failed to comply with any of these preconditions.
This result is surprising to me, given the experience of David Grais and Bill Frey, the principal of Greenwich Financial Services, in litigation surrounding RMBS deals (including Grais’ lawsuits on behalf of the Federal Home Loan Banks and Frey’s participation in the Syndicate of RMBS investors). These are sophisticated players familiar with the preconditions to suit found in nearly every PSA from this time period. It is also my understanding that Greenwich could have shown 25% ownership in at least some of the challenged deals, making it even more curious why they did not at least attempt to comply with Section 10.08 prior to filing suit. Of course, they were probably correct that such an attempt would have been futile, given that most investors have encountered general resistance from Trustees when they attempt to induce action on their behalf, but at least Greenwich would have then been able to make the argument that it attempted to comply but was rebuffed by the Trustee.
Perhaps there were other considerations at play that led Greenwich and Grais to file this suit prior to haggling with the Trustee and waiting the requisite 60 days to take action. Some readers will recall that this lawsuit was filed as a response to a broad settlement–to the tune of $8.4 billion dollars–by Countrywide with the Attorneys General of 15 states (dozens more signed on after the fact) regarding Countrywide’s predatory lending practices in those states. The settlement stipulated that Countrywide would remedy these practices by agreeing to modify over 400,000 loans to allow borrowers to stay in their homes.
There were only two glitches in this settlement, which was hailed by Jerry Brown as a great success story. First, Countrywide no longer owned upwards of 80% of these loans it was agreeing to modify. Because any modification imposes some kind of cost on the ultimate holder of the loan–by either reducing principal, reducing interest rates, or prolonging the repayment period–the bulk of the $8.4 billion in loan modifications would have been borne by the bondholders. Second, the bondholders have favorable provisions in the PSAs and in the Stipulated Settlement between Countrywide and the AGs requiring the servicer to buy back any loan it agrees to modify. Maybe the rush to the courts for a declaratory action was an effort to halt these modifications prior to their institution.
And perhaps this tactic was successful. Countrywide and other servicers have been largely reluctant to carry out extensive loan modifications (see interesting stories here, here and here), in part because as reported in the Wall St. Journal, they fear being forced to repurchase those loans. And the filing set the wheels of politics in motion, resulting in a full blown lobbying effort by BofA/Countrywide to encourage the passage of a Servicer Safe Harbor to shield servicers from liability for modifying mortgages. This lobbying effort had the reciprocal effect of inducing bondholders to band together to form their own lobbying group, which group became the precursor to the Investor Syndicate gearing up to take on servicers over a broader range of originating and servicing defaults.
Still, regardless of the political motives that may have encouraged a premature filing of suit by Greenwich, Judge Kapnick’s Order illustrates the difficulties facing all bondholders wishing to pursue claims against the servicers, originators or sponsors of their RMBS holdings for losses associated with their investments. Most PSAs require, first, proof of sufficient ownership–usually 25 to 50 percent–just to get the Trustees’ attention. Aggregating enough RMBS holdings to meet this requirement was the primary reason the Investor Syndicate has formed. Second, bondholders must make a demand that the Trustee institute suit in its own name. Often, the Trustee will seek unreasonable indemnity from bondholders and require the execution of onerous confidentiality agreements prior to doing so. Then, the bondholders have to sit on their hands and wait for the Trustee to decide not to institute an action before they can do so on their own.
Many investors appear unwilling to navigate the complexities or incur the expense of jumping through these procedural hurdles prior to taking action. Just last month, Bank of New York, one of the primary Trustees on 2005- to 2007-vintage RMBS deals, refused a demand to investigate by a group of investors, represented by Kathy Patrick of Houston law firm Gibbs & Bruns, because of a failure to comply with procedural preconditions. Sources indicate that this investor group failed to meet the peculiar obligation of the investigation provision under which it attempted to proceed, requiring 25% ownership in every class of securities, and that the group failed to identify particular Events of Default to trigger Bank of New York’s obligations. In short, as the dismissal of Greenwich’s suit against Countrywide and the rejection of Gibbs & Bruns’ efforts illustrate vividly, procedure cannot be ignored, and it would behoove investors to get their ducks in a row before taking expensive legal action.