With the recent decision by Judge Mariana Pfaelzer to dismiss BofA as a defendant in the case of Maine State Retirement System v. Countrywide Financial Corp., et al. (“Opinion,” link also provided at the end of this article), a difference of opinion has emerged among jurists over whether BofA should bear successor liability for the debts of its new lending subsidiary. Judge Eileen Bransten in New York state court held that bond insurer MBIA could proceed with claims against BofA as the successor-in-interest to Countrywide under the theory that the bank’s purchase of the subprime originator constituted a de facto merger. Judge Pfaelzer, on the other hand, has now ruled in California District Court that the plaintiff pension funds could not make such a claim, and has dismissed BofA from the lawsuit.
Two primary factors account for this difference of opinion. First and foremost is the fact that each judge applied a different state’s law to the question of whether the plaintiffs had sufficiently alleged that Bank of America’s purchase of Countrywide’s assets should be treated as a de facto merger. Judge Pfaelzer, turning to California choice of law principles under the federal Erie doctrine (as the forum state), applied Delaware law, which she found had historically used the doctrine of de facto merger “sparingly” and “only in very limited contexts” (Opinion at 6). Delaware courts have held that this exception to the general rule that the purchasing corporation does not assume the liabilities of the selling corporation in an asset sale generally requires a showing of intent to defraud, such as an allegation that the sale was designed to disadvantage creditors or shareholders.
Over the objections of the plaintiffs in Maine State Retirement, who asked the judge to apply California law, Pfaelzer held that there was an actual conflict between the law of the two states and that Delaware (the state in which Countrywide was incorporated) had a greater interest in seeing its law applied than California (the state in which Countrywide had its principal place of business). In particular, Pfaelzer found an actual conflict in that California law was much less restrictive than Delaware law in finding a de facto merger, the latter looking more to the substance of the transaction to see if it operated like a merger, notwithstanding its structure. The Judge then relied on the Restatement (Second) of Conflict of Laws–which is a well-respected but non-binding treatise on conflict of laws principles–in finding that Delaware, as the state of incorporation, had a greater interest in having its law applied to the determination of this issue. Certainly, this holding would have been stronger had Pfaelzer been able to cite to binding or persuasive case law to support her opinion.
By contrast, Judge Bransten applied New York law to the same question (opinion available here), which operates similarly to California law in looking more to the substance of the transaction than its form. Bransten did not conduct a choice of law analysis, as the issue was not raised by the parties in the course of arguing the motion to dismiss (transcript available here), and thus simply assumed that New York law applied. Of course, this did not stop BofA from challenging Bransten’s ruling on appeal, arguing that she should have applied Delaware law to the question of whether MBIA could state a claim for successor liability. Though this issue is still up on appeal, my take is that BofA is unlike to prevail on an issue it did not appear to raise or properly preserve before the lower court.
The second major factor that contributed to these divergent rulings is the level of detail included by the respective plaintiffs in their allegations regarding the transaction. The primary inquiry for New York courts in this regard is whether the acquirer absorbed and continued the prior operations of the acquired corporation or dissolved the company’s management and general business operations. In support of its allegations in this regard in MBIA, the plaintiff alleged facts showing that BofA retired the Countrywide brand, including its website; cited favorable New York case law holding that all-stock acquisitions, such as BofA’s acquisition of Countrywide, suggest that a de facto merger has occurred; and cited to BofA’s pursuit of a settlement of predatory lending suits with state Attorneys General immediately following its acquisition as evidence that BofA had taken over Countrywide’s business. All of these facts led Bransten to conclude that MBIA had alleged a de facto merger in which BofA intended to absorb and continue the operations of Countrywide.
In Maine State Retirement, the Judge Pfaelzer found that the plaintiffs had not made allegations sufficient to satisfy any of the de facto merger factors under Delaware law. Namely, the Judge found that the plaintiffs had failed to allege 1) that Countrywide did not receive valid consideration in the acquisition, 2) that the asset sale failed to comport with law, 3) that any creditors or stockholders were injured by way of the sale, or 4) that the sale was designed to disadvantage such creditors or stockholders (Opinion at 15). Whether the plaintiffs were unprepared for Judge Pfaelzer to apply Delaware law or simply felt that there was little chance of satisfying these factors should Delaware law apply (and, indeed, it would be hard to say that Countrywide shareholders received insufficient consideration for the sale, knowing what we know now), the fact remains that the plaintiffs’ allegations in Maine State Retirement lacked the particularity or the detail of those in MBIA. That being said, the Maine State plaintiffs had an uphill battle from the beginning, as Pfaelzer had already issued a conclusory ruling in a previous case, entitled Argent Classic Convertible Arbitrage Fund v. Countrywide, to the effect that BofA did not face successor liability for Countrywide because no bad faith had been alleged (the case eventually settled out of court).
All this does little to guide investors and other plaintiffs looking to hold BofA accountable for the fallout from Countrywide’s reckless lending spree leading up to the mortgage crisis. Certainly, it will mean we’re more likely to see lawsuits against Countrywide brought in New York than California going forward. But investors can’t be sure that there will be anything to fight for should they take Countrywide to court and secure a judgment. Though there are no concrete signs that Countrywide is currently unable to satisfy its debts, commentators have speculated that BofA is holding onto a potential trump card–the option of throwing Countrywide into bankruptcy down the road in an attempt to cut off its liability, should the unit reach that point. If nothing else, this recent decision provides yet another incentive for investors with valuable claims with respect to Countrywide mortgage backed securities and other derivatives to act quickly to enforce these claims. Each additional day that they wait could mean a smaller pot at the end of the rainbow.
[Update: BofA ultimately dropped its appeal of Judge Bransten's Order denying the bank's motion to dismiss on the issue of successor liability -- IMG]