Some rare good news for Bank of America: the Second Circuit just reversed the ruling of District Court Judge William Pauley in the highly-publicized $8.5 billion settlement between BofA, Bank of New York (BoNY), and Kathy Patrick’s institutional investors over mortgage putbacks; meaning the case will be sent back to state court to be tried as an Article 77 proceeding, rather than a class action. In doing so, the Court of Appeals held that the “securities exception” to the Class Action Fairness Act (CAFA) applied, because the case related solely to the rights and duties created by or pursuant to a security. This means BofA will have to weather only limited scrutiny of its proposed settlement and benefit from a much more deferential standard of review (“abuse of discretion” versus “entire fairness”)
In speaking to folks last week who attended the hearing before the Second Circuit on Feb. 15, it was clear that the three-judge panel was uncomfortable with the idea of this case remaining in federal court. Originally filed in state court under Article 77, the case had been removed by intervenor Walnut Place to federal court, as the aggrieved bondholder had argued that the case was more akin to a federal mass action and should be treated as such, including allowing dissatisfied bondholders to opt out. Judge Pauley in the Southern District of New York agreed, holding that this was the very type of case that Congress had directed be tried in federal court under CAFA.
However, rather than reversing Pauley on the threshold hurdles to CAFA jurisdiction, such as its requirements that the case be about monetary relief, have more than 100 plaintiffs, and involve common issues of law and fact; the Second Circuit relied solely on the securities exception to CAFA to support its decision. In this regard, it found that, having first characterized the Trustee’s claim as seeking a “declaration authorizing the exercise of a trustee’s powers,” the Trustee’s claim thus related solely to “the rights, duties (including fiduciary duties), and obligations relating to or created by or pursuant to any security. 28 U.S.C. § 1453(d)(3).” (Opinion at 23-24)
What’s novel about this finding is that prior Second Circuit holdings, such as Greenwich Financial v. Countrywide, indicated that the securities exception only applied to claims relating to the rights of Certificate holders as holders. The mere fact that a claim involved a security was not enough – it had to be a claim by the holder of the security to enforce the duties or rights created by or pursuant to the security. This latest decision extends that holding to trustees of a security acting as trustees – something that likely was not contemplated by Congress when passing CAFA, or even by the Second Circuit when issuing its prior holdings.
Regardless of the propriety of this decision, and barring a Hail Mary appeal to the Supreme Court by Walnut Place, it’s clear that this decision is a big win for Bank of America and other institutions with large exposure to legacy private label mortgage issuance. State court provides a much more favorable forum to the banks, as previously discussed, as it ensures that Article 77’s shortened procedures and deferential standard of review will be applied. New York Supreme Court Judge Barbara Kapnick will still have her hands full determining how to deal with the impressive slate of intervenors opposed to the settlement, including the New York Attorney General Schneiderman, when ruling on the scope and timing of discovery. But BoNY and BofA can rest assured that any decision approving the settlement will ultimately bind all bondholders in the affected trusts.
This ruling will also mean that other issuers will likely try to emulate the structure of this deal in reaching global settlements with friendly bondholder groups and trustees, in an effort to rid themselves of RMBS overhang. The challenge for bondholders wishing to avoid this result is to press as loudly and publicly as possible to be included in negotiations, so they can create a record of having been shut out of settlement talks. On the flip side, the challenge for other issuers will be to create a process that appears to solicit, or at least allow, other bondholder opinions on the deal, while still reaching a settlement dollar figure that is relatively low compared to what bondholders could recover through aggressive court proceedings.
Regardless, this challenge is small compared to the challenge that BofA would have faced if the case remained in federal court, so there is certainly cause for celebration in Charlotte today.
The full Second Circuit Opinion may be accessed here.