MBS Discovery Battles Heating Up, Impacting Litigation Timelines and Leverage

If litigation is war, then discovery is the hand-to-hand combat that takes place in the trenches, costing plenty and potentially having a major impact on the outcome of the war in the aggregate.  With most of the major MBS litigation still slogging through some phase of the discovery process, I thought I would highlight two cases in particular where the outcome of discovery battles could have major implications.

One case, the proposed Bank of New York settlement in New York Supreme Court, is in the very earliest stages of this trench warfare, as the parties are debating the scope and timing of discovery.  Another case, MBIA v. Countrywide, is at the tail end of the process, but the plaintiff is finding that important battles still remain.  Let’s take a look at each these in turn and explore how discovery – the process by which parties request and produce evidence to one another during litigation – could provide additional negotiating leverage and drive ultimate recoveries.

MBIA v. Countrywide

The case of MBIA v. Countrywide is already fairly far along in the discovery process.  Actually, fact discovery officially closed in that case in August 2011.  Nevertheless, there have been a whole host of issues surrounding discovery since that time, stemming primarily from the number and scope of depositions that MBIA has sought to take of current and former Countrywide and BofA employees.

These issues came to a head earlier this month, when MBIA sent and filed a letter to Judge Eileen Bransten, in which the monoline insurer accused Countrywide and Bank of America of an ongoing effort to “sabotage the discovery schedule” as part of “an indefensible pattern of delay and discovery abuses.”  The March 8 letter accused the defendants of failing to produce, or even reveal the existence of, several categories of documents concerning fraud in loan originations, and then revealing certain documents the defendants believed to be favorable on the eve of, or during, depositions.  Based on these allegations, the letter sought leave of court to file a motion seeking sanctions for discovery abuses.

Though MBIA criticized BofA in its letter for its delay tactics and for improperly withholding hundreds of thousands of documents as “privileged,” it reserved its most scathing language for Countrywide, which it accused of a “willful and contumacious disregard of its discovery obligations and of the Court’s scheduling orders and other discovery directives.”  This language appears to have been chosen to create a record that might justify discovery sanctions down the road.  A few of the categories of the abuses alleged by MBIA are worth noting:

  • Delaying and withholding documents related to the depositions of whistleblowers such as Eileen Foster (see part 1 of great series by Michael Hudson on Foster here), then “cherry picking” favorable documents in preparation for the depositions and producing them just prior to or during depos;
  • Harassing and bullying whisteblowers during depositions;
  • Failing to disclose an entire database of documents concerning allegations of fraud at Countrywide (the so-called “FACTS” database) until its existence came to light during depositions; and
  • Failing to disclose the existence of an internal Countrywide “Fraud Hotline” until it came out during depositions.

This letter eventually led to a full-blown and fully-briefed motion to compel, which is currently pending before Judge Bransten.  In its most recent brief on this motion, MBIA accuses Countrywide of, time and time again, taking a “catch me if you can” approach to discovery:

Countrywide has concealed the existence of the most damning evidence, and forced MBIA to waste its time and money sorting through a 12 million page haystack, only to discover that the proverbial needle was intentionally omitted. (Reply Brief at 1)

According to Countrywide/BofA, this is just a push for “air time” as many of the issues identified in the letter have now been resolved.  MBIA, on the other hand, states in its Reply Memorandum that it still seeks documents relating to the whistleblowers, the Fraud Hotline, Countrywide’s alleged “fraud cover-up,” and other internal fraud investigations, even if they don’t deal specifically with the loans in the securitizations at issue in the lawsuit.

Many of the requests identified by MBIA appear reasonable, and given Judge Bransten’s growing impatience with the speed of discovery (she’s already granted other MBIA motions to compel and castigated Countrywide for heel dragging in discovery), it’s likely that the defendants will be compelled to produce additional documents relating to loan origination fraud and their knowledge thereof.  Such documents would provide MBIA with significant litigation leverage, as they would support MBIA’s own claims of fraud, which carry the threat of punitive damages.

Even more significant from a leverage standpoint, once these documents are produced and cited as evidence in summary judgment or at trial, other existing or potential litigants could use them against Countrywide/BofA to prove their own claims of fraud.  Already, the mere fact that the existence of the FACTS database and an internal Fraud Hotline at Countrywide have been disclosed will provide litigants with a road map to obtaining those documents through their own discovery processes.  Should the contents of those databases prove dangerous enough, they may force BofA to settle the case rather than opening the lid on Pandora’s box any further.

The BNYM-BofA Settlement Over Countrywide Put-Backs

As previously reported, the proposed $8.5 billion settlement by Bank of New York Mellon (BNYM) over Countrywide loan repurchase claims has now been remanded back to state court.  The first order of business before Judge Barbara Kapnick in New York Supreme Court will be to determine whether the action should proceed under Article 77, as proposed, or proceed under some other form, such as a plenary action.  This, in turn, will bear directly on the scope of discovery and the timeline for potential approval of the settlement.

Though no pleadings have officially been filed in this case since it was remanded, the parties have filed a series of letters that demonstrate just how critical this issue will be to the outcome of this case.  On March 12, 2012, attorney Matthew Ingber, on behalf of BNYM as Trustee, filed a letter asking the court for a ruling on two issues: 1) that the single issue in the proceeding was whether the settlement was within the scope of BNYM’s reasonable discretion and 2) that the scope of discovery be limited to that one issue.  (Ingber March 12 Letter at 1)  Under Ingber’s proposed schedule, a final hearing on the settlement would take place a mere 120 days after the completion of fact discovery. (Ingber March 12 Letter at 7)

On March 16, 2012, attorney Daniel Reilly, on behalf of the Steering Committee formed to organize the more than 125 intervenors in the action, wrote to Judge Kapnick in response. Noting that “transparency is particularly important here since no lawsuit was ever filed on the claims BNYM seeks to settle,” Reilly asked the court to first rule that Article 77 was not an appropriate format for the action, prior to ruling on the scope of discovery.  (Reilly March 16 Letter at 1-2)  With respect to the scope of discovery, Reilly pointed out that the Trustee’s request for a ruling on the “sole issue” in the case of abuse of discretion “flatly contradict[ed] BNYM own Proposed Final Order and Judgement,” which requested an Order:

  1. Approving the terms of the settlement;
  2. Stating that the settlement “is the result of factual and legal investigation by the Trustee”;
  3. Stating that BNYM “appropriately evaluated the terms, benefits and consequences of the Settlement and the strengths and weakness of the claims”;
  4. Stating that the negotiation of the settlement was “arm’s length”;
  5. Stating that BNYM acted in good faith;
  6. Enjoining all certificateholders from bringing an action against Bank of America and/or Countrywide for the settled claims; and
  7. Enjoining all certificatehalders from bringing an action against BNYM for its settlement-related conduct. (Reilly March 16 Letter at 2)

Reilly went on to discuss several categories of documents that would have to be included in discovery if the court were to rule on all of the issues listed above.  Included in these categories were settlement communications and loan files.

That same day, the Attorneys General from Delaware and New York, who have also sought to intervene in the case but who are not represented by the Steering Committee, filed their own letter, adopting the arguments made by Reilly.  On March 19, Judge Kapnick held a telephonic conference with the parties, in which she asked them to meet and confer regarding a briefing schedule.  One day later, the parties responded that they had agreed to the following schedule:

  • April 3: Orders to show cause filed
  • April 13: Response briefs due
  • April 19: Reply briefs due
  • April 24: Hearing on orders to show cause

Debtwire (subscription only) has since reported that Judge Kapnick will rule on April 24 whether the case will proceed under Article 77.  The publication also quoted a source as saying that Kapnick “seemed much more critical of the settlement” than she had during initial hearings.

So, what does all this mean for the case?  As I’ve discussed in the past, this settlement was only attractive to BofA because it promised to be a quick process with a favorable standard of review, limited discovery, and and end result that bound all participants.  If the case instead proceeds as a plenary action, such as a class action, or an action to adjudicate substantive claims against BNYM or BofA, it will no longer be quick, favorable, or limited, and may not bind all bondholders (for example, bondholders may be able to “opt-out” of the settlement if it proceeds as a class action).  This may torpedo the deal, causing BNYM or BofA to pull out.

While speed is certainly a major factor, I would argue that scope of discovery is even more important to the parties pushing for the settlement.  They would prefer the limited review of whether the Trustee acted in good faith during the settlement process, and to avoid getting into the details of how the trusts were formed, whether the parties met their obligations during that process and after the trust closed, and whether conflicts of interest led the Trustee to put its own interests ahead of the bondholders it was supposed to protect.  As I’ve discussed in the past, New York Attorney General Eric Schneiderman wants to blow the cover off of every aspect of mortgage securitization in the context of this action (including improper mortgage transfers, misrepresentations in the sale of securities and loan origination fraud), which would open the door to a flood of civil and regulatory actions (none of which were released under the recent Attorney General Foreclosure Settlement).

Thus, while BNYM-BofA dodged a bulled with the Second Circuit’s remand of the settlement action to state court, they could again face a critical threat should Judge Kapnick decide to disregard Article 77 and broaden the scope of discovery.  Given the multifaceted Final Judgment sought by BNYM, even proceeding under Article 77 may require the Judge to dig deeper than making a surface-level good faith determination.

BofA, through BNYM, will certainly fight hard up front to keep the action constrained and avoid having to engage in such a long slog.  However, should BNYM lose this early battle and should Judge Kapnick decide to try the case as a plenary action, it could result in investors dredging up damaging evidence in the trenches of discovery, driving the settlement price higher and causing significant litigation casualties for BofA (in this lawsuit and others).  BofA would likely beat a rapid retreat from this deal long before that was allowed to happen.

About igradman

I am an attorney, consultant, book editor, and one of the nation's leading experts on mortgage backed securities litigation. I am the author of The Subprime Shakeout mortgage litigation blog, a partner at Northern California law firm Perry Johnson, Anderson, Miller & Moskowitz, LLP, and the editor of the critically-acclaimed book, "Way Too Big to Fail: How Government and Private Industry Can Build a Fail-Safe Mortgage System," by Bill Frey. Follow me on Twitter @isaacgradman
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